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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 THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED September 30, 2002
OR

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

FOR THE TRANSITION PERIOD FROM _____________ TO _____________.



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TERAYON COMMUNICATION SYSTEMS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


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

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



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

As of October 31, 2002, registrant had outstanding 73,128,720 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 (UNAUDITED)
|                              | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                              | ITEM 4. CONTROL AND PROCEDURES                                                               
|PART II. OTHER INFORMATION   
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5. OTHER INFORMATION                                                                    
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|EXHIBIT INDEX                
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

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





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

|                                               |                                               |                           |                                            |           |               |         |              |           |         |         | 
|---------------------------------------------- | --------------------------------------------- | ------------------------- | ------------------------------------------ | --------- | ------------- | ------- | ------------ | --------- | ------- | ------- | 
|                                               |                                               |                           |                                            |           | September 30, |         | December 31,
|                                               |                                               |                           |                                            |           | 2002          |         | 2001        
|                                               |                                               |                           |                                            |           |               |         |             
|                                               |                                               |                           |                                            |           | (unaudited)   |         |              |           |        
|ASSETS                                        
|Current assets:                                |                                               |                           |                                            |           |               |         |              |          
|                                               | Cash and cash equivalents                     |                           | $                                          | 128,610   |               |         | $            | 100,274   |        
|                                               | Short-term investments                        |                           |                                            | 91,266    |               |         |              | 233,614   |        
|                                               | Accounts receivable, net                      |                           |                                            | 21,974    |               |         |              | 48,386    |        
|                                               | Accounts receivable from related parties      |                           |                                            | 448       |               |         |              | 4,006     |        
|                                               | Other current receivables                     |                           |                                            | 6,942     |               |         |              | 7,476     |        
|                                               | Inventory                                     |                           |                                            | 9,033     |               |         |              | 16,658    |        
|                                               | Other current assets                          |                           |                                            | 11,539    |               |         |              | 13,462    |        
|                                               |                                               |                           |                                            |           |               |         |              |          
|                                               |                                               | Total current assets      |                                            |           | 269,812       |         |              |           | 423,876 |        
|                                               | Property and equipment, net                   |                           |                                            | 19,818    |               |         |              | 25,279    |        
|                                               | Intangibles and other assets, net             |                           |                                            | 13,626    |               |         |              | 17,491    |        
|                                               |                                               |                           |                                            |           |               |         |              |          
|                                               |                                               | Total assets              |                                            | $         | 303,256       |         |              | $         | 466,646 |        
|                                               |                                               |                           |                                            |           |               |         |              |          
|LIABILITIES AND STOCKHOLDERS EQUITY          
|Current liabilities:                           |                                               |                           |                                            |           |               |         |              |          
|                                               | Accounts payable                              |                           | $                                          | 21,120    |               |         | $            | 42,821    |        
|                                               | Accrued payroll and related expenses          |                           |                                            | 6,107     |               |         |              | 9,441     |        
|                                               | Deferred revenues                             |                           |                                            | 1,175     |               |         |              | 4,169     |        
|                                               | Accrued warranty                              |                           |                                            | 10,101    |               |         |              | 8,368     |        
|                                               | Accrued vendor cancellation charges           |                           |                                            | 19,888    |               |         |              | 17,291    |        
|                                               | Accrued restructuring                         |                           |                                            | 7,435     |               |         |              | 8,197     |        
|                                               | Other accrued liabilities                     |                           |                                            | 11,288    |               |         |              | 14,015    |        
|                                               | Interest payable on long-term debt            |                           |                                            | 542       |               |         |              | 3,273     |        
|                                               | Current portion of capital lease obligations  |                           |                                            | 164       |               |         |              | 126       |        
|                                               |                                               |                           |                                            |           |               |         |              |          
|                                               |                                               | Total current liabilities |                                            |           | 77,820        |         |              |           | 107,701 |        
|Long-term portion of capital lease obligations |                                               |                           | 101                                        |           |               |         | 233          |          
|Long-term obligations                          |                                               |                           | 3,483                                      |           |               |         | 4,267        |          
|Convertible subordinated notes                 |                                               |                           | 65,081                                     |           |               |         | 174,141      |          
|Commitments and contingencies                  |                                               |                           |                                            |           |               |         |              |          
|Stockholders equity:                          |                                               |                           |                                            |           |               |         |              |          
|                                               | Common stock                                  |                           |                                            | 73        |               |         |              | 73        |        
|                                               | Additional paid in capital                    |                           |                                            | 1,077,800 |               |         |              | 1,074,203 |        
|                                               | Accumulated deficit                           |                           |                                            | (916,741  | )             |         |              | (892,994  | )      
|                                               | Deferred compensation                         |                           |                                            | (40       | )             |         |              | (458      | )      
|                                               | Treasury stock, at cost                       |                           |                                            | (773      | )             |         |              | (768      | )      
|                                               | Accumulated other comprehensive (loss) income |                           |                                            | (3,548    | )             |         |              | 248       |        
|                                               |                                               |                           |                                            |           |               |         |              |          
|                                               |                                               |                           | Total stockholders equity                 |           |               | 156,771 |              |           |         | 180,304 | 
|                                               |                                               |                           |                                            |           |               |         |              |          
|                                               |                                               |                           | Total liabilities and stockholders equity |           | $             | 303,256 |              |           | $       | 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 |         | Nine Months Ended
|                                                             |                                            |   | September 30,      |         | September 30,    
|                                                             |                                            |   |                    |         |                  
|                                                             |                                            |   | 2002               |         | 2001              |   | 2002    |        | 2001
|                                                             |                                            |   |                    |         |                   |   |         |        |     
|Revenues:                                                    |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Product revenues                                             |                                            | $ | 23,983             |         |                   | $ | 71,145  |        |      | $ | 97,785  |         |   | $ | 155,152  |         
|Related party product revenues                               |                                            |   | 492                |         |                   |   | 8,458   |        |      |   | 6,315   |         |   |   | 44,168   |         
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Total revenues                             |   |                    | 24,475  |                   |   |         | 79,603 |      |   |         | 104,100 |   |   |          | 199,320  |  
|Cost of goods sold:                                          |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Cost of product revenues                   |   |                    | 23,872  |                   |   |         | 63,716 |      |   |         | 72,880  |   |   |          | 177,223  |  
|                                                             | Cost of related party product revenues     |   |                    | 307     |                   |   |         | 5,519  |      |   |         | 5,460   |   |   |          | 28,329   |  
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Total cost of goods sold                   |   |                    | 24,179  |                   |   |         | 69,235 |      |   |         | 78,340  |   |   |          | 205,552  |  
|Gross profit (loss)                                          |                                            |   | 296                |         |                   |   | 10,368  |        |      |   | 25,760  |         |   |   | (6,232   | )       
|Operating expenses:                                          |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Research and development                   |   |                    | 14,315  |                   |   |         | 20,163 |      |   |         | 45,959  |   |   |          | 61,942   |  
|                                                             | Sales and marketing                        |   |                    | 9,026   |                   |   |         | 16,105 |      |   |         | 28,020  |   |   |          | 47,922   |  
|                                                             | General and administrative                 |   |                    | 4,467   |                   |   |         | 8,086  |      |   |         | 11,653  |   |   |          | 24,697   |  
|                                                             | Goodwill amortization                      |   |                    |        |                   |   |         | 149    |      |   |         |        |   |   |          | 22,953   |  
|                                                             | Restructuring costs and asset write-offs   |   |                    | 4,950   |                   |   |         | 5,301  |      |   |         | 8,922   |   |   |          | 582,594  |  
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Total operating expenses                   |   |                    | 32,758  |                   |   |         | 49,804 |      |   |         | 94,554  |   |   |          | 740,108  |  
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Loss from operations                                         |                                            |   | (32,462            | )       |                   |   | (39,436 | )      |      |   | (68,794 | )       |   |   | (746,340 | )       
|Interest income                                              |                                            |   | 1,526              |         |                   |   | 3,341   |        |      |   | 5,636   |         |   |   | 14,587   |         
|Interest expense                                             |                                            |   | (990               | )       |                   |   | (2,351  | )      |      |   | (5,347  | )       |   |   | (12,399  | )       
|Other income (expense)                                       |                                            |   | 268                |         |                   |   | (698    | )      |      |   | (4,197  | )       |   |   | (819     | )       
|Gain on early retirement of debt                             |                                            |   | 15,813             |         |                   |   | 51,834  |        |      |   | 49,089  |         |   |   | 173,328  |         
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|                                                             | Income (loss) before tax (expense)
benefit |   |                    | (15,845 | )                 |   |         | 12,690 |      |   |         | (23,613 | ) |   |          | (571,643 | )
|Income tax (expense) benefit                                 |                                            |   | (127               | )       |                   |   | 392     |        |      |   | (134    | )       |   |   | 14,021   |         
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Net income (loss)                                            |                                            | $ | (15,972            | )       |                   | $ | 13,082  |        |      | $ | (23,747 | )       |   | $ | (557,622 | )       
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Basic net income (loss) per share                            |                                            | $ | (0.22              | )       |                   | $ | 0.19    |        |      | $ | (0.33   | )       |   | $ | (8.23    | )       
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Diluted net income (loss) per share                          |                                            | $ | (0.22              | )       |                   | $ | 0.19    |        |      | $ | (0.33   | )       |   | $ | (8.23    | )       
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Shares used in computing basic net
income (loss) per share   |                                            |   | 73,122             |         |                   |   | 68,181  |        |      |   | 72,828  |         |   |   | 67,723   |         
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         
|Shares used in computing diluted net
income (loss) per share |                                            |   | 73,122             |         |                   |   | 69,632  |        |      |   | 72,828  |         |   |   | 67,723   |         
|                                                             |                                            |   |                    |         |                   |   |         |        |      |   |         |         |   |   |          |         

See accompanying notes.





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

|                                                                            |                                                 |   |                   |         |      |   |          |          |  
|--------------------------------------------------------------------------- | ----------------------------------------------- | - | ----------------- | ------- | ---- | - | -------- | -------- | -
|                                                                            |                                                 |   | Nine Months Ended
|                                                                            |                                                 |   | September 30,    
|                                                                            |                                                 |   |                  
|                                                                            |                                                 |   | 2002              |         | 2001
|                                                                            |                                                 |   |                   |         |     
|Operating activities:                                                       |                                                 |   |                   |         |      |   |          |         
|Net loss                                                                    |                                                 | $ | (23,747           | )       |      | $ | (557,622 | )       
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                 |   |                   |         |      |   |          |         
|                                                                            | Depreciation and amortization                   |   |                   | 9,059   |      |   |          | 13,082   |  
|                                                                            | Write-off and amortization of intangible assets |   |                   | 3,972   |      |   |          | 615,447  |  
|                                                                            | Amortization related to stock options           |   |                   | 469     |      |   |          | 3,647    |  
|                                                                            | Gain on early retirement of debt                |   |                   | (49,088 | )    |   |          | (175,828 | )
|                                                                            | Lower
of cost or market inventory provision     |   |                   | 6,135   |      |   |          |         |  
|                                                                            | Impairment
of investment                        |   |                   | 4,500   |      |   |          |         |  
|                                                                            | Write-off
of fixed assets                       |   |                   | 2,257   |      |   |          |         |  
|                                                                            | Interest payable                                |   |                   | 5,656   |      |   |          | 11,821   |  
|Changes in operating assets and liabilities:                                |                                                 |   |                   |         |      |   |          |         
|                                                                            | Accounts receivable                             |   |                   | 20,160  |      |   |          | 15,526   |  
|                                                                            | Accounts receivable from related parties        |   |                   | 3,558   |      |   |          | (9,809   | )
|                                                                            | Interest paid                                   |   |                   | (8,387  | )    |   |          | (21,395  | )
|                                                                            | Inventory                                       |   |                   | 5,856   |      |   |          | 55,732   |  
|                                                                            | Other assets                                    |   |                   | (6,253  | )    |   |          | 19,991   |  
|                                                                            | Accounts payable                                |   |                   | (21,701 | )    |   |          | (75,190  | )
|                                                                            | Accrued payroll and related expenses            |   |                   | (3,334  | )    |   |          | (322     | )
|                                                                            | Deferred revenues                               |   |                   | (2,994  | )    |   |          | (1,583   | )
|                                                                            | Accrued warranty                                |   |                   | 1,733   |      |   |          | 2,547    |  
|                                                                            | Accrued restructuring                           |   |                   | (762    | )    |   |          | 7,449    |  
|                                                                            | Accrued vendor cancellation charges             |   |                   | 2,597   |      |   |          | 15,392   |  
|                                                                            | Deferred taxes                                  |   |                   |        |      |   |          | (18,565  | )
|                                                                            | Other accrued liabilities                       |   |                   | (6,142  | )    |   |          | (14,041  | )
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Net cash used in operating activities                                       |                                                 |   | (56,456           | )       |      |   | (113,721 | )       
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Investing activities:                                                       |                                                 |   |                   |         |      |   |          |         
|Purchases of investments                                                    |                                                 |   | (236,081          | )       |      |   | (279,085 | )       
|Proceeds from sales and maturities of investments                           |                                                 |   | 379,966           |         |      |   | 309,531  |         
|Purchases of property and equipment                                         |                                                 |   | (5,855            | )       |      |   | (10,239  | )       
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Net cash provided by investing activities                                   |                                                 |   | 138,030           |         |      |   | 20,207   |         
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Financing activities:                                                       |                                                 |   |                   |         |      |   |          |         
|Principal payments on capital leases                                        |                                                 |   | (94               | )       |      |   | (348     | )       
|Principal payments on long-term obligations                                 |                                                 |   |                  |         |      |   | (103     | )       
|Payments on repurchase of common stock                                      |                                                 |   | (5                | )       |      |   |         |         
|Exercise of options to purchase common stock                                |                                                 |   | 1,708             |         |      |   | 3,003    |         
|Proceeds from issuance of common stock through employee stock purchase
plan |                                                 |   | 1,838             |         |      |   |         |         
|Principal payment on stockholders note receivable                          |                                                 |   |                  |         |      |   | 3        |         
|Retirement of debt                                                          |                                                 |   | (57,627           | )       |      |   | (113,428 | )       
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Net cash used in financing activities                                       |                                                 |   | (54,180           | )       |      |   | (110,873 | )       
|Effect of exchange rate changes                                             |                                                 |   | 942               |         |      |   | (715     | )       
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Net decrease in cash and cash equivalents                                   |                                                 |   | 28,336            |         |      |   | (205,102 | )       
|Cash and cash equivalents at beginning of period                            |                                                 |   | 100,274           |         |      |   | 347,015  |         
|                                                                            |                                                 |   |                   |         |      |   |          |         
|Cash and cash equivalents at end of period                                  |                                                 | $ | 128,610           |         |      | $ | 141,913  |         
|                                                                            |                                                 |   |                   |         |      |   |          |         

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 data, voice and video 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 September 30, 2002 and for the three and nine months ended
September 30, 2002 and 2001 have been included.

Results for the three and nine months ended September 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 subsidiaries. All intercompany balances and
transactions have been eliminated.

Inventory and Purchase Obligations

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





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|                |  |               |       |              |  |   |        | 
|--------------- |  | ------------- | ----- | ------------ |  | - | ------ | 
|                |  | September 30, |       | December 31,
|                |  | 2002          |       | 2001        
|                |  |               |       |             
|Finished goods  |  | $             | 5,688 |              |  | $ | 6,433  | 
|Work-in-process |  |               | 378   |              |  |   | 236    | 
|Raw materials   |  |               | 2,967 |              |  |   | 9,989  | 
|                |  |               |       |              |  |   |        | 
|                |  | $             | 9,033 |              |  | $ | 16,658 | 
|                |  |               |       |              |  |   |        | 

The Company has purchase obligations to certain of its suppliers that
support the Companys ability to manufacture its products. The obligations
require the Company to purchase minimum quantities of the suppliers products
at a specified price. Cost of goods sold for the three and nine months ended September 30, 2002
included a reversal of $0.6 million and $13.1 million, respectively, in special
charges taken in 2001 for vendor cancellation charges and inventory considered
to be excess and obsolete. The Company was able to reverse the provision in
2002 as it was able to sell inventory originally considered to be excess and
obsolete. In addition, the Company was able to negotiate downward certain
vendor cancellation claims to terms more favorable to the Company. During the
three and nine months ended September 30, 2001, the Company
recorded special charges of $6.4 million and $35.1 million,
respectively, relating to vendor cancellation fees
as well as inventory obsolescence.

In the three and nine months ended September 30, 2002, the Company
recorded an inventory reserve of $1.6 million and $6.1 million, respectively,
to reduce certain inventories to the lower of cost or market as average selling
prices fell below the cost of these products.

As of September 30, 2002, the Company had $54.9 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.

Net Income (Loss) Per Share

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

|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |          |   |   | 
|----------------------------------- | ----------------------------------------------------------- | ------------------------------ | ----------------------------------------------------- | ------- | ------------------ | - | ----------------- | ------ | ---- | ----- | ----- | ------- | - | - | ----- | -------- | - | - | 
|                                    |                                                             |                                |                                                       |         | Three Months Ended |   | Nine Months Ended
|                                    |                                                             |                                |                                                       |         | September 30,      |   | September 30,    
|                                    |                                                             |                                |                                                       |         |                    |   |                  
|                                    |                                                             |                                |                                                       |         | 2002               |   | 2001              |        | 2002 |       | 2001 
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |      
|                                    | Net income (loss)                                           |                                | $                                                     | (15,972 | )                  |   | $                 | 13,082 |      |       | $     | (23,747 | ) |   | $     | (557,622 | )
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         
|Denominator:                        |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         
|                                    | Basic weighted average shares of
common stock outstanding   |                                |                                                       | 73,122  |                    |   |                   | 68,181 |      |       |       | 72,828  |   |   |       | 67,723   |  
|                                    |                                                             | Effect of dilutive securities: |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |          |   |  
|                                    |                                                             |                                | Common stock options and
shares subject to repurchase |         |                    |  |                   |        |      | 1,214 |       |         |   |  |       |          |   |  | 
|                                    |                                                             |                                | Warrants                                              |         |                    |  |                   |        |      | 237   |       |         |   |  |       |          |   |  | 
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         
|                                    | Diluted weighted average shares of
common stock outstanding |                                |                                                       | 73,122  |                    |   |                   | 69,632 |      |       |       | 72,828  |   |   |       | 67,723   |  
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         
|Basic net income (loss) per share   |                                                             | $                              | (0.22                                                 | )       |                    | $ | 0.19              |        |      | $     | (0.33 | )       |   | $ | (8.23 | )       
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         
|Diluted net income (loss) per share |                                                             | $                              | (0.22                                                 | )       |                    | $ | 0.19              |        |      | $     | (0.33 | )       |   | $ | (8.23 | )       
|                                    |                                                             |                                |                                                       |         |                    |   |                   |        |      |       |       |         |   |   |       |         





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For the three and nine months ended September 30, 2002 and the nine months
ended September 30, 2001, potentially dilutive options and warrants of
approximately 257,000 539,000 and 1,311,000 shares, respectively, were excluded
from the calculation since the effect was antidilutive.

For the three and nine months ended September 30, 2002 and September 30,
2001, potentially dilutive outstanding convertible debt, which is convertible
into shares of the Companys common stock, of approximately 914,000, 1,589,000,
2,382,000 and 3,468,000 shares, respectively, were excluded from the
calculation since the effect was 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 |        | Nine Months Ended
|                                      |                                                                     |   | September 30,      |        | September 30,    
|                                      |                                                                     |   |                    |        |                  
|                                      |                                                                     |   | 2002               |        | 2001              |   | 2002   |     | 2001
|                                      |                                                                     |   |                    |        |                   |   |        |     |     
|Net income (loss)                     |                                                                     | $ | (15,972            | )      |                   | $ | 13,082 |     |      | $ | (23,747 | )      |   | $ | (557,622 | )    
|                                      | Cumulative translation adjustments                                  |   |                    | (1,380 | )                 |   |        | (94 | )    |   |         | (2,937 | ) |   |          | (716  | )
|                                      | Change in unrealized gain (loss)
on available- for-sale investments |   |                    | (361   | )                 |   |        | 813 |      |   |         | (859   | ) |   |          | 1,163 |  
|                                      |                                                                     |   |                    |        |                   |   |        |     |      |   |         |        |   |   |          |      
|Total comprehensive net income (loss) |                                                                     | $ | (17,713            | )      |                   | $ | 13,801 |     |      | $ | (27,543 | )      |   | $ | (557,175 | )    
|                                      |                                                                     |   |                    |        |                   |   |        |     |      |   |         |        |   |   |          |      

Impact of Recently Issued Accounting Standards

Statement of Financial Accounting Standards (SFAS) 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 effect of adoption of SFAS No. 146 is dependent on the Companys related
activities subsequent to the date of adoption.

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 No. 145. Accordingly, the Company is now reporting its
gain from retirement of its Convertible Subordinated Notes in operations
instead of as an extraordinary item. All prior periods reflect the adoption of
SFAS No. 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





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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 the Company effective January 1, 2002. See Note 6.

In June 2001, FASB issued SFAS No. 141 (SFAS 141), Business Combinations
and 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 definite 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 income
(loss) and net income (loss) per share assuming the adoption of SFAS No. 142
had occurred on January 1, 2001 (in thousands):

|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |        |       |          |  
|---------------------------------------------- | ------------------------------------------------------------------------------------------ | ------------------------------------- | --------------------------- | ----- | ------------------ | ------- | ----------------- | ----- | ---- | ------ | ------- | ----- | ----- | ------- | -------- | ------ | ----- | -------- | -
|                                               |                                                                                            |                                       |                             |       | Three Months Ended |         | Nine Months Ended
|                                               |                                                                                            |                                       |                             |       | September 30,      |         | September 30,    
|                                               |                                                                                            |                                       |                             |       |                    |         |                  
|                                               |                                                                                            |                                       |                             |       | 2002               |         | 2001              |       | 2002 |        | 2001   
|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |        
|                                               |                                                                                            |                                       |                             |       | (Pro forma)        |         | (Pro forma)      
|                                               |                                                                                            |                                       |                             |       |                    |         |                  
|Reported net income (loss)                     |                                                                                            | $                                     | (15,972                     | )     |                    | $       | 13,082            |       |      | $      | (23,747 | )     |       | $       | (557,622 | )     
|                                               | Amortization of goodwill and
intangible assets with indefinite
lives                       |                                       |                             |      |                    |         |                   | 2,667 |      |        |         |      |       |         |          | 36,030 |      
|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |       
|                                               |                                                                                            |                                       | Pro forma net income (loss) |       | $                  | (15,972 | )                 |       | $    | 15,749 |         |       | $     | (23,747 | )        |        | $     | (521,592 | )
|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |       
|Basic and diluted net income (loss)
per share: |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |       
|                                               | Reported net income (loss)                                                                 |                                       | $                           | (0.22 | )                  |         | $                 | 0.19  |      |        | $       | (0.33 | )     |         | $        | (8.23  | )    
|                                               | Adjustment related to
amortization of goodwill and
intangible assets with indefinite
lives |                                       |                             |      |                    |         |                   | 0.04  |      |        |         |      |       |         |          | 0.53   |      
|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |       
|                                               |                                                                                            | Pro forma net income (loss) per share |                             | $     | (0.22              | )       |                   | $     | 0.23 |        |         | $     | (0.33 | )       |          | $      | (7.70 | )       
|                                               |                                                                                            |                                       |                             |       |                    |         |                   |       |      |        |         |       |       |         |          |       

2. Commitments

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.

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 argument
on the motion occurred on December 17, 2001. On March 29, 2002, the court
denied the defendants motion to dismiss. The parties are now in the discovery
process. In addition, plaintiffs have moved for class certification, and
defendants have opposed certain aspects of that motion.

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

On October 16, 2000, a lawsuit was filed against the Company and the
individual defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the
California Superior





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Court, San Luis Obispo County. This lawsuit is titled
Bertram v. Terayon Communications Systems, Inc. (Bertram). The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action for
unlawful business practices, unfair and fraudulent business practices, and
false and misleading advertising. Plaintiffs purport to bring the action on
behalf of themselves and as representatives of all persons or entities in the
State of California and such other persons or entities outside California that
have been and are adversely affected by defendants activity, and as the Court
shall determine is not inconsistent with the exercise of the Courts
jurisdiction. Plaintiffs seek equitable and injunctive relief. Defendants
removed the Bertram case to the United States District Court, Central District
of California and, on January 19, 2001, filed a motion to dismiss the
complaint. A hearing on defendants motion was held March 26, 2001 and the
court granted Defendants motion to dismiss the action and denied Plaintiffs
motion requesting remand. On April 5, 2001, Defendants moved for an order
requiring further proceedings, if any to take place in the Northern District of
California. Plaintiffs did not oppose this motion and eventually entered into a
stipulation to go forward in the Northern District. On July 9, 2001, a status
conference was held in this case before Judge Patel. Plaintiffs did not appear
for the conference, and the court requested that defendants submit an order
dismissing the Bertram action with prejudice, which the defendants have
submitted to the court. On August 7, 2002, the court held another conference
at which it entered an order dismissing the Bertramcase. The courts order
permits the individual plaintiffs in the Bertramcase to pursue any claims that
they may have as members of the purported class in the related, consolidated
class action discussed above. Plaintiffs have appealed this order.

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

On May 7, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of 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.

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 plaintiff in the OBriencase has dismissed the investor
defendants without prejudice.

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

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



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##### Table of Contents



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 System, TJ line
of DOCSIS cable modems, BW line of DOCSIS Cable Modem Termination Systems
(CMTS), and the CherryPicker family of Digital Video Management Systems that are sold
primarily to cable operators for the deployment of data, video and voice
services over the existing cable infrastructure. The Telecom segment 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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##### Table of Contents



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

|                                  |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |          |         | 
|--------------------------------- | ------------------------------------- | ----- | ------- | ------------------ | ------ | ----------------- | ------ | ------- | ------ | ---- | ------- | ------- | ------- | - | -------- | -------- | ------- | 
|                                  |                                       |       |         | Three Months Ended |        | Nine Months Ended
|                                  |                                       |       |         | September 30,      |        | September 30,    
|                                  |                                       |       |         |                    |        |                  
|                                  |                                       |       |         | 2002               |        | 2001              |        | 2002    |        | 2001
|                                  |                                       |       |         |                    |        |                   |        |         |        |     
|Cable Broadband Access Segment:   |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|                                  | Revenues                              |       | $       | 22,006             |        |                   | $      | 72,223  |        |      | $       | 95,834  |         |   | $        | 174,519  |        
|                                  | Operating loss                        |       | $       | (28,214            | )      |                   | $      | (27,038 | )      |      | $       | (58,111 | )       |   | $        | (454,660 | )      
|Telecom Broadband Access Segment: |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|                                  | Revenues                              |       | $       | 2,469              |        |                   | $      | 7,380   |        |      | $       | 8,266   |         |   | $        | 24,801   |        
|                                  | Operating loss                        |       | $       | (4,248             | )      |                   | $      | (12,398 | )      |      | $       | (10,683 | )       |   | $        | (291,680 | )      
|Operating income (loss):          |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|                                  | Operating loss by reportable segments |       | $       | (32,462            | )      |                   | $      | (39,436 | )      |      | $       | (68,794 | )       |   | $        | (746,340 | )      
|                                  | Unallocated amounts:                  |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |          |        
|                                  | Interest and other income, net        |       |         | 804                |        |                   |        | 292     |        |      |         | (3,908  | )       |   |          | 1,369    |        
|                                  | Gain on early retirement of debt      |       |         | 15,813             |        |                   |        | 51,834  |        |      |         | 49,089  |         |   |          | 173,328  |        
|                                  | Income tax (expense) benefit          |       |         | (127               | )      |                   |        | 392     |        |      |         | (134    | )       |   |          | 14,021   |        
|                                  |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|Net income (loss)                 |                                       | $     | (15,972 | )                  |        | $                 | 13,082 |         |        | $    | (23,747 | )       |         | $ | (557,622 | )       
|                                  |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|Geographic areas:                 |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|Revenues:                         |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|                                  | United States                         |       | $       | 12,049             |        |                   | $      | 4,587   |        |      | $       | 28,940  |         |   | $        | 37,816   |        
|                                  | Canada                                |       |         | 1,440              |        |                   |        | 41,628  |        |      |         | 11,448  |         |   |          | 77,698   |        
|                                  | Europe and Israel                     |       |         | 2,766              |        |                   |        | 18,019  |        |      |         | 15,340  |         |   |          | 35,719   |        
|                                  | Asia                                  |       |         | 7,671              |        |                   |        | 15,123  |        |      |         | 47,387  |         |   |          | 47,311   |        
|                                  | South America                         |       |         | 549                |        |                   |        | 246     |        |      |         | 985     |         |   |          | 776      |        
|                                  |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         
|                                  |                                       | Total |         | $                  | 24,475 |                   |        | $       | 79,603 |      |         | $       | 104,100 |   |          | $        | 199,320 | 
|                                  |                                       |       |         |                    |        |                   |        |         |        |      |         |         |         |   |          |         

|                   |                                  |                      |              |         |         |               |   |              |         |         |  | 
|------------------ | -------------------------------- | -------------------- | ------------ | ------- | ------- | ------------- | - | ------------ | ------- | ------- |  | 
|                   |                                  |                      |              |         |         | September 30, |   | December 31,
|                   |                                  |                      |              |         |         | 2002          |   | 2001        
|                   |                                  |                      |              |         |         |               |   |             
|Assets:            |                                  |                      |              |         |         |               |   |             
|                   | Cable Broadband Access Segment   |                      | $            | 300,058 |         |               | $ | 455,836      |        
|                   | Telecom Broadband Access Segment |                      |              | 3,198   |         |               |   | 10,810       |        
|                   |                                  |                      |              |         |         |               |   |             
|                   |                                  |                      | Total assets |         | $       | 303,256       |   |              | $       | 466,646 | 
|                   |                                  |                      |              |         |         |               |   |             
|Long-lived assets: |                                  |                      |              |         |         |               |   |             
|                   | United States                    |                      | $            | 30,303  |         |               | $ | 36,106       |        
|                   | Canada                           |                      |              | 575     |         |               |   | 256          |        
|                   | Europe and Israel                |                      |              | 2,215   |         |               |   | 4,145        |        
|                   | Asia                             |                      |              | 235     |         |               |   | 243          |        
|                   | South America                    |                      |              | 116     |         |               |   | 2,020        |        
|                   |                                  |                      |              |         |         |               |   |             
|                   | Total Long-lived assets          |                      |              | 33,444  |         |               |   | 42,770       |        
|                   |                                  | Total current assets |              |         | 269,812 |               |   |              | 423,876 |        
|                   |                                  |                      |              |         |         |               |   |             
|                   |                                  |                      | Total Assets |         | $       | 303,256       |   |              | $       | 466,646 | 
|                   |                                  |                      |              |         |         |               |   |             

Two customers accounted for 10% or more of total revenues (25% and 14%)
for the three months ended September 30, 2002. Three customers accounted for
10% or more of total revenues (41%, 11% and 10%) for the three months ended
September 30, 2001. One customer accounted for 10% or more of total revenues
(32%) for the nine months ended September 30, 2002. Two customers accounted
for 10% or





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more of total revenues (23% and 10%) for the nine months ended September
30, 2001. No other customer accounted for more than 10% of revenues during
these periods.

5. Restructuring Charges and Asset Write-offs

Restructuring

During the third quarter of 2002, the Companys Board of Directors
approved a new restructuring plan. The Company incurred restructuring charges
in the amount of $3.6 million of which $2.3 million related to employee
termination costs and the remaining $1.3 million related to costs for excess
leased facilities. At September 30, 2002, restructuring charges of $1.6
million remain accrued. As of September 30, 2002, 139 employees have been
terminated and the Company paid $2.0 million in termination costs. The Company
anticipates that the remaining employee termination costs related to an
additional 14 employees will be substantially paid in the fourth quarter of
2002. The Company anticipates the remaining restructuring accrual, primarily
relating to excess leased facilities will be utilized for servicing operating
lease payments or negotiated buyout of operating lease commitments, through
2005.

A summary of the 2002 accrued restructuring charges is as follows (in
millions):

|                              |  |              |      |                     |  |               |     |  |  |   |      |  
|----------------------------- |  | ------------ | ---- | ------------------- |  | ------------- | --- |  |  | - | ---- | -
|                              |  |              |      |                     |  | Excess Leased |     |  |  |  
|                              |  | Involuntary  |      | Facilities and      |  |               |     | 
|                              |  | Terminations |      | Cancelled Contracts |  | Total        
|                              |  |              |      |                     |  |              
|Total Charge                  |  | $            | 2.3  |                     |  | $             | 1.3 |  |  | $ | 3.6  |  
|Cash Payments                 |  |              | (2.0 | )                   |  |               |    |  |  |   | (2.0 | )
|                              |  |              |      |                     |  |               |     |  |  |   |      |  
|Balance at September 30, 2002 |  | $            | 0.3  |                     |  | $             | 1.3 |  |  | $ | 1.6  |  
|                              |  |              |      |                     |  |               |     |  |  |   |      |  

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 $9.1 million in the
first nine 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 September 30, 2002, restructuring
charges of $5.8 million remain accrued 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.

In the three and nine months ended September 30, 2002, the Company
reclassified $0.1 million and $1.1 million, respectively, which had originally
been accrued for as employee termination costs to accrued excess lease facility
costs due to a revision in estimate.

The following table summarizes the costs and activities during the first
nine months of fiscal 2002, related to the 2001 restructuring (in millions):





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|                              |  |              |      |                |  |               |      |   |  |   |      |  
|----------------------------- |  | ------------ | ---- | -------------- |  | ------------- | ---- | - |  | - | ---- | -
|                              |  |              |      |                |  | Excess Leased |      |   |  |  
|                              |  |              |      | Facilities and |  |               |      |  
|                              |  | Involuntary  |      | Cancelled      |  |               |      |  
|                              |  | Terminations |      | Contracts      |  | Total        
|                              |  |              |      |                |  |              
|Balance at December 31, 2001  |  | $            | 1.2  |                |  | $             | 7.0  |   |  | $ | 8.2  |  
|Additions                     |  |              |     |                |  |               |     |   |  |   |     |  
|Cash Payments                 |  |              | (0.1 | )              |  |               | (2.3 | ) |  |   | (2.4 | )
|Reclassification              |  |              | (1.1 | )              |  |               | 1.1  |   |  |   |     |  
|                              |  |              |      |                |  |               |      |   |  |   |      |  
|Balance at September 30, 2002 |  | $            |     |                |  | $             | 5.8  |   |  | $ | 5.8  |  
|                              |  |              |      |                |  |               |      |   |  |   |      |  

Asset Write-offs

During the three and
nine months ended September 30, 2002, the Company wrote-off $1.4 million and $2.2 million, respectively, of fixed assets which were determined to have no remaining useful
life. During the
third quarter of 2001, $1.6 million related to fixed assets acquired from ANE
were determined to have no remaining useful life and were written-off.

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
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 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 nine 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 three and nine months ended September 30, 2001, the Company
repurchased approximately $104.3 million and $299.9 million, respectively, of
Convertible Subordinated Notes (Notes) for $45.0 million and $113.4 million,
respectively, in cash, resulting in a gain of approximately $51.8 million and
$173.3 million, respectively, net of related unamortized issuance costs and
accrued taxes of $7.5 million and $13.2 million, respectively. 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 is now reporting its gain from retirement of
its Notes in its results of operations. All prior periods reflect the adoption
of SFAS No. 145.

In the first three and nine months of 2002, the Company repurchased
approximately $35.1 million and $109.1 million, respectively, of Notes for
$18.4 million and $57.6 million, respectively, in cash, resulting in a gain
included in operations of approximately $15.8 million and $49.1 million,
respectively, net of related unamortized issuance costs of $0.9 million and
$2.4 million, respectively.





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8. Advertising

In December 2001, the Company entered into co-marketing arrangements with
Shaw Communications, Inc. (Shaw) and Rogers Communications, Inc. (Rogers), a
related party (see Note 9). The Company paid $7.5 million to Shaw and $0.9
million to Rogers, and recorded these amounts as other current assets. In July
2002, the Company began amortizing these prepaid assets and charging them
against Cable revenues in accordance with EITF 01-09, Accounting for
Consideration given by a Vendor to a Customer or Reseller in Connection with
the Purchase or Promotion of the Vendors Products. The Company will continue
to charge the amortization of these assets against Cable revenues in each of
the next five quarters through December 31, 2003, the term of
the related arrangement, at the rate of $1.4 million per
quarter. Amounts charged against revenues in the third quarter of 2002 totaled
approximately $1.4 million.

9. 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. To date, there have been no significant transactions
between the two parties.

10. Investment in Net Servicos de Comunicacao SA

During the third quarter of 2002, the Company received approximately 35.9
million shares of Net Servicos de Comunicacao SA (Net Servicos), a customer,
valued at approximately $2.4 million as settlement for all outstanding accounts
receivables due from Net Servicos. All revenue and the cost of sales relating
to these receivables had been deferred due to extended payment terms offered in
the original sales agreements. The Company recorded a loss on the settlement
of the Net Servicos receivables of $0.9 million, which was charged to cost of
goods sold in the third quarter of 2002.

The shares are classified as available-for-sale and are included in the
balance sheet as short-term investments. The shares of Net Servicos are traded on the Sao Paulo Stock Exchange, and
the share price has traditionally been volatile and subject to significant
price fluctuations. This volatility could result in potential future losses to
the market value of the shares until the Company is able to sell them. The Company expects to liquidate
these shares in the fourth quarter of 2002 and the first quarter of 2003. The
Company expects to record revenue and the related cost of sales as the shares
are sold and cash is received.





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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 data, video, and voice 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 S-CDMA
technology, our TJ line of cable modems based on the DOCSIS specification, our
BW line of DOCSIS Cable Modem Termination Systems (CMTS), our CherryPicker
family of digital video management system. These products 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 $23.7 million for the nine months ended
September 30, 2002. We had an accumulated deficit of $916.7 million as of
September 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 $9 million on capital expenditures and
approximately $60 million to $62 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.

Critical Accounting Policies

There have been no material changes to our critical accounting policies
and estimates as disclosed in our report on Form 10-K for the year ended
December 31, 2001 except as follows:

Goodwill.On January 1, 2002, we adopted SFAS No. 142, Goodwill and
Other Intangible Assets. 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.

Due to a difficult economic environment and heightened price competition
in the modem and telecom businesses during the second quarter of 2002, we
experienced a significant drop in our market capitalization, and therefore
proceeded to perform an interim test to measure goodwill and intangible assets
for impairment. 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 during the
second quarter of 2002.

Results of Operations





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Three Months and Nine Months Ended September 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 69% to $24.5
million for the three months ended September 30, 2002 from $79.6 million in
2001 and decreased 48% to $104.1 million for the nine months ended September
30, 2002 from $199.3 million in 2001. Revenues from Cable were $22.0 million
during the three months ended September 30, 2002, down 70% from $72.2 million
for the same period in 2001 and $95.8 million in the first nine months of 2002,
down 45% from $174.5 million in 2001. Our decrease in Cable revenues reflects
the challenge of transitioning from our products to standards-based products
during a period of difficult market conditions including significant declines
in the Average Selling Prices (ASPs) of our 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.

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

Revenues from Telecom were $2.5 million during the three months ended
September 30, 2002, down 67% from $7.4 million for the same period in 2001 and
$8.3 million in the first nine months of 2002, down 67% from $24.8 million in
2001. Our telecom business revenues in the third 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, freight and warehousing, inventory provisions,
and associated costs of personnel and equipment. In the three months ended
September 30, 2002, cost of goods sold decreased by 65% to $24.2 million
compared to $69.2 million in 2001. This decrease in cost of goods sold is
primarily due to the decrease in revenues in 2002, special charges of $6.4
million in the third quarter of 2001, a reversal of special charges of $0.6
million in the third quarter of 2002 as we were able to sell inventory
originally considered to be in excess and obsolete, and approximately $0.9 million of
amortization of acquired intangible assets recorded in the third quarter of
2001. In the third quarter of 2002, we recorded additional inventory reserves
of $1.6 million to reduce certain inventories to the lower of cost or market.

During the third quarter of 2002, we received approximately 35.9 million
shares of Net Servicos de Comunicacao SA (Net Servicos), a customer, valued at
approximately $2.4 million as settlement for all outstanding accounts
receivables due from Net Servicos to us. All revenue and the cost of sales
relating to these receivables had been deferred due to extended payment terms
offered in the original sales agreement. We recorded a loss on the settlement
of the Net Servicos receivables of $0.9 million, which was charged to
cost of goods sold in the third quarter of 2002. The shares of Net Servicos are traded on the Sao Paulo Stock Exchange, and
the share price has traditionally been volatile and subject to significant
price fluctuations. This volatility could result in potential future losses to
the market value of the shares until we are able to sell them. We expect to record
revenue and the related cost of sales as the shares are sold for cash in the
fourth quarter of 2002 and the first quarter of 2003.





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##### Table of Contents



In the nine months ended September 30, 2002, cost of goods sold decreased
by 62% to $78.3 million compared to $205.6 million in 2001. Cost of goods sold
for the nine months ended September 30, 2002 included a reversal of
approximately $13.1 million in special charges taken in 2001 for vendor
cancellation charges and inventory previously reserved for excess and obsolete.
We reversed the provision, as we were able to sell inventory originally
considered to be in excess and obsolete. In addition, we were able to
negotiate downward certain vendor cancellation claims to terms more favorable
to us than originally anticipated. Cost of goods sold for the nine months
ended September 30, 2001 also included special charges of $35.1 million and
approximately $13.3 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 three months ended September 30, 2002, increased as a percentage of sales
due to certain fixed indirect product costs which are allocated to a smaller
revenue base as well as a higher percentage of revenue attributable to lower
margin cable modems. During the nine months ended September 30, 2002, our cost
of goods sold, excluding the effects of special charges in 2002 and 2001 and
the amortization of acquired intangible assets in 2001, decreased as a
percentage of sales primarily due to sales of higher margin head-end and video
products in the first quarter of 2002.

Gross Profit
(Loss). We achieved a gross profit of $0.3 million or 1% of
sales for the three months ended September 30, 2002 compared to a gross profit
of $10.4 million or 13% of sales for the three months ended September 30, 2001.
The decrease in gross profit in the three months ended September 30, 2002
compared to the three months ended September 30, 2001 is primarily related to
lower sales volume in the third quarter of 2002.

For the nine months ended September 30, 2002, we achieved a gross profit
of $25.8 million or 25% of sales, compared to a gross loss of $6.2 million for
the nine months ended September 30, 2001. The increase in gross profit is
primarily related to a $13.1 million reversal of special charges in 2002, as
well as sales of higher-margin headend equipment in the first quarter of 2002.
Additionally, in the nine months ended September 30, 2001, we recorded special
charges of $35.1 million and amortization of $13.3 million of acquired
intangible assets, which were not recorded in 2002. Excluding the reversal of
special charges, gross profit for the nine months ended September 30, 2002 was
12% of sales. Excluding special charges and amortization costs, gross profit
for the nine months ended September 30, 2001 was 4% 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, if not offset by
a decrease in our product costs, will likely have an adverse impact on our
operating results through at least 2003.

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 29% to $14.3 million in the three months ended
September 30, 2002 and 26% to $46.0 million in the nine months ended September
30, 2002, compared to $20.2 million in three months ended September 30, 2001
and $61.9 million in the nine months ended September 30, 2001. The decrease in
research and development expenses was primarily related to overall reductions
in research and development spending, particularly through lower headcount and
reductions in prototype development, during 2002. Additionally, in 2001, we
recorded amortization of acquired intangible assets of $1.1 million and $4.3
million in the three and nine months ended September 30, 2001, respectively.
There was no amortization in 2002. We intend to continue our investment in
research and development and expect research and development to
remain relatively flat during the fourth quarter of 2002.

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





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travel. Sales and marketing expenses decreased 44% to $9.0 million in the three months ended September
30, 2002 and 42% to $28.0 million in the nine months ended September 30,
2002, compared to $16.1 million in the three months ended September 30, 2001
and $47.9 million in the nine months ended September 30, 2001. The decrease in
sales and marketing expenses was primarily related to lower headcount due to
reductions in force during late 2001 and the third quarter of 2002.
Additionally, in 2001, we recorded amortization of acquired intangible assets
of $1.9 million and $3.6 million in first three and nine months of 2001,
respectively. There was no amortization in 2002. We expect sales and
marketing expenses to continue to decrease in the fourth quarter 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 45% to $4.5 million for the three months
ended September 30, 2002 and 53% to $11.7 million in the nine months ended
September 30, 2002, compared to $8.1 million in the first three months of 2001
and $24.7 million in the first nine months of 2001. General and administrative
expenses in the first three and nine months of 2001 include $1.1 million and
$3.4 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 slightly in the fourth quarter 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 definite lives will continue to be amortized over their estimated
useful lives. As of September 30, 2002, we have no further goodwill and
intangible assets. No amortization expense was recorded during the three and
nine months ended September 30, 2002. Goodwill arising from acquisitions
accounted for $0.15 million in amortization in the three months ended September
30, 2001 and $23.0 million in amortization in the nine months ended September
30, 2001.

Restructuring Costs and Asset Write-offs. We incurred restructuring
charges of $9.1 million in
the first nine months of 2001. Of the total restructuring charges recorded,
$2.9 million related to employee termination costs covering 293 technical,
production, and administrative employees. The remaining $6.2 million related
primarily to costs for excess leased facilities. During the first nine months
of 2002, we made cash payments of $2.4 million against the restructuring
accrual. In the three and nine months ended September 30, 2002, we
reclassified $0.1 million and $1.1 million, respectively, which had originally
been accrued for as employee termination costs to accrued excess lease facility
costs due to a revision in estimate. As of September 30, 2002, restructuring
charges of $5.8 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.

We incurred additional restructuring charges of $3.6 million in the third
quarter of 2002. Of the total restructuring charge, $2.3 million
is related to
employee termination costs. The remaining $1.3 million relates primarily to
costs for excess leased facilities. During the third quarter ended 2002, 139
employees have been terminated and we made cash payments of $2.0 million
against the restructuring accrual. We anticipate that the remaining employee
termination costs related to an additional 14 employees will be substantially
paid in the fourth quarter of 2002. At September 30, 2002, restructuring
charges of $1.6 million remain accrued, primarily related to excess facility
costs. We anticipate that the termination costs will be substantially paid in
the fourth quarter of 2002. We anticipate utilizing the remaining
restructuring accrual, which relates to servicing operating lease payments or
negotiated buyout of operating lease commitments, through 2005.

During the three and
nine months ended September 30, 2002, we wrote-off
$1.4 million and $2.2 million, respectively, of fixed assets which were
determined to have no remaining useful life. We recorded a charge of $1.6
million in the third quarter of 2001, resulting from the write-down of
impaired assets.

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





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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.

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 second quarter of 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 second quarter of 2002 to write off goodwill in both the Cable
and Telecom segments.

Gain on early
retirement of debt. In the three and nine months ended September
30, 2001, we
repurchased approximately $104.3 million and $299.9 million,
respectively, of our Convertible Subordinated Notes
(Notes) for $45.0 million and $113.4 million, respectively, in
cash, resulting in a gain of approximately $51.8 million and $173.3
million, respectively, net of related unamortized issuance costs and
accrued taxes of $7.5 million and $13.2 million, respectively. 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). Prior to the
adoption of SFAS No. 145 we had reported the gain from early retirement of our
debt as an extraordinary item. Accordingly, we now report our gain from
retirement of our Notes in operations. All prior periods reflect the adoption
of SFAS No. 145. In the first three and nine months of 2002, we repurchased
approximately $35.1 million and $109.1 million, respectively, of our Notes for
$18.4 million and $57.6 million, respectively, in cash, resulting in a gain
included in operations of approximately $15.8 million and $49.1 million,
respectively, net of related unamortized issuance costs of $0.9 million and
$2.4 million, respectively.

Interest Income and Expense. Interest income decreased 54% to $1.5 million
for the three months ended September 30, 2002 and 61% to $5.6 million in the
nine months ended September 30, 2002, compared to $3.3 million and $14.6
million in the comparable periods of 2001. Interest expense, which relates
primarily to interest on our Notes due in 2007, decreased 58% to $1.0 million
for the three months ended September 30, 2002 and 57% to $5.3 million in the
nine months ended September 30, 2002, compared to $2.4 million and $12.4
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 $109.1 million of the Notes in the first nine
months of 2002 and to the use of cash for operations.

Other income and expense. During the second quarter of 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 $0.1 million
during the three and nine months ended September 30, 2002. During the three
and nine months ended September 30, 2001 we had a benefit for income taxes of
$0.4 million and $14.0 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 $0.5 million provision for foreign taxes.





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Litigation

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

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

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

On October 16, 2000, a lawsuit was filed against us and the individual
defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the California
Superior Court, San Luis Obispo County. This lawsuit is titled Bertram v.
Terayon Communications Systems, Inc. (Bertram). The Bertram complaint contains
factual allegations similar to those alleged in the federal securities class
action lawsuit. The complaint asserts causes of action for unlawful business
practices, unfair and fraudulent business practices, and false and misleading
advertising. Plaintiffs purport to bring the action on behalf of themselves and
as representatives of all persons or entities in the State of California and
such other persons or entities outside California that have been and are
adversely affected by 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. On August 7,
2002, the court held another conference at which it entered an order dismissing
the Bertramcase. The courts order permits the individual plaintiffs in the
Bertramcase to pursue any claims that they may have as members of the
purported class in the related, consolidated class action discussed above.
Plaintiffs have appealed this order.

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

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

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

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

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





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Liquidity and Capital Resources

Cash used in operating activities for the nine months ended September 30,
2002 was $56.5 million compared to $113.7 million used in 2001. In the nine
months ended September 30, 2002, cash used by operating activities included a
$23.7 million net loss, $8.4 million of interest paid on convertible bonds and
a decrease of $31.2 million in accounts payable, accrued payroll and other
accrued liabilities partially offset by cash provided by accounts receivable
and other assets. In the nine months ended September 30, 2001, cash used by
operating activities was primarily related to decreases in accounts payable,
deferred taxes, interest paid on convertible bonds and other non-current
liabilities partially offset by an decrease in inventory.

During the third quarter of 2002, we received approximately 35.9 million
shares of Net Servicos de Comunicacao SA (Net Servicos), a customer, valued at
approximately $2.4 million as settlement for all outstanding accounts
receivables due from Net Servicos to us. These shares are classified as
available-for-sale and are included in the balance sheet as short-term
investments. The shares of Net Servicos are traded on the Sao Paulo Stock
Exchange, and the share price has traditionally been volatile and subject
to significant price fluctuations. This volatility could result in potential
future losses to the market value of the shares until we are able to sell them.
We expect to sell these shares for cash in the fourth quarter of
2002 and the first quarter of 2003.

Cash provided by investing activities during the nine months ended
September 30, 2002 was $138.0 million, compared $20.2 million in 2001.
Investing activities consist primarily of the purchase and sale of short-term
investments and fixed assets.

Cash used by financing activities was $54.2 million in the first nine
months of 2002, compared to cash used in financing activities of $110.9 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 early retirement of convertible bonds. In the first nine months
of 2001, we repurchased Notes for $113.4 million in cash. In the first nine
months of 2002, we repurchased Notes for $57.6 million in cash.

As of
September 30, 2002, we had standby letters of credit outstanding
for $9.5 million in support of certain operating lease
commitments.

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 products, 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





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competitive pressures or unanticipated requirements, which could have a
material adverse effect on our business, financial condition and operating
results.

The following summarizes our contractual obligations at September 30,
2002, and the effect such obligations are expected to have on our liquidity and
cash flows in future periods (in millions):

|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 
|---------------------------------- |  | ----- | ----- | ------ |  | ---------------------- | ---- | ----- |  | ----- | ---- | ------- |  | - | ---- |  |  | - | --- | 
|Contractual Obligations            |  |       |       |        |  | Payments Due by Period
|                                   |  |       |       |        |  |                       
|                                   |  |       |       |        |  | Less than              |      | 1-3   |  | 4-5   |      | After 5
|                                   |  | Total |       | 1 year |  | years                  |      | years |  | years
|                                   |  |       |       |        |  |                        |      |       |  |      
|Capital Lease Obligations          |  | $     | 0.2   |        |  | $                      | 0.1  |       |  | $     | 0.1  |         |  | $ |     |  |  | $ |    | 
|Unconditional Purchase Obligations |  |       | 54.9  |        |  |                        | 42.8 |       |  |       | 12.1 |         |  |   |     |  |  |   |    | 
|Long Term Debt                     |  |       | 65.1  |        |  |                        |     |       |  |       |     |         |  |   | 65.1 |  |  |   |    | 
|Operating Lease Obligations        |  |       | 34.2  |        |  |                        | 7.2  |       |  |       | 12.6 |         |  |   | 8.1  |  |  |   | 6.3 | 
|Other Obligations                  |  |       | 6.4   |        |  |                        | 1.5  |       |  |       | 4.1  |         |  |   | 0.8  |  |  |   |    | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 
|Total Contractual Commitments      |  | $     | 160.8 |        |  | $                      | 51.6 |       |  | $     | 28.9 |         |  | $ | 74.0 |  |  | $ | 6.3 | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 

We have unconditional purchase obligations to certain of our suppliers
that support our ability to manufacture our products. The obligations require
us to purchase minimum quantities of the suppliers products at a specified
price. As of September 30, 2002, we had approximately $54.9 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.

Other commercial commitments are as follows (in millions):

|                             |  |                                            |     |           |  |       |   |       |  |        |   |  |  |   |     |  |  |   |     | 
|---------------------------- |  | ------------------------------------------ | --- | --------- |  | ----- | - | ----- |  | ------ | - |  |  | - | --- |  |  | - | --- | 
|Other Commercial             |  |                                            |     |           |  |       |   |       |  |        |   |  |  |   |     |  |  |   |     | 
|Commitments                  |  | Amount of Commitment Expiration Per Period
|                             |  |                                           
|                             |  | Total                                      |     |           |  |       |   |       |  |        |   |  |  |   |     |  |  |  
|                             |  | Amounts                                    |     | Less than |  | 1-3   |   | 4-5   |  | Over 5
|                             |  | Committed                                  |     | 1 year    |  | years |   | years |  | years 
|                             |  |                                            |     |           |  |       |   |       |  |       
|Standby Letters of Credit    |  | $                                          | 9.5 |           |  | $     |  |       |  | $      |  |  |  | $ | 9.2 |  |  | $ | 0.3 | 
|                             |  |                                            |     |           |  |       |   |       |  |        |   |  |  |   |     |  |  |   |     | 
|Total Commercial Commitments |  | $                                          | 9.5 |           |  | $     |  |       |  | $      |  |  |  | $ | 9.2 |  |  | $ | 0.3 | 
|                             |  |                                            |     |           |  |       |   |       |  |        |   |  |  |   |     |  |  |   |     | 

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.
The effect of adoption of SFAS No. 146 is dependent on our related activities
subsequent to the date of adoption.

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





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with our adoption of SFAS No. 145, all prior periods 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. See
Note 6 in Notes to Condensed Consolidated Financial Statements
(Unaudited).

In June 2001, the FASB issued SFAS No. 141, Business Combinations, and
SFAS 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 definite
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 Notes 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 September 30, 2002, we had an
accumulated deficit of $916.7 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;
| | - |  | -----------------------------------------------------------------





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| |  |  | variations in the size of the orders by our customers;                                                         
| | - |  | ---------------------------------------------------------------------------------------------------------------
|
| |  |  | new product introductions by competitors;                                                                      
|
| |  |  | 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 Cable Modem Termination Systems (CMTSs), and
lower margin, higher volume Customer Premise Equipment (CPE),
such as modems. 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. One customer
accounted for approximately 32% of our revenues for the nine months ended
September 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. As a result, our sales have been and
will continue to be dependent upon product acceptance by the leading cable
operators and telecom carriers.

The timing and size of each customers order is critical to our operating
results. Our major customers, as well as large broadband service providers,
have significant negotiating leverage and





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sometimes attempt to change the terms, including pricing, upon which we do
business with them. These companies, including our customers may decide to
purchase competitive 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 the twelve months ended December 31, 2001, and $4.0 million during the second quarter of 2002.

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. 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 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 nine
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 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 competitors will be able to
incorporate some aspects of our technology into their products, our current





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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 Certify and Qualify Our Products and Develop New Products in Order to Remain Competitive.

Our future success depends on our ability to
develop, market and sell products, including new products, in a
timely manner, as well as responding 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.  We
believe that to sell our DOCSIS 2.0
based products to services providers that our products must be
DOCSIS 2.0
certified or qualified. In order to be DOCSIS 2.0
certified or qualified, our products must pass the testing requirements established by CableLabs®,
 which administers the tests and testing process. CableLabs®
conducts DOCSIS testing once per quarter, and is currently in the
process of testing DOCSIS 2.0
 based products for the first time. We have submitted our products to
CableLabs® for DOCSIS 1.1 and DOCSIS 2.0
 certification and qualification. There is no guarantee that our
products will pass testing to be DOCSIS 1.1 and DOCSIS 2.0 certified or
qualified. If we are unable to certify or qualify our products as
DOCSIS compliant in a timely manner, we may be unable to
sell our products until such products are DOCSIS certified
or qualified and 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 in the past, the
majority of our sales have been derived from our proprietary S-CDMA
products, which are not DOCSIS compliant. We are currently in the
process of transitioning from deriving the majority of our sales from
our proprietary S-CDMA products to DOCSIS compliant products.
Despite the fact that we now sell DOCSIS compliant products, there
have been and may continue to be instances where our existing
customers and potential new customers who elect to purchase
DOCSIS-compliant products from one or more of our competitors rather
than purchasing our products.  As a result of this competition, 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 equipment becomes more
widely deployed, the price of cable modems and other similar CPE (Customer





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Premise Equipment) 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.

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

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;
| | - |  | ------------------------------





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| |  |  | 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
$54.9 million as of September 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.

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





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##### Table of Contents



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 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.

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;
| | - |  | -----------------------------------------------------------------------





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| |  |  | export license requirements, tariffs and taxes;
| | - |  | -----------------------------------------------
|
| |  |  | trade barriers;                                
|
| |  |  | difficulty in protecting intellectual property;
|
| |  |  | difficulty in collecting accounts receivable;  
|
| |  |  | currency fluctuations                          
|
| |  |  | difficulty in managing foreign operations; and 
|
| |  |  | political and economic instability.            

If our customers are affected by currency devaluations or general economic
downturns, such as the recent economic downturns 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, and availability of favorable pricing for other
communications services or the availability and cost of related equipment. Any
action like this by foreign countries would reduce the market for our products.

While we generally invoice our foreign sales in U.S. dollars, we 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, Com21, Motorola, Thomson
Consumer Electronics (which markets products under the brand name RCA),
Scientific-Atlanta and Toshiba. We also compete with companies that develop
integrated circuits for broadband products, such as Broadcom, Conexant and
Texas Instruments. The principal competitive factors in our market include the
following:



| |  |  | product performance, features and reliability;
| | - |  | ----------------------------------------------





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| |  |  | 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 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.

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.

We Are Dependent on Key Personnel.

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

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

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





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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 Property
Rights.

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

We have entered into confidentiality and invention assignment agreements
with our employees, and we enter into non-disclosure agreements with many of
our suppliers, distributors and appropriate customers so as to limit access to
and disclosure of our proprietary information. These contractual arrangements,
as well as statutory protections, may not prove sufficient to prevent
misappropriation of our 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 many of our intellectual property rights to the extent
that such rights may be asserted against a party desiring to design,
manufacture or sell DOCSIS based products, including DOCSIS 2.0 based products.
This license agreement grants to CableLabs the right to sublicense our
intellectual property, including our intellectual 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, Euro-DOCSIS and/or PacketCable specifications.

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

Our corporate headquarters, as well as the majority of our research and
development activities and some manufacturing operations are located in
California, an area known for seismic activity. In addition, the operations of
some of our key suppliers are also located in this area and in other areas
known for seismic activity, such as Taiwan. An earthquake, or other significant
natural disaster, could result in an interruption in our business or the
operations of one or more of our key suppliers. Our business may also
be impacted by labor issues that affect or disrupt our shipping
arrangements or those of our suppliers, service providers and
customers. An example of a labor issue that could affect such
shipping arrangements is the recent West Coast port workers lock-out
or any additional lock-outs or strikes that affect ports worldwide.
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 September 30, 2002, we had approximately $65.3 million of
indebtedness outstanding. This level of indebtedness may adversely affect
our stockholders by:



| |  |  | making it more difficult for us to satisfy our obligations with respect
to our indebtedness;                                                                                                                                                                                                                     
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increasing our vulnerability to general adverse economic and industry
conditions;                                                                                                                                                                                                                                
|
| |  |  | limiting our ability to obtain additional financing;                                                                                                                                                                                                                                                             
|
| |  |  | requiring the dedication of a substantial portion of our cash flow from
operations to the payment of principal of, and interest on, our
indebtedness, thereby reducing the availability of our cash flow to fund
our growth strategy, working capital, capital expenditures and other
general corporate purposes;
|
| |  |  | 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 since the second quarter of 2000. This volatility and
decline has affected many companies irrespective of or disproportionately to
the operating performance of these companies. Additionally, industry factors
may materially adversely affect the market price of our common stock,
regardless of our actual operating performance.




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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##### Table of Contents



within the next twenty-four months. A hypothetical 50 basis point increase
in interest rates would result in an approximate $774,000 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, Brazil, Canada and Israel. An adverse
change of 10% in exchange rates would result in a decline in income before
taxes of approximately $292,000.

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

Market Risk.

During the third quarter of 2002, we received approximately 35.9 million
shares of Net Servicos de Comunicacao SA (Net Servicos), a customer, valued
at approximately $2.4 million as settlement for all outstanding accounts
receivables due from Net Servicos.

The shares are classified as available-for-sale and are included in the
balance sheet as short-term investments. The shares of Net Servicos are traded
on the Sao Paulo Stock Exchange, and the share price has traditionally been
volatile and subject to significant price fluctuations. This volatility could
result in potential future losses to the market value of the shares until we
are able to sell them. We expect to liquidate these shares in the fourth
quarter of 2002 and the first quarter of 2003.




ITEM 4. CONTROL AND PROCEDURES

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

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




PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

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




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None




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

None




ITEM 5. OTHER INFORMATION

None




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



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

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





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##### Table of Contents





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



| | 1. |  | On August 14, 2002, the Company filed a report on
Form 8-K announcing that the Chief Executive Officer, Zaki
Rakib, and the Chief Financial Officer, Carol Lustenader, had
executed a certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, which accompanied the Companys 10-Q filed with the
Securities and Exchange Commission on August 14, 2002.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | On August 19, 2002, the Company filed a report on
Form 8-K announcing its plan to implement a reduction in force
in order to decrease operating expenses. The Company publicly
announced this reduction in force in a press release on August
14, 2002.                                                                                                                                                                 

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





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





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##### Table of Contents



Certification:

I, Zaki Rakib, Chief Executive Officer, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Terayon
Communication Systems, Inc.;                                                                                                                                                                                                                                    
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (11/14/02); and                                                                                                               
|
| | c) |  | presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;                                                                                                                        



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



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



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

|                        |  |     |  |                                   
|----------------------- |  | --- |  | ----------------------------------
|Date: November 14, 2002 |  | By: |  | /s/ Zaki Rakib                    
|                        |  |     |  |                                   
|                        |  |     |  | Zaki Rakib
Chief Executive Officer





---



##### Table of Contents



Certification:

I, Carol Lustenader, Chief Financial Officer, certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of Terayon
Communication Systems, Inc.;                                                                                                                                                                                                                                    
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;                   
|  
|4. |  | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (11/14/02); and                                                                                                               
|
| | c) |  | presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;                                                                                                                        



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



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



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

|                        |  |     |  |                                         
|----------------------- |  | --- |  | ----------------------------------------
|Date: November 14, 2002 |  | By: |  | /s/ Carol Lustenader                    
|                        |  |     |  |                                         
|                        |  |     |  | Carol Lustenader
Chief Financial Officer





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##### Table of Contents






EXHIBIT INDEX

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