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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



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FORM 10-Q

|    |  |                                                                                       
|--- |  | --------------------------------------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED June 30, 2002
OR

|      |  |                                                                                        
|----- |  | ---------------------------------------------------------------------------------------
|[   ] |  | TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THESECURITIES 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                                                       |  | 77-0328533                       
|(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION) |  | (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 [   ]

As of July 30, 2002, registrant had outstanding 72,776,546 shares of Common
Stock.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED 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                           
|PART II. OTHER INFORMATION   
|                              | ITEM 3. 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                   



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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This report on Form 10-Q contains forward-looking statements of Terayon
Communication Systems, Inc. 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. The 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 June 30, 2002 (unaudited) and
December 31, 2001                                  |  |      | 3 | 
|Condensed Consolidated Statements of Operations for the three months and
six months ended June 30, 2002 and 2001 (unaudited) |  |      | 4 | 
|Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2002 and 2001 (unaudited)                  |  |      | 5 | 
|Notes to Condensed Consolidated Financial Statements                                                                         |  |      | 6 | 





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

|                                               |                                              |                                               |                                            |           |          |          |         |              |          |         |  | 
|---------------------------------------------- | -------------------------------------------- | --------------------------------------------- | ------------------------------------------ | --------- | -------- | -------- | ------- | ------------ | -------- | ------- |  | 
|                                               |                                              |                                               |                                            |           |          | June 30, |         | December 31,
|                                               |                                              |                                               |                                            |           |          | 2002     |         | 2001        
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              | (unaudited)                                   |                                            |           |          |         
|ASSETS                                        
|Current assets:                                |                                              |                                               |                                            |           |          |          |         |             
|                                               | Cash and cash equivalents                    |                                               | $                                          | 76,525    |          |          | $       | 100,274      |         
|                                               | Short-term investments                       |                                               |                                            | 194,329   |          |          |         | 233,614      |         
|                                               | Accounts receivable, net                     |                                               |                                            | 27,062    |          |          |         | 48,386       |         
|                                               | Accounts receivable from related parties     |                                               |                                            | 301       |          |          |         | 4,006        |         
|                                               | Other current receivables                    |                                               |                                            | 9,782     |          |          |         | 7,476        |         
|                                               | Inventory                                    |                                               |                                            | 10,578    |          |          |         | 16,658       |         
|                                               | Other current assets                         |                                               |                                            | 11,925    |          |          |         | 13,462       |         
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              |                                               | Total current assets                       |           |          | 330,502  |         |              |          | 423,876 | 
|Property and equipment, net                    |                                              |                                               | 21,628                                     |           |          |          | 25,279  |             
|Intangibles and other assets, net              |                                              |                                               | 18,059                                     |           |          |          | 17,491  |             
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              |                                               | Total assets                               |           | $        | 370,189  |         |              | $        | 466,646 | 
|                                               |                                              |                                               |                                            |           |          |          |         |             
|LIABILITIES AND STOCKHOLDERS EQUITY          
|Current liabilities:                           |                                              |                                               |                                            |           |          |          |         |             
|                                               | Accounts payable                             |                                               | $                                          | 33,046    |          |          | $       | 42,821       |         
|                                               | Accrued payroll and related expenses         |                                               |                                            | 8,714     |          |          |         | 9,441        |         
|                                               | Deferred revenues                            |                                               |                                            | 2,853     |          |          |         | 4,169        |         
|                                               | Accrued warranty                             |                                               |                                            | 8,477     |          |          |         | 8,368        |         
|                                               | Accrued vendor cancellation charges          |                                               |                                            | 19,898    |          |          |         | 17,291       |         
|                                               | Accrued restructuring                        |                                               |                                            | 6,400     |          |          |         | 8,197        |         
|                                               | Other accrued liabilities                    |                                               |                                            | 9,781     |          |          |         | 14,015       |         
|                                               | Interest
payable on long-term debt           |                                               |                                            | 2,117     |          |          |         | 3,273        |         
|                                               | Current portion of capital lease obligations |                                               |                                            | 169       |          |          |         | 126          |         
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              |                                               | Total current liabilities                  |           |          | 91,455   |         |              |          | 107,701 | 
|Long-term obligations                          |                                              |                                               | 4,348                                      |           |          |          | 4,267   |             
|Long-term portion of capital lease obligations |                                              |                                               | 102                                        |           |          |          | 233     |             
|Convertible subordinated notes                 |                                              |                                               | 100,141                                    |           |          |          | 174,141 |             
|                                              
|Commitments and contingencies                  |                                              |                                               |                                            |           |          |          |         |             
|                                              
|Stockholders equity:                          |                                              |                                               |                                            |           |          |          |         |             
|                                               | Common stock                                 |                                               |                                            | 73        |          |          |         | 73           |         
|                                               | Additional paid in capital                   |                                               |                                            | 1,077,549 |          |          |         | 1,074,203    |         
|                                               |                                              | Accumulated deficit                           |                                            |           | (900,769 | )        |         |              | (892,994 | )      
|                                               |                                              | Deferred compensation                         |                                            |           | (130     | )        |         |              | (458     | )      
|                                               |                                              | Treasury stock, at cost                       |                                            |           | (773     | )        |         |              | (768     | )      
|                                               |                                              | Accumulated other comprehensive (loss) income |                                            |           | (1,807   | )        |         |              | 248      |        
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              |                                               | Total stockholders equity                 |           |          | 174,143  |         |              |          | 180,304 | 
|                                               |                                              |                                               |                                            |           |          |          |         |             
|                                               |                                              |                                               | Total liabilities and stockholders equity |           | $        | 370,189  |         |              | $        | 466,646 | 
|                                               |                                              |                                               |                                            |           |          |          |         |             

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 |        | Six Months Ended
|                                                              |                                          |  | June 30,           |        | June 30,        
|                                                              |                                          |  |                    |        |                 
|                                                              |                                          |  | 2002               |        | 2001             |  | 2002     |         | 2001
|                                                              |                                          |  |                    |        |                  |  |          |         |     
|Revenues:                                                     |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Product revenues                         |  | $                  | 22,193 |                  |  | $        | 40,119  |      |  | $       | 73,802  |   |  | $         | 84,008   |  
|                                                              | Related party product revenues           |  |                    | 214    |                  |  |          | 25,614  |      |  |         | 5,823   |   |  |           | 35,709   |  
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Total revenues                           |  |                    | 22,407 |                  |  |          | 65,733  |      |  |         | 79,625  |   |  |           | 119,717  |  
|Cost of goods sold:                                           |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Cost of product revenues                 |  |                    | 22,417 |                  |  |          | 35,889  |      |  |         | 60,451  |   |  |           | 84,803   |  
|                                                              | Cost of related party product revenues   |  |                    | 17     |                  |  |          | 16,871  |      |  |         | 5,153   |   |  |           | 22,810   |  
|                                                              | Special charges                          |  |                    |       |                  |  |          | 28,704  |      |  |         | (11,443 | ) |  |           | 28,704   |  
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Total cost of goods sold                 |  |                    | 22,434 |                  |  |          | 81,464  |      |  |         | 54,161  |   |  |           | 136,317  |  
|Gross profit (loss)                                           |                                          |  | (27                | )      |                  |  | (15,731  | )       |      |  | 25,464  |         |   |  | (16,600   | )       
|Operating expenses:                                           |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Research and development                 |  |                    | 14,704 |                  |  |          | 19,152  |      |  |         | 31,644  |   |  |           | 41,779   |  
|                                                              | Sales and marketing                      |  |                    | 10,141 |                  |  |          | 16,334  |      |  |         | 18,994  |   |  |           | 31,817   |  
|                                                              | General and administrative               |  |                    | 3,552  |                  |  |          | 8,664   |      |  |         | 7,186   |   |  |           | 16,611   |  
|                                                              | Goodwill amortization                    |  |                    |       |                  |  |          | 322     |      |  |         |        |   |  |           | 22,804   |  
|                                                              | Restructuring costs and asset write-offs |  |                    | 3,972  |                  |  |          | 2,549   |      |  |         | 3,972   |   |  |           | 577,293  |  
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Total operating expense                  |  |                    | 32,369 |                  |  |          | 47,021  |      |  |         | 61,796  |   |  |           | 690,304  |  
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|Loss
from operations                                          |                                          |  | (32,396            | )      |                  |  | (62,752  | )       |      |  | (36,332 | )       |   |  | (706,904  | )       
|Interest income                                               |                                          |  | 2,013              |        |                  |  | 4,512    |         |      |  | 4,110   |         |   |  | 11,246    |         
|Interest expense                                              |                                          |  | (2,177             | )      |                  |  | (4,304   | )       |      |  | (4,357  | )       |   |  | (10,048   | )       
|Other income (expense)                                        |                                          |  | (4,400             | )      |                  |  | 317      |         |      |  | (4,465  | )       |   |  | (121      | )       
|Gain on early retirement of debt                              |                                          |  | 33,276             |        |                  |  |         |         |      |  | 33,276  |         |   |  | 121,494   |         
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|                                                              | Loss before tax (expense) benefit        |  |                    | (3,684 | )                |  |          | (62,227 | )    |  |         | (7,768  | ) |  |           | (584,333 | )
|Income tax (expense) benefit                                  |                                          |  | (1                 | )      |                  |  | (277     | )       |      |  | (7      | )       |   |  | 13,629    |         
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|Net loss                                                      |                                          |  | ($3,685            | )      |                  |  | ($62,504 | )       |      |  | ($7,775 | )       |   |  | ($570,704 | )       
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|Basic and diluted net loss per share                          |                                          |  | ($0.05             | )      |                  |  | ($0.93   | )       |      |  | ($0.11  | )       |   |  | ($8.45    | )       
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         
|Shares used in computing basic and diluted
net loss per share |                                          |  | 72,761             |        |                  |  | 67,493   |         |      |  | 72,682  |         |   |  | 67,542    |         
|                                                              |                                          |  |                    |        |                  |  |          |         |      |  |         |         |   |  |           |         

See accompanying notes.





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

|                                                                            |                                                  |                                  |          |                  |       |      |          |          |       | 
|--------------------------------------------------------------------------- | ------------------------------------------------ | -------------------------------- | -------- | ---------------- | ----- | ---- | -------- | -------- | ----- | 
|                                                                            |                                                  |                                  |          | Six Months Ended
|                                                                            |                                                  |                                  |          | June 30,        
|                                                                            |                                                  |                                  |          |                 
|                                                                            |                                                  |                                  |          | 2002             |       | 2001
|                                                                            |                                                  |                                  |          |                  |       |     
|Operating activities:                                                       |                                                  |                                  |          |                  |       |      |          |         
|Net loss                                                                    |                                                  | $                                | (7,775   | )                |       | $    | (570,704 | )       
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                  |                                  |          |                  |       |      |          |         
|                                                                            | Depreciation and amortization                    |                                  |          | 5,734            |       |      |          | 4,903    |      
|                                                                            | Write-off and amortization of intangible assets  |                                  |          | 3,972            |       |      |          | 611,427  |      
|                                                                            | Amortization related to stock options            |                                  |          | 366              |       |      |          | 1,892    |      
|                                                                            | Compensation
expense related to warrant issuance |                                  |          |                 |       |      |          | 753      |      
|                                                                            | Gain on early retirement of debt                 |                                  |          | (33,276          | )     |      |          | (121,494 | )    
|                                                                            |                                                  | Provision for inventory          |          |                  | 4,532 |      |          |          |      | 
|                                                                            |                                                  | Impairment of investment         |          |                  | 4,500 |      |          |          |      | 
|                                                                            |                                                  | Loss
on disposal of fixed assets |          |                  | 1,115 |      |          |          |      | 
|                                                                            |                                                  | Interest payable                 |          |                  | 3,198 |      |          |          | 8,193 | 
|Changes in operating assets and liabilities:                                |                                                  |                                  |          |                  |       |      |          |         
|                                                                            | Accounts receivable                              |                                  |          | 21,324           |       |      |          | 11,495   |      
|                                                                            | Accounts receivable from related parties         |                                  |          | 3,705            |       |      |          | 1,979    |      
|                                                                            | Interest
paid                                    |                                  |          | (4,354           | )     |      |          | (12,951  | )    
|                                                                            | Inventory                                        |                                  |          | 4,550            |       |      |          | 48,365   |      
|                                                                            | Other assets                                     |                                  |          | (11,312          | )     |      |          | 15,300   |      
|                                                                            | Accounts payable                                 |                                  |          | (9,775           | )     |      |          | (71,669  | )    
|                                                                            | Accrued payroll and related expenses             |                                  |          | (727             | )     |      |          | (250     | )    
|                                                                            | Deferred revenues                                |                                  |          | (1,316           | )     |      |          | (601     | )    
|                                                                            | Accrued warranty                                 |                                  |          | 109              |       |      |          | 2,519    |      
|                                                                            | Accrued restructuring                            |                                  |          | (1,797           | )     |      |          |         |      
|                                                                            | Accrued vendor cancellation charges              |                                  |          | (753             | )     |      |          |         |      
|                                                                            | Deferred taxes                                   |                                  |          |                 |       |      |          | (18,110  | )    
|                                                                            | Other accrued liabilities                        |                                  |          | (3,876           | )     |      |          | 14,716   |      
|                                                                            | Other non-current liabilities                    |                                  |          | 81               |       |      |          | (15,700  | )    
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Net cash used in operating activities                                       |                                                  |                                  | (21,775  | )                |       |      | (89,937  | )       
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Investing activities:                                                       |                                                  |                                  |          |                  |       |      |          |         
|Purchases of short-term investments                                         |                                                  |                                  | (204,524 | )                |       |      | (171,862 | )       
|Proceeds from sales and maturities of short-term investments                |                                                  |                                  | 243,310  |                  |       |      | 238,502  |         
|Purchases of property and equipment                                         |                                                  |                                  | (3,198   | )                |       |      | (4,182   | )       
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Net cash provided by investing activities                                   |                                                  |                                  | 35,588   |                  |       |      | 62,458   |         
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Financing activities:                                                       |                                                  |                                  |          |                  |       |      |          |         
|Principal payments on capital leases                                        |                                                  |                                  | (88      | )                |       |      | (34      | )       
|Payments on repurchase of common stock                                      |                                                  |                                  | (5       | )                |       |      |         |         
|Exercise of options to purchase common stock                                |                                                  |                                  | 1,693    |                  |       |      | 453      |         
|Proceeds from issuance of common stock through employee stock purchase
plan |                                                  |                                  | 1,614    |                  |       |      |         |         
|Principal payment on stockholders note receivable                          |                                                  |                                  |         |                  |       |      | 3        |         
|Retirement of debt                                                          |                                                  |                                  | (39,220  | )                |       |      | (68,459  | )       
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Net cash used in financing activities                                       |                                                  |                                  | (36,006  | )                |       |      | (68,037  | )       
|Effect of exchange rate changes                                             |                                                  |                                  | (1,556   | )                |       |      | (621     | )       
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Net decrease in cash and cash equivalents                                   |                                                  |                                  | (23,749  | )                |       |      | (96,137  | )       
|Cash and cash equivalents at beginning of period                            |                                                  |                                  | 100,274  |                  |       |      | 347,015  |         
|                                                                            |                                                  |                                  |          |                  |       |      |          |         
|Cash and cash equivalents at end of period                                  |                                                  | $                                | 76,525   |                  |       | $    | 250,878  |         
|                                                                            |                                                  |                                  |          |                  |       |      |          |         

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 June 30, 2002 and for the three and six months ended June 30,
2002 and 2001 have been included.

Results for the three and six months ended June 30, 2002 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 April 1, 2002, as filed with the U.S. Securities and
Exchange Commission. The accompanying balance sheet at December 31, 2001 is
derived from audited consolidated financial statements at that date.

Reclassifications

Certain amounts in the 2001 financial statements have been reclassified to
conform to the 2002 presentation. See Note 7.

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. See Critical Accounting Policies
in Managements Discussion and Analysis of Financial Condition
and Results of Operations.

Basis of Consolidation

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

Concentrations of Credit Risk, Customers, Suppliers, and Products

The Company operates in two principal operating segments: Cable Broadband
Access Systems (Cable) and Telecom Access Systems (Telecom). The Company sells
primarily to customers within the cable and telecommunications industries,
including related parties. The Company performs ongoing credit





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evaluations of its customers and generally requires no collateral. A
relatively small number of customers account for a significant percentage of
the Companys revenues and accounts receivable. The Company expects that the
sale of its products to a limited number of customers and resellers may
continue to account for a high percentage of revenues for the foreseeable
future.

Currently, the Company relies on single source suppliers of materials and
labor for the significant majority of its product inventory but is actively
pursuing additional supplier alternatives. As a result, should the Companys
current suppliers not produce and deliver inventory for the Company to sell on
a timely basis, operating results may be adversely impacted.

A majority of the Companys revenues have been attributable to sales of
its Cable products, primarily modems and headend equipment. These products are
expected to account for a significant part of the Companys revenues for the
foreseeable future. As a result, a decline in demand for or failure to achieve
broad market acceptance of the Companys Cable products would adversely affect
operating results.

In addition, market acceptance of the Companys products may be affected
by the emergence and evolution of industry standards. While the Company expects
its products to become compliant with industry standards, its inability to do
so may adversely affect operating results.

The Company invests its excess cash in debt instruments of governmental
agencies, and corporations with credit ratings of AA/AA- or better or A1/P1 or
better, respectively. The Company has established guidelines relative to
diversification and maturities that attempt to maintain safety and liquidity.
The Company has not experienced any significant losses on its cash equivalents
or short-term investments.

Revenue Recognition

The Company sells its products directly to broadband access service
providers, system resellers and distributors and recognizes revenue upon
shipment to the customer when title is transferred. Revenues related to product
sales are generally recognized when: (1) persuasive evidence that an
arrangement exists, (2) delivery has occurred or services have been rendered,
(3) the sellers price to the buyer is fixed or determinable, and (4)
collectibility is reasonably assured. The Companys existing agreements with
its system resellers and distributors do not contain price protection
provisions and do not grant return rights beyond those provided by the
Companys standard warranty.

Warranty Reserves

The Company provides a standard warranty for most of its products,
generally lasting one year from the date of purchase. The Company provides for
the estimated cost of product warranties at the time revenue is recognized.
The Companys warranty obligation is affected by product failure rates,
material usage and service delivery costs incurred in correcting a product
failure. Reserve estimates are based on historical experience and
expectations
of future conditions.

Cash Equivalents and Short-Term Investments

The Company invests its excess cash in money market accounts and debt
instruments and considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Investments
with an original maturity at the time of purchase of over three months are
classified as short-term investments regardless of maturity date as all
investments are classified as available-for-sale and can be readily liquidated
to meet current operational needs.

The Company accounts for investments in accordance with Statement of
Financial Accounting Standards No. 115, Accounting for Certain Investments in
Debt and Equity Securities. Management determines the appropriate
classification of debt securities at the time of purchase and reevaluates such
designation as of each balance sheet date. The Companys short-term
investments, which consist primarily of commercial paper, U.S. government and
U.S. government agency obligations and fixed income corporate securities, are
classified as available-for- sale and are carried at amortized cost which





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approximates fair market value. Realized gains and losses and declines in
value judged to be other-than-temporary on available-for-sale securities are
included in interest income. The cost of securities sold is based on the
specific identification method. The Company had no investments in
equity securities at either June 30, 2002 or December 31, 2001.

Inventory

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

|                |  |          |        |              |  |   |        | 
|--------------- |  | -------- | ------ | ------------ |  | - | ------ | 
|                |  | June 30, |        | December 31,
|                |  | 2002     |        | 2001        
|                |  |          |        |             
|Finished goods  |  | $        | 9,308  |              |  | $ | 6,433  | 
|Work-in-process |  |          | 212    |              |  |   | 236    | 
|Raw materials   |  |          | 1,058  |              |  |   | 9,989  | 
|                |  |          |        |              |  |   |        | 
|                |  | $        | 10,578 |              |  | $ | 16,658 | 
|                |  |          |        |              |  |   |        | 

Cost of goods sold for the six months ended June 30, 2002 included a
reversal of approximately $11.4 million in special charges taken in 2001 for
vendor cancellation charges and inventory previously reserved for
as obsolete. The Company was able to reverse the provision as it was able to
sell inventory originally considered to be excess. In addition, the Company
was able to negotiate downward certain vendor cancellation claims to terms more
favorable to the Company. In the second quarter of 2002, the Company recorded
an additional inventory reserve of $4.5 million to reduce certain inventories
to the lower of cost or market as average selling prices fell below the cost of
these products.

Net Loss Per Share

Basic and diluted net loss per share were computed using the weighted
average number of common shares outstanding. Options to purchase 18,811,454
and 34,993,219 shares of common stock were outstanding at
June 30, 2002 and June 30, 2001, respectively. Warrants to purchase 2,408,300 and 2,684,700 shares
of common stock were outstanding at June 30, 2002 and June 30, 2001,
respectively. Neither the options nor warrants were included in the
computation of diluted net loss per share, since the effect would be
antidilutive.

Comprehensive Net Income (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 income (loss) (in thousands):

|                             |                                                                    |  |                    |        |                  |  |          |      |      |  |         |        |   |  |           |      |  
|---------------------------- | ------------------------------------------------------------------ |  | ------------------ | ------ | ---------------- |  | -------- | ---- | ---- |  | ------- | ------ | - |  | --------- | ---- | -
|                             |                                                                    |  | Three Months Ended |        | Six Months Ended
|                             |                                                                    |  | June 30,           |        | June 30,        
|                             |                                                                    |  |                    |        |                 
|                             |                                                                    |  | 2002               |        | 2001             |  | 2002     |      | 2001
|                             |                                                                    |  |                    |        |                  |  |          |      |     
|Net loss                     |                                                                    |  | ($3,685            | )      |                  |  | ($62,504 | )    |      |  | ($7,775 | )      |   |  | ($570,704 | )   
|                             | Cumulative translation adjustments                                 |  |                    | (1,321 | )                |  |          | (633 | )    |  |         | (1,556 | ) |  |           | (621 | )
|                             | Change in unrealized gain (loss) on available-for-sale investments |  |                    | 376    |                  |  |          | (33  | )    |  |         | (499   | ) |  |           | 349  |  
|                             |                                                                    |  |                    |        |                  |  |          |      |      |  |         |        |   |  |           |     
|Total comprehensive net loss |                                                                    |  | ($4,630            | )      |                  |  | ($63,170 | )    |      |  | ($9,830 | )      |   |  | ($570,976 | )   
|                             |                                                                    |  |                    |        |                  |  |          |      |      |  |         |        |   |  |           |     





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Impact of Recently Issued Accounting Standards

Statement of Financial Accounting Standards No. 146, Accounting for
Costs Associated with Exit or Disposal Activities (SFAS No. 146), requires
the Company to recognize costs associated with exit or disposal activities
when they are incurred rather than at the date of a commitment to an exit or
disposal plan. SFAS No. 146 replaces Emerging Issues Task Force (EITF) Issue
No. 94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). The provisions of SFAS No. 146 are to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
The Company has not yet determined whether the adoption of SFAS No. 146 will have a
material impact on its financial position, results of operations, or
cash flows.

In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections (SFAS No. 145). SFAS No. 145
allows only those gains and losses on the extinguishment of debt that meet the
criteria of extraordinary items to be treated as such in the financial
statements. SFAS No. 145 also requires sales-leaseback accounting for certain
lease modifications that have economic effects that are similar to lease-back
transactions. As permitted, the Company early adopted the provisions of SFAS
No. 145 in the second quarter of 2002. The Company determined that the
extinguishment of its debt did not meet the criteria of an extraordinary item
as set forth in SFAS 145. Accordingly, the Company will now report its gain
from retirement of its Convertible Subordinated Notes in operations instead of
as an extraordinary item. All prior periods will reflect the adoption of SFAS
145. See Note 7.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets (SFAS No. 144). SFAS No. 144
supercedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets
and Assets to be Disposed Of and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations -Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transaction.
SFAS No. 144 also amends Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. The provisions of SFAS
No. 144 were adopted by the Company effective January 1,
2002. See Note 6.

In June 2001, FASB issued SFAS No. 141 (SFAS 141), Business
Combinations, SFAS No. 142 (SFAS 142), Goodwill and Other Intangible Assets.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS No. 141 also includes
guidance on the initial recognition and measurement of goodwill and other
intangible assets arising from business combinations completed after June 30,
2001. SFAS No. 142 prohibits the amortization of goodwill and intangible assets
with indefinite useful lives. SFAS No. 142 requires that these assets be
reviewed for impairment at least annually. Intangible assets with finite lives
will continue to be amortized over their estimated useful lives. Additionally,
SFAS No. 142 requires that goodwill included in the carrying value of equity
method investments no longer be amortized.

The Company adopted SFAS No. 142 on January 1, 2002. The Company
reclassified identifiable intangible assets with indefinite lives, as defined
by SFAS No. 142, to goodwill at the date of adoption. The Company tests
goodwill for impairment using the two-step process prescribed in SFAS No. 142.
The first step is a screen for potential impairment, while the second step
measures the amount of the impairment, if any. See Note 5.

The following pro forma information reflects the impact on net loss and
net loss per share assuming the adoption of SFAS No. 142 had occurred on
January 1, 2001 (in thousands):





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|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |        |   |          |  
|------------------------------------- | ------------------------------------------------------------------------------------------ |  | ---------------------------- | ------ | ------------------ | ------ | ---------------- | ------ | ----------- | ------- | ------- | ------ | - | ------ | ----------- | ------ | - | -------- | -
|                                      |                                                                                            |  |                              |        | Three Months Ended |        | Six Months Ended
|                                      |                                                                                            |  |                              |        | June 30,           |        | June 30,        
|                                      |                                                                                            |  |                              |        |                    |        |                 
|                                      |                                                                                            |  |                              |        | 2002               |        | 2001             |        | 2002        |         | 2001   
|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |        
|                                      |                                                                                            |  |                              |        |                    |        |                  |        | (Pro forma) |         |         |        |   |        | (Pro forma)
|Reported net loss                     |                                                                                            |  | ($3,685                      | )      |                    |        | ($62,504         | )      |             |         | ($7,775 | )      |   |        | ($570,704   | )     
|                                      | Amortization of goodwill and intangible
assets with indefinite lives                       |  |                              |       |                    |        |                  | 2,211  |             |         |         |       |   |        |             | 28,231 |  
|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |       
|                                      |                                                                                            |  | Pro forma net loss           |        |                    | (3,685 | )                |        |             | (60,293 | )       |        |   | (7,775 | )           |        |   | (542,473 | )
|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |       
|Basic and diluted net loss per share: |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |       
|                                      | Reported net loss                                                                          |  |                              | ($0.05 | )                  |        |                  | ($0.93 | )           |         |         | ($0.11 | ) |        |             | ($8.45 | )
|                                      | Adjustment related to amortization of goodwill
and intangible assets with indefinite
lives |  |                              |       |                    |        |                  | 0.03   |             |         |         |       |   |        |             | 0.42   |  
|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |       
|                                      |                                                                                            |  | Pro forma net loss per share |        |                    | ($0.05 | )                |        |             | ($0.90  | )       |        |   | ($0.11 | )           |        |   | ($8.03   | )
|                                      |                                                                                            |  |                              |        |                    |        |                  |        |             |         |         |        |   |        |             |       

2. Commitments and Purchase Obligations

On April 1,
2002, the Company entered into a sublease agreement to lease a
facility located in Santa Clara, California. The facility encompasses
approximately 141,000 square feet and has become the Companys new
headquarters. The sublease agreement expires on October 31, 2009. The Company
will be required to make monthly rental payments that escalate to predetermined
amounts on an annual basis. The Company also leases its other facilities and
certain equipment under operating leases. These operating leases expire at
various dates through 2005.

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. During the first six months of 2001, and for the fiscal
year 2001, the Company recorded special charges of $28.7 million and $33.5
million, respectively, relating to vendor cancellation fees as well as inventory
obsolescence. During the first quarter of 2002, special charges were reduced
by $11.4 million as the Company was able to reverse the
provision upon the sale of inventory originally considered to be excess. As of June 30, 2002,
the Company had $71.6 million of purchase obligations, of which $19.9 million
is included on the balance sheet as accrued vendor cancellation charges. The
remaining obligations are expected to become payable at various times through
mid 2003.

3. 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 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 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





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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.

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
superior court of San Luis Obispo County, California. 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 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. The Company believes that these allegations, 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 Terayon 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
it made any misleading statements. The derivative complaint also alleges
claims relating to stock sales by certain of the director and officer
defendants. The Company believes that there are many defects in these
complaints.

On July 12, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of Terayon 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
that it made any misleading statements. The derivative complaint also alleges
claims relating to stock sales by certain of the director and officer
defendants. The Company believes that there are many defects in these
complaints.

4. Operating Segment Information

The Chief Executive Officer has been identified as the Chief Operating
Decision Maker (CODM) because he has final authority over resource allocation
decisions and performance assessment. The CODM allocates resources to each
segment based on their business prospects, competitive factors, revenues and
operating results.

The Company views its business as having two principal operating segments:
Cable Broadband Access Systems (Cable) and Telecom Carrier Access Systems
(Telecom). The Cable segment consists primarily of its TeraComm Systems,
CherryPicker Digital Video Management Systems, and Multigate





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Telephony and Data Access 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 consists 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.





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Information on reportable segments for the three and six months ended June
30, 2002 and 2001 is as follows (in thousands):

|                                  |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |          |         | 
|--------------------------------- | ------------------------------------- | ----- | ------- | ------------------ | ------ | ---------------- | -------- | ------- | ------ | ---- | ------- | ------- | ------ |  | --------- | -------- | ------- | 
|                                  |                                       |       |         | Three Months Ended |        | Six Months Ended
|                                  |                                       |       |         | June 30,           |        | June 30,        
|                                  |                                       |       |         |                    |        |                 
|                                  |                                       |       |         | 2002               |        | 2001             |          | 2002    |        | 2001
|                                  |                                       |       |         |                    |        |                  |          |         |        |     
|Cable Broadband Access Segment:   |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|                                  | Revenues                              |       | $       | 19,203             |        |                  | $        | 57,931  |        |      | $       | 73,829  |        |  | $         | 102,297  |        
|                                  | Operating loss                        |       | $       | (29,240            | )      |                  | $        | (44,602 | )      |      | $       | (29,897 | )      |  | $         | (429,800 | )      
|Telecom Broadband Access Segment: |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|                                  | Revenues                              |       | $       | 3,204              |        |                  | $        | 7,802   |        |      | $       | 5,796   |        |  | $         | 17,420   |        
|                                  | Operating loss                        |       | $       | (3,156             | )      |                  | $        | (18,150 | )      |      | $       | (6,435  | )      |  | $         | (277,104 | )      
|Operating
loss:                   |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|                                  | Operating loss by reportable segments |       | $       | (32,396            | )      |                  | $        | (62,752 | )      |      | $       | (36,332 | )      |  | $         | (706,904 | )      
|                                  | Unallocated amounts:                  |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |          |        
|                                  | Interest and other income, net        |       |         | (4,564             | )      |                  |          | 525     |        |      |         | (4,712  | )      |  |           | 1,077    |        
|                                  | Gain
on early retirement of debt      |       |         | 33,276             |        |                  |          |        |        |      |         | 33,276  |        |  |           | 121,494  |        
|                                  | Income tax (expense) benefit          |       |         | (1                 | )      |                  |          | (277    | )      |      |         | (7      | )      |  |           | 13,629   |        
|                                  |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|Net loss                          |                                       |       | ($3,685 | )                  |        |                  | ($62,504 | )       |        |      | ($7,775 | )       |        |  | ($570,704 | )       
|                                  |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|Geographic areas:                 |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|Revenues:                         |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|                                  | United States                         |       | $       | 7,246              |        |                  | $        | 13,644  |        |      | $       | 16,891  |        |  | $         | 33,229   |        
|                                  | Canada                                |       |         | 2,896              |        |                  |          | 24,827  |        |      |         | 10,008  |        |  |           | 36,070   |        
|                                  | Europe and Israel                     |       |         | 4,535              |        |                  |          | 8,506   |        |      |         | 12,574  |        |  |           | 17,700   |        
|                                  | Asia                                  |       |         | 7,730              |        |                  |          | 18,268  |        |      |         | 39,716  |        |  |           | 32,188   |        
|                                  | South America                         |       |         |                   |        |                  |          | 488     |        |      |         | 436     |        |  |           | 530      |        
|                                  |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         
|                                  |                                       | Total |         | $                  | 22,407 |                  |          | $       | 65,733 |      |         | $       | 79,625 |  |           | $        | 119,717 | 
|                                  |                                       |       |         |                    |        |                  |          |         |        |      |         |         |        |  |           |         

|                   |                                  |  |                      |              |  |          |         |              |  |         |         | 
|------------------ | -------------------------------- |  | -------------------- | ------------ |  | -------- | ------- | ------------ |  | ------- | ------- | 
|                   |                                  |  |                      |              |  | June 30, |         | December 31,
|                   |                                  |  |                      |              |  | 2002     |         | 2001        
|                   |                                  |  |                      |              |  |          |         |             
|Assets:            |                                  |  |                      |              |  |          |         |             
|                   | Cable Broadband Access Segment   |  | $                    | 365,348      |  |          | $       | 455,836      | 
|                   | Telecom Broadband Access Segment |  |                      | 4,841        |  |          |         | 10,810       | 
|                   |                                  |  |                      |              |  |          |         |             
|                   |                                  |  |                      | Total assets |  | $        | 370,189 |              |  | $       | 466,646 | 
|                   |                                  |  |                      |              |  |          |         |             
|Long-lived assets: |                                  |  |                      |              |  |          |         |             
|                   | United States                    |  | $                    | 32,889       |  |          | $       | 36,106       | 
|                   | Canada                           |  |                      | 333          |  |          |         | 256          | 
|                   | Europe and Israel                |  |                      | 3,345        |  |          |         | 4,145        | 
|                   | Asia                             |  |                      | 201          |  |          |         | 243          | 
|                   | South America                    |  |                      | 2,919        |  |          |         | 2,020        | 
|                   |                                  |  |                      |              |  |          |         |             
|                   | Total Long-lived assets          |  |                      | 39,687       |  |          |         | 42,770       | 
|                   |                                  |  | Total current assets |              |  | 330,502  |         |              |  | 423,876 |        
|                   |                                  |  |                      |              |  |          |         |             
|                   |                                  |  |                      | Total Assets |  | $        | 370,189 |              |  | $       | 466,646 | 
|                   |                                  |  |                      |              |  |          |         |             

Three customers accounted for 10% or more of total revenues (28%, 11% and
10%) for the three months ended June 30, 2002. Two customers accounted for 10%
or more of total revenues (37% and 19%) for the three months ended June 30,
2001. One customer accounted for 10% or more of total revenues (34%) for the
six months ended June 30, 2002. Two customers accounted for 10% or more of
total





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revenues (26% and 16%) for the six months ended June 30, 2001. No other
customer accounted for more than 10% of revenues during these periods.

5. Restructuring Charges and Asset Write-offs

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 $4.0 million in the
first six months of 2001 and $12.7 million in fiscal year 2001. Of the total
restructuring charges recorded during fiscal year 2001, $3.2 million related to
employee termination costs and the remaining $9.5 million related primarily to
costs for excess leased facilities. At June 30, 2002, restructuring charges
of $6.4 million remain accrued, primarily related to excess facility costs. The
Company anticipates utilizing the remaining restructuring accrual, which
relates to servicing operating lease payments or negotiated buyout of operating
lease commitments, through 2005. As a result of these headcount
reductions, the Company expects reductions in overall
operating expenses.

In the second quarter of 2002, the Company reclassified $1.0 million,
which had originally been accrued for as employee termination costs to accrued
excess lease facility costs due to a revision in estimate. Remaining employee
termination costs of $0.1 million are expected to be paid during fiscal 2002.

Restructuring
liabilities are summarized below (in millions):

|                             |  |              |      |                     |  |               |      |   |  |   |      |  
|---------------------------- |  | ------------ | ---- | ------------------- |  | ------------- | ---- | - |  | - | ---- | -
|                             |  |              |      |                     |  | Excess Leased |      |   |  |  
|                             |  | Involuntary  |      | Facilities and      |  |               |      |  
|                             |  | Terminations |      | Cancelled Contracts |  | Total        
|                             |  |              |      |                     |  |              
|Balance at December 31, 2001 |  | $            | 1.2  |                     |  | $             | 7.0  |   |  | $ | 8.2  |  
|Additions                    |  |              |     |                     |  |               |     |   |  |   |     |  
|Cash Payments                |  |              | (0.1 | )                   |  |               | (1.7 | ) |  |   | (1.8 | )
|Reclassification             |  |              | (1.0 | )                   |  |               | 1.0  |   |  |   |     |  
|                             |  |              |      |                     |  |               |      |   |  |   |      |  
|Balance at June 30, 2002     |  | $            | 0.1  |                     |  | $             | 6.3  |   |  | $ | 6.4  |  
|                             |  |              |      |                     |  |               |      |   |  |   |      |  

During the six months ended June 30, 2001, $1.6 million related to fixed
assets acquired from ANE were determined to have no remaining useful life and
were written-off.

In March 2001, the Company evaluated the carrying value of certain
long-lived assets and acquired intangibles, consisting primarily of goodwill
recorded on its balance sheet. Pursuant to accounting rules, the majority of
the goodwill was recorded based on stock prices at the time acquisition
agreements were executed and announced. Prior to the adoption of SFAS No. 142,
goodwill and other long-lived assets were reviewed for impairment whenever
events such as product discontinuance, plant closures, product dispositions or
other changes in circumstances indicate that the carrying amount may not be
recoverable. When such events occur, the Company compares the carrying amount
of the assets to undiscounted expected future cash flows. If this comparison
indicates that there is an impairment, the amount of the impairment is based on
the fair value of the assets, typically calculated using discounted expected
future cash flows. The discount rate applied to these cash flows is based on
the Companys weighted average cost of capital, which represents the blended
costs of debt and equity.





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Downturns in the broadband services and telecommunications markets created
unique circumstances with regard to the assessment of goodwill and other
intangible assets for recoverability. As a result of the Companys decision to
suspend certain product lines and product development efforts during the first
six months of 2001, intangible assets totaling $165.8 million relating to
certain acquisitions were deemed to be impaired with no future value and were
written-off. Further, the aforementioned downturns in the principal markets in
which the Company continues to operate, have negatively impacted the forecasted
revenues and cash flows from certain other companies acquired during fiscal
1999 and 2000. In accordance with the Companys policy, the comparison of the
discounted expected future cash flows to the carrying amount of the related
intangible assets resulted in a write-down of these assets related to both the
Cable and Telecom segments of $405.9 million in the first six months of 2001.

As discussed in Note
1, the company adopted SFAS
142 on January 1, 2002. The Company reclassified identifiable intangible
assets with indefinite lives, as defined by SFAS No. 142, to goodwill at the date of adoption. The Company tested goodwill for impairment using the two-step
process prescribed in SFAS No. 142. The first step is a screen for potential
impairment, while the second step measures the amount of the impairment, if
any. The first step was completed during the three months ended March 31, 2002
and did not result in an impairment charge based on the determination
of fair value at January 1, 2002.

Due to a difficult economic
environment and heightened price competition in the modem and telecom
businesses during the three months ended June 30, 2002, the Company experienced
a significant drop in its market capitalization, and therefore proceeded to
perform an interim test to measure goodwill and intangible
assets for impairment at June 30, 2002. The outcome of this test resulted in a non-cash charge
of $4.0 million to write off goodwill in both the Cable and Telecom segments.

6. Impairment of Long-Term
Investment

The Companys long-lived assets include
long-term equity investments. During the three months ended June 30, 2002, the
Company determined that one such equity investment in a
privately-held company, classified as a cable asset, was impaired and
recorded an impairment charge of $4.5 million. In the second quarter of 2002,
the investees forecasts were not met and market conditions
significantly deteriorated. The Companys estimate
of the fair value of the long-term investment was dependent on the performance
of the investment, as well as the volatility inherent
in the external markets for this investment.

7. Convertible Subordinated Notes

In the first six months of 2001, the Company repurchased approximately
$195.6 million of its Convertible Subordinated Notes (Notes) for $68.5 million
in cash, resulting in a gain of approximately $121.5 million, net of related
unamortized issuance costs of $5.6 million. In April 2002, the Company adopted
SFAS No. 145 and determined that the extinguishment of its debt did not meet
the criteria of an extraordinary item as set forth in SFAS No. 145.
Accordingly, the Company will now report its gain from retirement of its Notes
in its results of operations. All prior periods will reflect the adoption of
SFAS No. 145. In the first six months of 2002, the Company repurchased
approximately $74 million of its Notes for $39.2 million in cash, resulting in
a gain included in operations of approximately $33.3 million net of related
unamortized issuance costs of $1.5 million.

8. Related Party Transaction

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 June 2002, the
Company entered a reseller agreement with Harmonic to sell certain of
the Companys products. For the quarter ended June 30,
2002, there was approximately $70,000 in revenues generated from this
reseller agreement.

9. Subsequent Event

In August 2002, the Company repurchased approximately $35.1 million of its
Notes for $18.4 million in cash, resulting in a gain to be included in
operations in the third quarter of fiscal 2002 of approximately $15.8 million,
net of related unamortized issuance costs of $0.9 million.





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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 develop, market and sell equipment to cable television operators,
telecom carriers and satellite network operators, who use our products to
deliver broadband voice, video and data services to residential and business
subscribers. We strive to deliver innovative broadband data, video and
voice solutions that enable service providers to accelerate 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, South America, Europe
and Asia. We also distribute our products through resellers and system
integrators. We are structured around, and our sales are derived from, the
following operating segments: Cable Broadband Access Systems (Cable) and
Telecom Carrier Systems (Telecom). The products sold in Cable consist
primarily of our TeraComm System products which are based on our proprietary
S-CDMA technology, 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. The products sold in Telecom consist primarily
of our MiniPlex DSL Systems, our IPTL Converged Voice and Data Service System
and our MainSail products, which are sold to broadband service providers for
the deployment of voice and data services over the existing copper wire
infrastructure. We sell directly to providers of broadband access services and
to distributors and resellers throughout the world.

We sustained a net loss of $7.8 million for the six months ended June 30,
2002. We had an accumulated deficit of $900.8 million as of June 30, 2002. 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
$6 million to $10 million on capital expenditures and approximately $60 million
to $65 million on research and development during the year ending December 31,
2002. Anticipated capital expenditures consist of purchases of computer hardware,
furniture and leasehold improvements for our facilities, and software and
equipment for newly hired employees.

Critical Accounting Policies

We consider certain accounting policies related to revenue recognition,
bad debt reserves, inventory valuation, impairment of long-lived assets,
warranty returns and contingencies to be critical policies due to the
estimation processes involved in each.

Use of Estimates.The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires that we make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.

Revenue
Recognition.We recognize revenue in accordance with SEC Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements(SAB 101), as amended by SAB 101A and 101B. SAB 101 requires that four basic
criteria must be met before revenue can be recognized: (1) persuasive evidence
of an arrangement exists; (2) delivery has occurred or services
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fixed and determinable; and (4) collectibility is reasonably assured.
Determination of criteria (4) is based on managements judgments regarding the
collectibility of the selling price.

Bad Debt Reserves. We evaluate our trade receivables based upon a
combination of factors. When we become aware of a customers inability to pay,
such as in the case of bankruptcy or a decline in the customers operating
results or financial position, we record a specific reserve for bad debt to
reduce the related receivable to an amount we reasonably believe is
collectible. We also record reserves for bad debt for customers based upon
other factors including the length of time the receivables are past due and
historical experience. If circumstances related to a specific customer change,
our estimates of the recoverability of receivables could be further reduced.

Inventory Valuation.We perform a detailed assessment of inventory at
each balance sheet date, which includes a review of, among other factors,
demand requirements, product lifecycle and product development plans. Based on
this analysis, we record adjustments, when appropriate, to reflect inventory at
lower of cost or market.

We have adjusted our reserves significantly in recent periods due to
changes in strategic direction, such as discontinuances of product lines as
well as fluctuations in market conditions due to changes in demand
requirements. If future demand is less favorable than we have projected,
additional inventory write-downs may be required.

Warranty Reserves.We provide a standard warranty for most of our
products, generally lasting one year from the date of purchase. We provide for
the estimated cost of product warranties at the time revenue is recognized.
Our warranty obligations are affected by product failure rates, material usage
and service delivery costs incurred in correcting a product failure. Our
estimate of costs to service our warranty obligations is based on historical
experience and expectation of future conditions. Should actual product failure
rates, material usage or service delivery costs differ from our estimates,
revisions to the estimated warranty liability would be required, resulting in
decreased gross profits.

Contingencies.We are subject to proceedings, lawsuits and other claims
related to labor, acquisition and other matters. We are required to assess the
likelihood of any adverse judgments or outcomes to these matters as well as
potential ranges of probable losses. A determination of the amount of reserves
required, if any, for these contingencies are made after careful analysis of
each individual issue. The required reserves may change in the future due to
new developments in each matter or changes in approach such as a change in
settlement strategy in dealing with these matters, resulting in higher net
loss.





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Results of Operations

Three Months and Six Months Ended June 30, 2002 and 2001

Revenues. We sell our products directly to broadband service providers,
and to a lesser extent, resellers and integrators. Revenues related to product
sales are generally recognized when: (1) persuasive evidence that 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 66% to $22.4
million for the three months ended June 30, 2002 from $65.7 million in 2001 and
decreased 33% to $79.6 million for the six months ended June 30, 2002 from
$119.7 million in 2001. Revenues from Cable were $73.8 million in the first
six months of 2002, down 28% from $102.3 million in 2001 and $19.2 million
during the three months ended June 30, 2002, down 67% from $57.9 for the same
period in 2001. Our decrease in Cable revenues reflects the challenge of
transitioning from our proprietary-based products to standards-based products
during a period of difficult market conditions including significant declines
in the Average Selling Price (ASPs) of our proprietary-based modems.

The intensely competitive nature of the market for broadband products has
resulted in significant price erosion over time. We have experienced and
expect to continue to experience downward pressure on our unit ASPs. A key component of our strategy is to decrease the cost of
manufacturing our products to offset the decline in ASPs. We intend to
continue to implement cost reduction efforts, including design changes and
manufacturing efficiencies. However, there can be no assurance that we will be
able to successfully achieve cost reductions and efficiencies necessary to
offset the decline in ASPs.

Revenues from Telecom were $5.8 million in the first six months of 2002,
down 67% from $17.4 million in 2001 and $3.2 million during the three months
ended June 30, 2002, down 59% from $7.8 for the same period in 2001. Our
telecom business revenues in the second quarter continue to reflect the lower
capital expenditures in the telecom industry due to weak demand and
over-capacity in existing networks.

Cost of Goods Sold. Cost of goods sold consists of direct product costs as
well as the cost of our manufacturing. The cost of the
manufacturing includes contract manufacturing, test and quality assurance
for products, warranty costs and associated costs of personnel and equipment.
In the three months ended June 30, 2002, cost of goods sold decreased by 72% to
$22.4 million compared to $81.5 million in 2001. The decrease in cost of goods
sold is primarily due to the decrease in revenues and to special charges of $28.7
million and approximately $0.7 million of amortization of acquired intangible
assets recorded in the second quarter of 2001. In the second quarter of 2002,
we recorded additional inventory reserves of $4.5 million to reduce certain
inventories to the lower of cost or market.

In the six months ended June 30, 2002, cost of goods sold decreased by 60%
to $54.2 million compared to $136.3 million in 2001. Cost of goods sold for the
six months ended June 30, 2002 included a reversal of approximately $11.4
million in special charges taken in 2001 for vendor cancellation charges and
inventory previously reserved for obsolescence. We reversed the provision as
we were able to sell inventory originally considered to be in excess. In
addition, we were able to negotiate downward certain vendor cancellation claims
to terms more favorable to us. Cost of goods sold for the six months ended
June 30, 2001 also included special charges of $28.7 million and approximately
$12.5 million of amortization of acquired intangible assets. There was no
amortization of acquired intangible assets in 2002.

Excluding the effects of special charges in 2002 and 2001 and the
amortization of acquired intangible assets in 2001, our cost of goods sold for
the six months ended June 30, 2002, increased as a percentage of sales due to
certain fixed indirect product costs which are allocated to a smaller revenue
base, and a write-down of a prepaid license agreement which no longer
has future value to us.





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Gross Profit (loss). We incurred a gross loss of $27,000 of sales for the
three months ended June 30, 2002 compared to a gross loss of $15.7 million for
the three months ended June 30, 2001. The decrease in gross loss in the three
months ended June 30, 2002 compared to the three months ended June 30, 2001 is
primarily related to the $28.7 million special charge in 2001.

For the six months ended June 30, 2002, we achieved a gross profit of
$25.5 million or 32% of sales, compared to a gross loss of $16.6 million for
the six months ended June 30, 2001. The increase in gross profit is primarily
related to an $11.4 million reversal of special charges in 2002, the special
charges and amortization of acquired intangible assets in 2001 which were not
recorded in 2002, and the change in our product mix which included
higher-margin headend equipment. Excluding the reversal of special charges,
gross profit for the six months ended June 30, 2002 was 18% of sales.
Excluding special charges and amortization costs, gross profit for the six
months ended June 30, 2001 was 21% of sales. We anticipate further decreases
in our ASPs and continued pressure on margins unless and until we can produce
lower cost products and increase sales of our higher-margin headend products.
These ASP decreases, without a corresponding decrease in our product costs,
will likely have an adverse impact on our operating results through at least
2002.

Research and Development. Research and development expenses consist
primarily of personnel costs, as well as prototype materials, equipment and
supplies required to develop and to enhance our products. Research and
development expenses decreased 23% to $14.7 million in the three months ended
June 30, 2002 and 24% to $31.6 million in the six months ended June 30, 2002,
compared to $19.2 million in three months ended June 30, 2001 and $41.8 million
in the six months ended June 30, 2001. The decrease in research and
development expenses was primarily related to overall reductions in
research and development spending, particularly in prototype
development, during 2002. Additionally, in 2001, we recorded amortization of acquired intangible assets
of $1.1 million and $3.2 million in the three and six months ended June 30,
2001, respectively. There was no amortization in 2002. We intend to continue
our investment in research and development.

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 38% to $10.1 million in the three months ended June 30, 2002
and 40% to $19.0 million in the six months ended June 30, 2002, compared to
$16.3 million in the three months ended June 30, 2001 and $31.8 million in the
six months ended June 30, 2001. The decrease in sales and marketing expenses
was due to lower headcount due to reductions in force during late 2001.
Additionally, in 2001, we recorded amortization of acquired intangible assets
of $0.5 million and $1.8 million in first three and six months of 2001,
respectively. There was no amortization in 2002. We expect sales and
marketing expenses to continue to decrease in the second half of 2002.

General and Administrative. General and administrative expenses primarily
consist of salary and benefits for administrative officers and support
personnel, travel expenses, legal, accounting and consulting fees. General and
administrative expenses decreased 59% to $3.6 million for the three months
ended June 30, 2002 and 57% to $7.2 million in the six months ended June 30,
2002, compared to $8.7 million in the first three months of 2001 and $16.6
million in the first six months of 2001. General and administrative expenses in
the first three and six months of 2001 include $1.1 million and $2.4 million,
respectively, of amortization of acquired intangible assets. There was no
amortization in 2002. In addition, general and administrative expenses
decreased due to lower headcount and reduced legal and information technology
expenditures in 2002. We expect general and administrative expenses to remain
flat or continue to decrease in the second half of 2002.

Goodwill Amortization. On January 1, 2002, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets. Statement 142 prohibits the amortization
of goodwill and intangible assets with indefinite useful lives and requires
that these assets be reviewed for impairment at least annually. Intangible
assets with finite lives will continue to be amortized over their estimated
useful lives. As of June 30, 2002, we have no further goodwill and intangible
assets. No amortization expense was recorded during the six months ended June
30, 2002. Unallocated goodwill arising from acquisitions accounted for $0.3
million in amortization in the three months ended June 30, 2001 and $22.8
million in amortization in the six months ended June 30, 2001.





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Restructuring Costs and Asset Write-offs. In March 2001, we evaluated the
carrying value of certain long-lived assets and acquired intangibles,
consisting primarily of goodwill recorded on the balance sheet. Pursuant to
accounting rules, the majority of the goodwill was recorded based on stock
prices at the time acquisition agreements were executed and announced. Prior
to the adoption of FAS 142, goodwill and other long-lived assets were reviewed
for impairment whenever events such as product discontinuance, plant closures,
product dispositions or other changes in circumstances indicate that the
carrying amount may not be recoverable. When such events occur, we compare the
carrying amount of the assets to undiscounted expected future cash flows. If
this comparison indicates that there is an impairment, the amount of the
impairment is based on the fair value of the assets, typically calculated using
discounted expected future cash flows. The discount rate applied to these cash
flows is based on our weighted average cost of capital, which represents the
blended costs of debt and equity.

Downturns in the broadband services and telecommunications markets created
unique circumstances with regard to the assessment of goodwill and other
intangible assets for recoverability. As a result of our decision to suspend
certain product lines and product development efforts during the first quarter
of 2001, intangible assets totaling $165.8 million relating to certain
acquisitions were deemed to be impaired with no future value and were written
off. Further, the aforementioned downturns in the principal markets in which
we continue to operate, have negatively impacted the forecasted revenues and
cash flows from certain other companies acquired during fiscal 1999 and 2000.
In accordance with our policy, the comparison of the discounted expected future
cash flows to the carrying amount of the related intangible assets resulted in
a write-down of these assets related to both our Cable and Telecom segments of
$405.9 million during the first quarter 2001.

We incurred restructuring charges in the amount of $4.0 million in the
first six months of 2001 and $12.7 million in fiscal year 2001. Of the total
restructuring charges recorded during fiscal year 2001, $3.2 million related to
employee termination costs and the remaining $9.5 million relates primarily to
costs for excess leased facilities. During the first six months of 2002, we
made cash payments of $1.8 million against the restructuring accrual. At June
30, 2002, restructuring charges of $6.4 million remain accrued, primarily
related to excess facility costs. We anticipate utilizing the remaining
restructuring accrual, which relates to servicing operating lease payments or
negotiated buyout of operating lease commitments, through 2005. Remaining
employee termination costs of $0.1 million are expected to be paid during
fiscal 2002. We recorded a charge of $1.6 million in the
six months ended June 30, 2001, resulting from
the write-down of impaired assets.

In January 1, 2002, we adopted
SFAS No. 142. We tested goodwill for impairment using the two-step
process prescribed in SFAS No. 142. The first step is a screen for potential
impairment, while the second step measures the amount of the impairment, if
any. The first step was completed during the three months ended
March 31, 2002 and did not result in an impairment charge based
on the determination of fair value at January 1, 2002.

Due to a difficult economic
environment and heightened price competition in the modem and telecom
businesses during the three months ended June 30, 2002, we experienced a
significant drop in our market capitalization, and we proceeded to
perform an interim step to measure goodwill and intangible assets for
impairment. The outcome of this test resulted in a non-cash charge of $4.0
million in the six months ended June 30, 2002 to write off goodwill in both the Cable and Telecom segments.

Gain on early retirement of debt. In the first six months of 2001, we
repurchased approximately $195.6 million of our Convertible Subordinated Notes
(Notes) for $68.5 million in cash, resulting in a gain of approximately $121.5
million, net of related unamortized issuance costs. In April 2002, we adopted
SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of
FASB Statement No. 13, and Technical Corrections (SFAS No. 145). Accordingly,
we will now report our gain from retirement of our Notes in operations. All
prior periods will reflect the adoption of SFAS No. 145. In the first six
months of 2002, we repurchased approximately $74 million of our Notes for $39.2
million in cash, resulting in a gain of approximately $33.3 million net of
related unamortized issue costs.





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Interest Income and Expense. Interest income decreased 55% to $2.0 million
for the three months ended June 30, 2002 and 63% to $4.1 million in the six
months ended June 30, 2002, compared to $4.5 million and $11.2 million in the
comparable periods of 2001. Interest expense, which relates primarily to
interest on our Notes due in 2007, decreased 49% to $2.2 million for the three
months ended June 30, 2002 and 57% to $4.4 million in the six months ended June
30, 2002, compared to $4.3 million and $10.0 million in the comparable periods
of 2001. The decrease in both interest income and interest expense was due to
the use of cash to repurchase of $325.9 million of the Notes in 2001 and $74
million of the Notes in the first half of 2002 and to the use of cash for
operations.

Other income and expense. During the three months ended June 30, 2002, we
wrote down $4.5 million of long-term investments which were
included in our Cable Segment (as defined by SFAS No. 131) and were
charged due to impairment to other expense. We
estimated the fair value of the long-term investment based on the performance
of the investment, as well as the volatility inherent
in the external markets for this investment.

Income Taxes. We recorded a provision for income taxes of $1,000 during
the three months ended June 30, 2002 and a provision for income taxes of $7,000
during the six months ended June 30, 2002. During the three and six months
ended June 30, 2001 we had a provision for income taxes of $0.3 million and a
benefit for income taxes of $13.6 million, respectively. During the first three
months of 2001 we recorded a benefit of $13.9 million, which consisted of a
reduction of deferred tax liabilities related to the Telegate, Radwiz,
Ultracom, and Combox acquisitions and a $485,000 provision for 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 consolidated lawsuit is named In re Terayon Communication
Systems, Inc. Securities Litigation, Case No. C 00-1967-MHP. 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 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.

The lawsuit seeks an unspecified amount of damages, in addition to other
forms of relief. We consider the lawsuits to be without merit and we 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 superior court of
San Luis Obispo County, California. This lawsuit is titled Bertram v. Terayon
Communications Systems, Inc., Case No. CV 000900 (Bertram). The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action under
California Business & Professions Code Sections 17200 et





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seq. and 17500 et seq. 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 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. We believe that these allegations,
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
our behalf against five of our current directors, two former directors and two
former officers. This lawsuit is titled Campbell vs. Rakib, et al.(No.
CV807650), 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 we made any
misleading statements. The derivative complaint also alleges claims relating
to stock sales by certain of the director and officer defendants. We believe
that there are many defects in these complaints.

On July 12, 2002, a shareholder filed a derivative lawsuit purportedly on
our behalf against three of our current directors, one former officer and three
former investors. This lawsuit is titled OBrien vs. Rakib, et al.(No.
410201), 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 that we made
any misleading statements. The derivative complaint also alleges claims
relating to stock sales by certain of the director and officer defendants. We
believe that there are many defects in these complaints.

Liquidity and Capital Resources

Cash used in operating activities for the six months ended June 30, 2002
was $21.8 million compared to $89.9 million used in 2001. In the six months
ended June 30, 2002, cash used by operating activities included $7.8 million
net loss, and an $11.3 million decrease in other assets relating primarily to cash
which was restricted due to certain operating lease commitments and is now
classified in other assets. In the six months ended June 30, 2001, cash used
by operating activities was primarily related to decreases in accounts payable,
deferred taxes and other non-current liabilities partially offset by an
increase in inventory.

Cash used in investing activities during the six months ended June 30,
2002 was $35.6 million, compared to cash provided by investing activities of
$62.5 million in 2001. Investing activities consisted primarily of the purchase
and sale of short-term investments.

Cash used by
financing activities was $36.0 million in the first six
months of 2002, compared to cash used in financing activities of $68.0 million
in 2001. Financing activities typically consist of cash received through the
exercise of stock options and shares issued through stock purchase plans, which
are offset by interest payments on outstanding debt. In the first half of
2001, we repurchased Notes for $68.5 million in cash. In the first half of
2002, we repurchased Notes for $39.2 million in cash.





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As of June 30, 2002, we had a standby letter of credit outstanding for
$9.0 million in support of certain operating lease commitments and another $0.7
million in letters of credit in support of purchase obligations.

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 June 30, 2002, we had approximately $71.6 million of purchase
obligations, of which $19.9 million is included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times through mid-2003.

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, 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 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
develop our products, take advantage of future opportunities or respond to
competitive pressures or unanticipated requirements, which could have a
material adverse effect on our business, financial condition and operating
results.

Impact of Recently Issued Accounting Standards

In July 2002, the
Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (SFAS No. 146), which requires us to recognize
costs associated with exit or disposal activities when they are incurred
rather than at the date of a commitment to an exit or disposal plan. SFAS No.
146 replaces Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring). The
provisions of SFAS No. 146 are to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. We have not yet
determined whether adoption
of SFAS No. 146 will have a material impact on our financial statements.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS No. 145). SFAS No. 145 allows only those gains and losses on
the extinguishment of debt that meet the criteria of extraordinary items to be
treated as such in the financial statements. SFAS No. 145 also requires
sales-leaseback accounting for certain lease modifications that have economic
effects that are similar to lease-back transactions. We adopted the provisions
of SFAS No. 145 in the second quarter of 2002. In accordance with its adoption
of SFAS No. 145, all prior periods will reflect the adoption of SFAS No. 145 in
our condensed consolidated financial statements.

In August 2001, the
FASB issued
SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets (SFAS No. 144). SFAS No. 144
supercedes SFAS No. 121, Accounting for the Impairment of Long-lived Assets
and Assets to be Disposed of and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, Reporting the Results of
Operations -Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions.
SFAS No. 144 also amends Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. The provisions of SFAS
No. 144 were adopted by us effective January 1, 2002.





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In June 2001, the
FASB issued SFAS No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets (SFAS No. 141 and SFAS No. 142). SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS No. 141 also includes guidance
on the initial recognition and measurement of goodwill and other intangible
assets arising from business combinations completed after June 30, 2001. SFAS
No. 142 prohibits the amortization of goodwill and intangible assets with
indefinite useful lives. SFAS No. 142 requires that these assets be reviewed
for impairment at least annually. Intangible assets with finite lives will
continue to be amortized over their estimated useful lives. Additionally, SFAS
No. 142 requires that goodwill included in the carrying value of equity method
investments no longer be amortized.

We adopted SFAS No. 142 on January 1, 2002. We reclassified identifiable
intangible assets with indefinite lives, as defined by SFAS No. 142, to
goodwill at the date of adoption. We test goodwill for impairment using the
two-step process prescribed in SFAS No. 142. The first step is a screen for
potential impairment, while the second step measures the amount of the
impairment, if any. See Note 5 in Note to Condensed Consolidated
Financial Statements.

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.

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 June 30, 2002, we had an
accumulated deficit of $900.8 million. We believe that we will continue to
experience net losses for the foreseeable future. We generally are unable to
reduce our expenses significantly in the short term to compensate for any
unexpected delay or decrease in anticipated revenues. In addition, significant
delays in our commercialization of new products will adversely affect our
business. Moreover, even though we have experienced significant revenue growth
since our inception, the profit potential of our business remains unproven.

Our Operating Results May Fluctuate.

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

Factors that could 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;           
|
| |  |  | new product introductions by competitors;                        





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| |  |  | delays in our introduction of new products;                                                                    
| | - |  | ---------------------------------------------------------------------------------------------------------------
|
| |  |  | delays in our receipt of and cancellation of orders forecasted by customers;                                   
|
| |  |  | delays by our customers in the completion of upgrades to their cable infrastructures;                          
|
| |  |  | variations in capital spending budgets of broadband service providers; and                                     
|
| |  |  | adoption of industry standards and the inclusion in or compatibility of
our technology with any such 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; and                                                                
|
| |  |  | the costs of manufacturing our products and the effectiveness of our cost reduction measures.

We anticipate that unit ASPs of our products will continue to decline in
the future. This could cause a decrease in the gross margins for these
products. 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 headend equipment, such as CMTSs, and lower margin, higher volume CPE,
such as modems. We typically sell more headend equipment in connection with
new deployments of our systems. As deployments mature, we tend to sell more
CPE into the deployments compared to headend equipment. Sales of our CPE have
constituted, and we expect will continue to constitute, a significant portion
of our revenues.

Our expenses generally vary from quarter to quarter depending on the level
of actual and anticipated business activities. Moreover, our research and
development expenses increase as we develop new products and our development
programs move to wafer fabrication and prototype development.

We Are Dependent on a Small Number of Customers.

A substantial majority of our revenues have been and will continue to be
derived from sales to a relatively small number of customers. Three customers
(one of which is a related party) accounted for approximately 49% of our
revenues for the six months ended June 30, 2002. The loss of any one of these
customers could have a material adverse effect on our results of operations.
In addition, sales to our customers are and will continue to be focused on a
limited number of projects.

The markets we serve are undergoing significant consolidation in both
North America and internationally, as a limited number of service providers
control an increasing number of systems. Currently, ten cable operators in the
United States own and operate facilities passing approximately 82% of total
homes passed. In addition, the North American DSL market is concentrated with
the major ILECs constituting a significant percentage of the market. As a
result, our sales have been and will continue to be dependent upon product
acceptance by the leading broadband service providers.

The timing and size of each customers order is critical to our operating
results. Our major customers have significant negotiating leverage and
sometimes attempt to change the terms, including pricing, upon which we do
business with them. These customers may decide to purchase competitive





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products from other vendors at any time and can reschedule or cancel
purchase orders on short notice. When purchasing product from us, these
customers are requiring longer payment terms than in the past, which requires
us to maintain additional capital to meet our working capital needs. Reduced
spending in the cable and telecom industries has had and may continue to have a
negative impact on our operations.

Acquisitions Could Result In Dilution, Operating Difficulties and Other Adverse
Consequences.

We acquired ten companies from September 1999 through December 2000. We
may acquire additional companies in the future. As a result of our decision to
suspend certain product lines and product development efforts and downturns in
the broadband services and telecommunications industries, in general, we
wrote-down intangible assets relating to these acquisitions of approximately
$572.8 million in 2001, and $4.0 million during the first six months of 2002.
The process of integrating any such acquired company into our business and
operations may be risky and may create unforeseen operating difficulties and
expenditures going forward.

Future acquisitions could result in potentially dilutive issuances of
equity securities, the incurrence of additional debt, contingent liabilities or
amortization expenses related to goodwill and other intangible assets, any of
which could harm our business. Future acquisitions also could require us to
obtain additional equity or debt financing, which may not be available on
favorable terms or at all. Even if available, this financing may be dilutive.

The Sales Cycle for Our Products Is Lengthy.

The sales cycle for our products typically is lengthy, often lasting six
months to more than a year. Our customers typically conduct significant
technical evaluations of competing technologies prior to making a purchasing
decision. In addition, purchasing decisions may be delayed because of our
customers internal budget approval procedures. Sales also generally are
subject to customer trials, which typically last more than three months.
Because of the lengthy sales cycle and the large size of customer orders, if
orders forecasted for a specific customer for a particular quarter do not occur
in that quarter, our revenues and operating results could suffer.

There Are Many Risks Associated with Our Participation in DOCSIS.

In January 2002, CableLabs announced that it had finished specifications
for an advanced generation of cable modems called DOCSIS 2.0. DOCSIS 2.0
incorporates two advanced physical layer modulation techniques, S-CDMA and
A-TDMA that four companies, including us, had helped to develop.

In connection with the finalization of the DOCSIS 2.0 specification, we
have contributed some aspects of our current proprietary S-CDMA technology to a
royalty-free intellectual property pool established by CableLabs to the extent
that the technology is included in the DOCSIS 2.0 specification. This
royalty-free pool facilitates the participation of as many vendors as possible
in providing equipment that is compatible with the DOCSIS specification. As a
result, any of our competitors who join the DOCSIS intellectual property pool
would have access to these aspects of our technology and would not be required
to pay us any royalties or other compensation for the use of our technology. If
a competitor is able to duplicate the functionality and capabilities of our
technology, we could lose some or all of the time-to-market advantage we might
otherwise have due to our familiarity with S-CDMA. This may adversely affect
our future revenues and operating results.

We believe the addition of advanced upstream physical layer (PHY)
capabilities to DOCSIS in the DOCSIS 2.0 specification could increase the
overall market for DOCSIS-compatible products and, as such, could result in
increased competition in the cable modem market. This competition could come
from existing competitors or from new competitors who enter the market. This
increased competition is likely to result in lower ASPs of cable products and
could harm revenues and gross margins. Because our





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competitors will be able to incorporate some aspects of our technology
into their products, our current customers may choose alternate suppliers or
choose to purchase DOCSIS-compliant cable products with advanced PHY
capabilities from multiple suppliers. We may be unable to produce DOCSIS
compliant cable products with advanced PHY capabilities more quickly or at
lower cost than our competitors. As a result of the inclusion of S-CDMA
technology in the DOCSIS 2.0 specification, competition for the services of our
existing employees who have experience with S-CDMA could increase. The loss of
these employees to one or more competitors could harm our business.

DOCSIS standards have not yet been accepted in Europe and Asia. An
alternate specification for cable products, called the Euro-DOCSIS
specification, has been formalized, and some European cable system operators
have embraced it. We intend to develop and sell products that comply with the
Euro-DOCSIS specification and to pursue having portions of our S-CDMA
technology included in a future version of the Euro-DOCSIS specification. We
may be unsuccessful in these efforts.

We Need to Develop New Products in Order to Remain Competitive.

Our future success depends on our ability to develop, market and sell new
products in a timely manner. We also must respond to competitive pressures,
evolving industry standards and technological advances. We are developing
products that include both S-CDMA and A-TDMA, the two modulation techniques
required by the DOCSIS 2.0 specification. There is no guarantee that our
products will pass testing to be DOCSIS certified or qualified. If we are
unable to certify or qualify our products as DOCSIS compliant in a timely
manner, we may lose some or all of the time to market advantage we might
otherwise have had, and our future operating results may be adversely affected.

Although we sell DOCSIS systems, the majority of our sales are derived
from our proprietary S-CDMA products, which are not DOCSIS compliant. There
have been instances where our customers and potential customers delayed or
canceled purchases of our proprietary products in order to purchase products
that comply with the DOCSIS specification. In addition, there have been
instances where our existing customers and potential new customers purchased
DOCSIS-compliant products from one or more of our competitors rather than
purchasing our products. We believe that this may be an increasing trend in the
future as service providers look to purchase DOCSIS certified or qualified
products. As a result, 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 operating results and gross margin.

Average Selling Prices of Broadband Access Equipment Typically Decrease.

The broadband access market has been characterized by erosion of ASPs. We
expect this to continue. This erosion is due to a number of factors, including
competition, rapid technological change and price performance enhancements. The
ASPs for our products may be lower than expected as a result of competitive
pricing pressures, promotional programs and customers who negotiate price
reductions in exchange for longer term purchase commitments. We anticipate that
ASPs and gross margins for our products will decrease over their life cycles.
In addition, we believe that the widespread adoption of industry standards is
further eroding ASPs, particularly for cable modems and other similar CPE. It
is likely that widespread adoption of industry standards will result in
increased retail distribution of cable modems and other similar CPE, which
could put further price pressure on our products. Decreasing ASPs could result
in decreased revenues even if the number of units sold increases. As a result,
we may experience substantial period-to-period fluctuations in future revenue
and operating results due to ASP erosion. Therefore, we must continue to
develop and introduce on a timely basis 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.

We Must Achieve Cost Reductions.

Certain of our competitors currently offer products at prices lower than
ours. Market acceptance of our products will depend in part on reductions in
the unit cost of our products. We expect that as CMTS





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equipment becomes more widely deployed, the price of cable modems and
other similar CPE will decline. In particular, we believe that the widespread
adoption of industry standards such as DOCSIS will cause increased price
competition for CPE. However, we may be unable to reduce the cost of our
products sufficiently to enable us to compete with other equipment
manufacturers. Even if we achieve certain cost reductions, it is not certain
that these efforts will allow us to keep pace with competitive pricing
pressures or lead to gross margin improvement.

Some of our competitors are larger and manufacture products in
significantly greater quantities than we currently intend to manufacture for
the foreseeable future. Consequently, these competitors have more leverage in
obtaining favorable pricing from suppliers and manufacturers. In order to
remain competitive, we must significantly reduce the cost of manufacturing our
products through design and engineering changes. We may not be successful in
redesigning our products. Even if we are successful, our redesign may be
delayed or 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 manufacturing costs will require us to use more highly
integrated components 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. We could
incur expenses without related revenues if we enter into a high volume or
long-term purchase or manufacturing agreements and then decide that we cannot
use the products or services offered by the agreement. We have incurred
cancellation charges in the past and may incur such charges in the future.

We Must Keep Pace with Rapid Technological Change to Remain Competitive.

The markets for our products are characterized by rapid technological
change, evolving industry standards, changes in end-user requirements and
frequent new product introductions and enhancements. Our future success will
depend upon our ability to enhance our existing products and to develop and
introduce new products that achieve market acceptance. Service providers may
adopt alternative technologies or may deploy alternative services that are
incompatible with our products.

In January 2002, CableLabs announced that it had finished specifications
for an advanced generation of cable products called DOCSIS 2.0. DOCSIS 2.0
incorporates two advanced physical layer modulation techniques, S-CDMA and
A-TDMA. We believe that, as DOCSIS 2.0 gains acceptance among cable operators,
our future success depends on our ability to manufacture, market and sell cable
products certified and qualified as meeting the DOCSIS 2.0 specification. Our
inability to produce DOCSIS 2.0 compliant cable products more quickly or at
lower cost than our competitors may adversely affect our future results of
operations.

Broadband Access Services Have Not Achieved Widespread Market Acceptance, and
Many Competing Technologies Exist.

Our success will depend upon the widespread acceptance of broadband
services by providers and end users. The markets for these services are not
fully developed. We cannot accurately predict the future growth rate or the
ultimate size of the market for broadband services. Potential users of our
products may have concerns regarding the security, reliability, cost, ease of
installation and use and capability of broadband services in general.

The markets for our products may be impacted by the development of other
technologies that enable the provisioning of broadband services and the
deployment of services over other media. Widespread acceptance of other
technologies or deployment of services over media not supported by our products
could materially limit acceptance of our products. Broadband services based on
our products and technology may fail to gain widespread commercial acceptance
by service providers and end users. We may not be successful in marketing and
selling these products.

We Need to Develop Additional Distribution Channels.





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We presently market our products to service providers. With changes in the
industry, we may need to establish new, additional distribution channels. For
example, we believe that much of the North American market for CPE may shift to
a retail distribution model. Accordingly, we may need to redirect our future
marketing efforts to sell our CPE directly to retail distributors and end
users. This shift would require us to establish new distribution channels for
these products.

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

| |                                                                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     our inability to hire additional personnel necessary to establish and
enhance these new distribution channels;                                                                                                                                                                                                                                     
|
| |     to the extent that large consumer electronics companies enter the
cable modem market, their well-established retail distribution
capabilities would provide them with a significant competitive advantage;                                                                                                                                         
|
| |     our potential customers are likely to prefer purchasing products from
established manufacturing companies that can demonstrate the capability
to supply large volumes of products on short notice; and                                                                                                                                             
|
| |     many of our potential customers may be reluctant to adopt technologies
that have not gained acceptance among other providers of similar
services. This reluctance could result in lengthy product testing and
acceptance cycles for our products. Consequently, the impediments to our
initial sales may be even greater than those to later sales.

The vast majority of our sales are to larger, more established service
providers that are critical to our business. We do not have access to smaller
or geographically diverse service providers. 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 service providers 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.

We Are Dependent on Service Providers Choosing to Offer Additional Services to
Their Customers.

We depend on service providers to purchase our products. Service providers
have a limited amount of available bandwidth over which they can offer new
services, such as high speed Internet access and telephony. They may choose
not to provide these new services to their customers. When service providers
choose to provide these new services, we depend upon them to market these
services to their customers, to install our equipment and to provide support to
end-users. In addition, we depend on these service providers to continue to
maintain their infrastructures in a manner that allows us to provide
consistently high performance and reliable services.

Sales of Our Cable Products Are Dependent on the Cable Industry Upgrading to
Two-Way Cable Infrastructure.

Demand for our cable products will depend, to a significant degree, upon
the magnitude and timing of capital spending by cable operators for
implementation of access systems for data transmission over cable networks.
This involves the enabling of two-way transmission over existing coaxial cable
networks and the eventual upgrade to hybrid fiber coaxial (HFC) in areas of
higher penetration of data services. If cable operators fail to complete these
upgrades of their cable infrastructures in a timely and satisfactory manner,
the market for our products could be limited. In addition, few businesses in
the United States currently have cable access. Cable operators may not choose
to upgrade existing residential cable systems or to install new cable systems
to serve business locations.





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The success and future growth of our cable business will be subject to
economic and other factors affecting the cable television industry generally,
particularly its 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 in the cable industry. 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;               
|
| |  |  | 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 the
acquisition of smaller and independent cable operators by larger operators. 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.

Supply of Our Products Depends On Our Ability to Forecast Demand Accurately.

The emerging nature of the broadband services market 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 product 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
$71.6 million as of June 30, 2002, 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.

Our Business May Be Affected By Conditions In Israel.

Our operations may be affected by conditions in Israel because of our
significant operations there. 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 Have Financial Exposure to Litigation Against Our Directors and
Officers.





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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 purchase insurance.

In October 2001, Reliance Insurance Co. (Reliance) was placed into
liquidation by the state of Pennsylvania. Reliance was the underwriter for one
excess layer of our directors and officers insurance for the period covering
the claims made against the company and its officers in the pending securities
litigation. Because Reliance is in liquidation, we may have to pay the amount
insured under the Reliance policy ($2.5 million).

We Are Dependent on Key Third-Party Suppliers.

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.

In addition, some of our components are custom parts produced to our
specifications. For example, we have relied and will continue to rely on sole
source semiconductor manufacturers to supply us with custom ASICs for use in
our products. Additional components, such as the radio frequency tuner and
some surface acoustic wave filters, are also procured from sole source
suppliers. Any interruption in the operations of vendors of sole source parts
could adversely affect our ability to meet our scheduled product deliveries to
customers. We are dependent on semiconductor manufacturers and are affected by
worldwide conditions in the semiconductor market. 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. 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. As a result of our dependence on these
contract manufacturers for 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
manufacture, assembly or testing of 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.





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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.

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

If our customers are affected by currency devaluations or general economic
crises, such as the recent economic crises affecting many Asian 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 broadband services
infrastructures for a variety of reasons. These reasons include environmental
issues, economic downturns, 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 do
invoice our sales into Brazil in reals and certain sales in Europe in euros. We
currently do not engage in foreign currency hedging transactions. As we expand
our international operations, payments to us in foreign currencies and our
exposure to losses as the result of foreign currency fluctuations may increase.
We may 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.

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 broadband products, particularly in the initial deployment
and implementation stages. To date, our sales have been concentrated in a small
number of customers. We have limited experience with widespread deployment of
our products to a diverse customer base. 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. 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
gaining new customers.

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 in the cable arena
include Cisco Systems, ADC, Arris, Juniper Networks,





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Com21, Motorola, Nortel Networks, Thomson Consumer Electronics (which markets products under the brand
name RCA), Samsung, Scientific-Atlanta and Toshiba. We also compete with
companies that develop integrated circuits for broadband products, such as
Broadcom, Conexant and Texas Instruments. In addition, we compete with
companies in the DSL arena such as Alcatel, Siemens, Lucent, Nortel Networks,
Efficient Networks, Zhone, Marconi, Charles Industries, Accelerated Networks
and Integral Access. 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. The existing conditions
in the market for broadband services 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 is likely to cause
increased worldwide price competition, particularly in the North American
market. We believe that the adoption of these standards have resulted in and
are likely to continue to result in lower sales of our proprietary S-CDMA
products. Any increased price competition or reduction in sales of our
products, particularly our higher margin headend products, would result in
downward pressure on our gross margin. These competitive pressures have and are
likely to continue to adversely impact our business.

Our Business Is Dependent on the Internet and the Development of Internet
Infrastructure.

Our success depends on increased demand for high-speed Internet services
for commercial use. Critical issues concerning the commercial use of the
Internet remain largely unresolved and are likely to affect the development of
the market for our products. These issues include security, reliability, cost,
ease of access and quality of service. Our success also will depend on the
growth of the use of the Internet by businesses for multimedia applications
that require high bandwidth. The recent growth in the use of the Internet has
caused frequent periods of performance degradation. This has required the
upgrade of routers, telecommunications links and other components forming the
infrastructure of the Internet by service providers and other organizations
with links to the Internet. Any perceived degradation in the performance of
the Internet as a whole could undermine the benefits of our products.

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





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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.

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

Products like ours are very complex and 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 management time and resources.

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

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 the 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 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 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 whereby
we licensed to CableLabs any 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 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





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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 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. In addition to regulatory compliance, some cable
operators require that our products be certified or qualified as having met
DOCSIS or Euro-DOCSIS specifications.

We Are Vulnerable to Earthquakes, Power Outages 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. 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 June 30,
2002, we had approximately $100.4 million of indebtedness
outstanding. This high 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;
|
| |  |  | limiting our flexibility in planning for, or reacting to, changes in
our business and the industry; and                                                                                                                                                                                                          





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| |  |  | 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 market for broadband services and technology companies in particular,
have experienced extreme price and volume volatility and a significant
cumulative decline over the last two years. 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.




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





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within the next
twenty-four months. A hypothetical 50 basis point increase in interest rates
would result in an approximate $854,000 decline (less than 0.4%) 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
in Belgium, United Kingdom, Hong Kong, Korea, Canada and Israel. An adverse change of
10% in exchange rates would result in a decline in income before taxes of
approximately $160,000.

All of the potential changes noted above are based on sensitivity analyses
performed as of June 30, 2002. Actual results may differ materially




PART II. OTHER INFORMATION




ITEM 3. 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



|(a) |  | The registrants Annual Meeting of Stockholders was held on
May 22, 2002.                                                                                                                             
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | The meeting involved the election of two officers:
Aleksander Krstajic and Lewis Solomon. The following directors
terms continued after the meeting: Shlomo Rakib, Zaki Rakib and
Christopher Schaepe.
|   
|(c) |  | There were four matters voted on at the Meeting. A brief
description of each of these matters, and the results of the votes
thereon, are as follows:                                                  



| | 1. |  | Election of Directors
| | -- |  | ---------------------

|                    |  |     |            |          |  |  |           | 
|------------------- |  | --- | ---------- | -------- |  |  | --------- | 
|Nominee             |  | For |            | Withheld
|                    |  |     |            |         
|Aleksander Krstajic |  |     | 58,004,446 |          |  |  | 1,121,509 | 
|Lewis Solomon       |  |     | 58,023,105 |          |  |  | 1,102,850 | 



| | 2. |  | Amendment to the 1998 Non-Employee Directors
Plan to increase the aggregate number of
common stock authorized for issuance under
the plan by 400,000 shares
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|           |  |         |            |         |  |  |         | 
|---------- |  | ------- | ---------- | ------- |  |  | ------- | 
|For        |  | Against |            | Abstain
|           |  |         |            |        
|46,354,850 |  |         | 12,639,675 |         |  |  | 131,430 | 



| | 3. |  | Amendment to the 1998 Employee Stock Purchase
Plan to increase the aggregate number of
common stock authorized for issuance under
the plan by 3,000,000 shares
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents



|           |  |         |           |         |  |  |         | 
|---------- |  | ------- | --------- | ------- |  |  | ------- | 
|For        |  | Against |           | Abstain
|           |  |         |           |        
|56,431,564 |  |         | 2,590,465 |         |  |  | 103,926 | 



| | 4. |  | Ratification of the appointment of Ernst &
Young LLP as the registrants auditors for
the fiscal year ending December 31, 2002
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------

|           |  |         |         |         |  |  |        | 
|---------- |  | ------- | ------- | ------- |  |  | ------ | 
|For        |  | Against |         | Abstain
|           |  |         |         |        
|58,446,244 |  |         | 620,123 |         |  |  | 59,589 | 




ITEM 5. OTHER INFORMATION

None




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) |  | EXHIBITS
|--- |  | --------



| |  |  | None
| |  |  | ----



|(b) |  | REPORTS ON FORM 8-K
|--- |  | -------------------

The Company filed no reports on Form 8-K during the quarter ended June 30,
2002.





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##### Table of Contents






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: August 14, 2002 | TERAYON COMMUNICATION SYSTEMS, INC.     
|                     
|                      | By  /s/      Carol Lustenader           
|                      |                                         
|                      | Carol Lustenader
Chief Financial Officer