##### Table of Contents



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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, 2003
OR

o
    
    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
    
    77-0328533(STATE OR OTHER JURISDICTION OF
    
    (IRS EMPLOYERINCORPORATION OR ORGANIZATION)
    
    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 o

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

As of October 31, 2003, registrant had outstanding 74,875,623 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 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 31.1                 
|EXHIBIT 31.2                 
|EXHIBIT 32.1                 
|EXHIBIT 32.2                 



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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

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




PART I. FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS

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

PageCondensed Consolidated Balance Sheets as of September 30, 2003 (unaudited) and
December 31, 2002
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2003 and 2002 (unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 (unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    6


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##### Table of Contents



TERAYON COMMUNICATION SYSTEMS, INC.




CONDENSED CONSOLIDATED BALANCE
SHEETS
(in thousands)


September 30,
    
    December 31,2003
    
    2002(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    42,438
    
    
    $
    117,079Short-term investments
    
    
    106,954
    
    
    
    89,424Accounts receivable, net
    
    
    29,386
    
    
    
    16,355Accounts receivable from related parties
    
    
    200
    
    
    
    842Inventory
    
    
    5,508
    
    
    
    8,257Other current assets
    
    
    7,503
    
    
    
    10,860Total current assets
    
    
    191,989
    
    
    
    242,817Property and equipment, net
    
    
    12,970
    
    
    
    17,906Restricted cash and other assets, net
    
    
    12,500
    
    
    
    14,987Total assets
    
    $
    217,459
    
    
    $
    275,710LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    23,330
    
    
    $
    23,920Accrued payroll and related expenses
    
    
    6,047
    
    
    
    6,227Deferred revenues
    
    
    2,172
    
    
    
    497Accrued warranty
    
    
    6,209
    
    
    
    8,607Accrued restructuring
    
    
    4,837
    
    
    
    6,754Accrued vendor cancellation charges
    
    
    3,930
    
    
    
    13,865Other accrued liabilities
    
    
    6,204
    
    
    
    8,609Other current obligations
    
    
    659
    
    
    
    1,509Total current liabilities
    
    
    53,388
    
    
    
    69,988Long-term obligations
    
    
    3,327
    
    
    
    3,499Convertible subordinated notes
    
    
    65,081
    
    
    
    65,081Commitments
and contingencies
Stockholders equity:Common stock
    
    
    75
    
    
    
    73Additional paid in capital
    
    
    1,080,628
    
    
    
    1,078,144Accumulated deficit
    
    
    (981,545
    )
    
    
    (937,207
    )Deferred compensation
    
    
    (83
    )
    
    
    (25
    )Treasury stock, at cost
    
    
    (773
    )
    
    
    (773
    )Accumulated other comprehensive loss
    
    
    (2,639
    )
    
    
    (3,070
    )Total stockholders equity
    
    
    95,663
    
    
    
    137,142Total liabilities and stockholders equity
    
    $
    217,459
    
    
    $
    275,710


See accompanying notes.

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##### Table of Contents



TERAYON COMMUNICATION SYSTEMS, INC.




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)


Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Product revenues
    
    $
    37,168
    
    
    $
    23,820
    
    
    $
    87,568
    
    
    $
    97,449Related party product revenues
    
    
    460
    
    
    
    655
    
    
    
    2,927
    
    
    
    6,651Total revenues
    
    
    37,628
    
    
    
    24,475
    
    
    
    90,495
    
    
    
    104,100Cost of product revenues
    
    
    27,296
    
    
    
    23,632
    
    
    
    69,500
    
    
    
    72,085Cost of related party product revenues
    
    
    138
    
    
    
    547
    
    
    
    1,262
    
    
    
    6,255Total cost of goods sold
    
    
    27,434
    
    
    
    24,179
    
    
    
    70,762
    
    
    
    78,340Gross profit
    
    
    10,194
    
    
    
    296
    
    
    
    19,733
    
    
    
    25,760Operating expenses:Research and development
    
    
    9,363
    
    
    
    14,315
    
    
    
    32,797
    
    
    
    45,959Sales and marketing
    
    
    6,452
    
    
    
    9,026
    
    
    
    19,741
    
    
    
    28,020General and administrative
    
    
    2,783
    
    
    
    4,467
    
    
    
    9,510
    
    
    
    11,653Restructuring costs (recovery) and asset write-offs
    
    
    (244
    )
    
    
    4,950
    
    
    
    2,803
    
    
    
    8,922Total operating expenses
    
    
    18,354
    
    
    
    32,758
    
    
    
    64,851
    
    
    
    94,554Loss from operations
    
    
    (8,160
    )
    
    
    (32,462
    )
    
    
    (45,118
    )
    
    
    (68,794
    )Interest income
    
    
    583
    
    
    
    1,526
    
    
    
    2,394
    
    
    
    5,636Interest expense
    
    
    (787
    )
    
    
    (990
    )
    
    
    (2,438
    )
    
    
    (5,347
    )Other income (expense)
    
    
    1,238
    
    
    
    268
    
    
    
    1,038
    
    
    
    (4,197
    )Gain on early retirement of debt
    
    
    
    
    
    
    15,813
    
    
    
    
    
    
    
    49,089Loss before income tax expense
    
    
    (7,126
    )
    
    
    (15,845
    )
    
    
    (44,124
    )
    
    
    (23,613
    )Income tax expense
    
    
    (84
    )
    
    
    (127
    )
    
    
    (214
    )
    
    
    (134
    )Net loss
    
    $
    (7,210
    )
    
    $
    (15,972
    )
    
    $
    (44,338
    )
    
    $
    (23,747
    )Net loss per share, basic and diluted
    
    $
    (0.10
    )
    
    $
    (0.22
    )
    
    $
    (0.60
    )
    
    $
    (0.33
    )Shares used in per share calculation, basic and diluted
    
    
    74,551
    
    
    
    73,122
    
    
    
    73,994
    
    
    
    72,828


See accompanying notes.

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TERAYON COMMUNICATION SYSTEMS, INC.




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


Nine Months EndedSeptember 30,2003
    
    2002Operating activities:Net loss
    
    $
    (44,338
    )
    
    $
    (23,747
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation
    
    
    7,155
    
    
    
    9,059Write-off and amortization of intangible assets
    
    
    
    
    
    
    3,972Amortization related to stock options
    
    
    17
    
    
    
    469Gain on early retirement of debt
    
    
    
    
    
    
    (49,088
    )Recovery of inventory reserves
    
    
    (8,138
    )
    
    
    (13,111
    )Impairment of investment
    
    
    
    
    
    
    4,500Write-off and disposal of fixed assets
    
    
    497
    
    
    
    2,257Changes in operating assets and liabilities:Accounts receivable
    
    
    (13,031
    )
    
    
    20,160Accounts receivable from related parties
    
    
    642
    
    
    
    3,558Inventory
    
    
    12,826
    
    
    
    25,102Other current and non-current assets
    
    
    5,844
    
    
    
    (6,253
    )Accounts payable
    
    
    (590
    )
    
    
    (21,701
    )Accrued payroll and related expenses
    
    
    (180
    )
    
    
    (3,334
    )Deferred revenues
    
    
    1,675
    
    
    
    (2,994
    )Accrued warranty
    
    
    (2,398
    )
    
    
    1,733Accrued restructuring
    
    
    (1,917
    )
    
    
    (762
    )Accrued vendor cancellation charges
    
    
    (11,274
    )
    
    
    2,597Other accrued liabilities
    
    
    (3,099
    )
    
    
    (6,142
    )Interest payable
    
    
    (812
    )
    
    
    (2,731
    )Net cash used in operating activities
    
    
    (57,121
    )
    
    
    (56,456
    )Investing activities:Purchases of short-term investments
    
    
    (200,239
    )
    
    
    (236,081
    )Proceeds from sales and maturities of short-term investments
    
    
    182,231
    
    
    
    379,966Purchases of property and equipment
    
    
    (2,716
    )
    
    
    (5,855
    )Net cash provided by (used in) investing activities
    
    
    (20,724
    )
    
    
    138,030Financing activities:Principal payments on capital leases
    
    
    (116
    )
    
    
    (94
    )Proceeds from issuance of common stock
    
    
    2,411
    
    
    
    3,541Retirement of debt
    
    
    
    
    
    
    (57,627
    )Net cash provided (used in) by financing activities
    
    
    2,295
    
    
    
    (54,180
    )Effect of exchange rate changes
    
    
    909
    
    
    
    942Net increase (decrease) in cash and cash equivalents
    
    
    (74,641
    )
    
    
    28,336Cash and cash equivalents at beginning of period
    
    
    117,079
    
    
    
    100,274Cash and cash equivalents at end of period
    
    $
    42,438
    
    
    $
    128,610


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., or 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 Cable Modem Termination Systems,
or CMTSs, customer premise equipment, or CPE, including cable modems and
digital video equipment. Our CMTS and CPE products enable cable operators to
provision, deliver and manage cost-effective broadband Internet access and
voice over Internet Protocol, or VoIP. Our digital video equipment allows
cable and satellite operators to provide advanced digital video services to
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, 2003 and for the three and nine months ended
September 30, 2003 and 2002 have been included.

Results for the three and nine months ended September 30, 2003 are not
necessarily indicative of results for the entire fiscal year or future periods.
These financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Companys Form
10-K dated March 27, 2003, as filed with the U.S. Securities and Exchange
Commission. The accompanying balance sheet at December 31, 2002 is derived
from audited consolidated financial statements at that date.

Reclassifications

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

Basis of Consolidation

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

Use of Estimates

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

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Stock-based compensation

The Company accounts for stock-based compensation for its employees using
the intrinsic value method presented in Accounting Principles Board, or APB,
Statement No. 25, Accounting for Stock Issued to Employees, or APB No. 25,
and related interpretations, and complies with the disclosure provisions of
Statement of Financial Accounting Standards, or SFAS, Interpretation No. 123,
Accounting for Stock-Based Compensation, or SFAS No. 123, and with the
disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation
 Transition and Disclosure Amendment of SFAS No. 123. Under APB No. 25,
compensation expense is based on the difference, as of the date of the grant,
between the fair value of the stock and the exercise price. The Company
accounts for stock options issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force, or EITF, Issue No.
96-18, Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

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

Three months ended
    
    Nine months endedSeptember 30
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net loss, as reported
    
    $
    (7,210
    )
    
    $
    (15,972
    )
    
    $
    (44,338
    )
    
    $
    (23,747
    )Add:
    Stock-based compensation
under APB 25
    
    
    9
    
    
    
    103
    
    
    
    17
    
    
    
    469Deduct:
    Stock option compensation
expense determined under fair
value-based method
    
    
    (5,602
    )
    
    
    (8,341
    )
    
    
    (17,201
    )
    
    
    (27,576
    )Employee stock purchase plan
compensation expense
determined under fair value-
based method
    
    
    (366
    )
    
    
    (381
    )
    
    
    (1,646
    )
    
    
    (1,685
    )Pro forma net loss
    
    $
    (13,169
    )
    
    $
    (24,591
    )
    
    $
    (63,168
    )
    
    $
    (52,539
    )Pro forma net loss per share, basic and
diluted
    
    $
    (0.18
    )
    
    $
    (0.34
    )
    
    $
    (0.85
    )
    
    $
    (0.72
    )Shares used in computing pro forma net
loss per share, basic and diluted
    
    
    74,551
    
    
    
    73,122
    
    
    
    73,994
    
    
    
    72,828


Inventory

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

September 30,
    
    December 31,2003
    
    2002Finished goods
    
    $
    4,457
    
    
    $
    5,915Work-in-process
    
    
    553
    
    
    
    769Raw materials
    
    
    498
    
    
    
    1,573$
    5,508
    
    
    $
    8,257


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Purchase Obligations

The Company records losses on commitments to purchase inventory in
accordance with Statement 10 of Chapter 4 of Accounting Release Bulletin No.
43. The Companys policy for valuation of inventory and commitments to
purchase inventory, including the determination of obsolete or excess
inventory, requires it to perform a detailed assessment of inventory at each
balance sheet date which includes a review of, among other factors, an estimate
of future demand for products within specific time horizons, generally six
months or less as well as product lifecycle and product development plans.
Given the rapid technological change in the technology and communications
equipment industries as well as significant, unpredictable changes in capital
spending by the Companys customers, the Company believes that assessing the
value of inventory using generally a six month time horizon is appropriate.

The estimates of future demand that the Company uses in the valuation of
inventory are the basis for the revenue forecast, which is also consistent with
its short-term manufacturing plan. Based on this analysis, the Company reduces
the cost of inventory that it specifically identifies and considers obsolete or
excessive to fulfill future sales estimates. The Company defines excess
inventory as inventory that will no longer be used in the manufacturing
process. Excess inventory is generally defined as inventory in excess of
projected usage, and is determined using the Companys best estimate of future
demand at the time, based upon information then available.

For the three and nine months ended September 30, 2003, the Company
reversed approximately $2.0 million and $8.1 million, respectively, of
inventory provisions, which were previously recorded as cost of goods sold.
For the three and nine months ended September 30, 2002, the Company reversed
approximately $0.6 million and $13.1 million, respectively, of inventory
provisions, which were previously recorded as cost of goods sold. The Company
reversed these provisions as it was able to sell inventory originally
considered to be excess or obsolete.

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

On September 29, 2003, the Company entered into an agreement with
Flextronics (Israel) Ltd., an Israeli company, or Flextronics, to purchase
inventory from Flextronics and settle all outstanding claims between the
Company and Flextronics. Under the terms of the settlement agreement, the
Company paid Flextronics approximately $1.5 million to be applied toward the
purchase of future inventory from Flextronics, if any. Additionally, each
party released all claims that it may have had against the other party. The
Company previously accrued $2.0 million toward the settlement of the
Flextronics matter as a vendor cancellation charge in the second quarter of
2001. In the third quarter of 2003, in connection with the Flextronics
settlement, the Company reversed $0.5 million of the accrued vendor
cancellation charges included in cost of goods sold.

As of September 30, 2003, the Company had $53.0 million of purchase
obligations, of which $3.9 million are included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times through the first quarter of 2004.

Net Loss Per Share

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

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##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net loss
    
    $
    (7,210
    )
    
    $
    (15,972
    )
    
    $
    (44,338
    )
    
    $
    (23,747
    )Shares used in computing basic
and diluted net loss per share
    
    
    74,551
    
    
    
    73,122
    
    
    
    73,994
    
    
    
    72,828Basic and diluted net
loss per share
    
    $
    (0.10
    )
    
    $
    (0.22
    )
    
    $
    (0.60
    )
    
    $
    (0.33
    )


Options to purchase 17,634,021 and 16,309,988 shares of common stock were
outstanding at September 30, 2003 and September 30, 2002, respectively, and
warrants to purchase 425,593 and 2,408,300 shares of common stock were
outstanding at September 30, 2003 and September 30, 2002, respectively, but
were not included in the computation of diluted net loss per share, since the
effect would have been antidilutive.

Accumulated Other Comprehensive Loss

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

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

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net loss
    
    $
    (7,210
    )
    
    $
    (15,972
    )
    
    $
    (44,338
    )
    
    $
    (23,747
    )Cumulative translation adjustments
    
    
    360
    
    
    
    (1,380
    )
    
    
    910
    
    
    
    (2,937
    )Change in unrealized gain (loss) on
available-for-sale investments
    
    
    (67
    )
    
    
    (361
    )
    
    
    (478
    )
    
    
    (859
    )Total comprehensive net loss
    
    $
    (6,917
    )
    
    $
    (17,713
    )
    
    $
    (43,906
    )
    
    $
    (27,543
    )


Impact of Recently Issued Accounting Standards

In May 2003, the Financial Accounting Standards Board, or FASB issued SFAS
No. 150, Accounting For Certain Financial Instruments with Characteristics of
Both Liabilities and Equity which establishes standards for how an issuer of
financial instruments classifies and measures certain financial instruments
with characteristics of both liabilities and equity. It requires that certain
financial instruments, which under previous guidance were accounted for as
equity, must now be accounted for as liabilities. The financial instruments
affected include mandatory redeemable stock, certain financial instruments that
require or may require the issuer to buy back some of its shares in exchange
for cash or other assets and certain obligations that can be settled with
shares of stock. SFAS No. 150 is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on the Companys
financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and

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##### Table of Contents



reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. This statement is effective for contracts entered
into or modified after June 30, 2003, and did not have a material impact on the
Companys financial position or results of operations.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. Interpretation No. 46 clarifies the application
of Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. This Interpretation
is applicable to the Company in the quarter ending December 31, 2003, for
interests acquired in variable interest entities prior to February 1, 2003.
This Interpretation requires variable interest entities to be consolidated if
the equity investment at risk is not sufficient to permit an entity to finance
its activities without support from other parties or the equity investors lack
specified characteristics. The adoption of this Interpretation will not have a
material impact on the Companys financial statements.

In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF Issue No. 00-21 provides guidance on how to account for
certain arrangements that involve the delivery or performance of multiple
products, services and/or rights to use assets. The provisions of EITF Issue
No. 00-21 will apply to revenue arrangements entered into in fiscal periods
beginning after June 15, 2003. The adoption of EITF Issue No. 00-21 did not
have any significant impact on the Companys financial position or results of
operations.



|2. |  | Contingencies
|-- |  | -------------

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

On September 21, 2000, the lead plaintiffs filed a consolidated class
action complaint containing factual allegations nearly identical to those in
the original lawsuits. The consolidated class action complaint, however,
alleged claims on behalf of a class whose members purchased or otherwise
acquired the Companys securities between November 15, 1999 and April 11, 2000.
On October 30, 2000, defendants moved to dismiss the consolidated class action
complaint. On March 14, 2001, after defendants motion had been fully briefed
and argued, the court issued an order granting in part defendants motion and
giving plaintiffs leave to file an amended complaint. On April 13, 2001,
plaintiffs filed their first amended consolidated class action complaint. On
June 15, 2001, defendants moved to dismiss this new complaint and oral argument
on the motion occurred on December 17, 2001. On March 29, 2002, the court
denied the defendants motion to dismiss. On February 24, 2003, the court
certified the plaintiffs proposed class. Since then, the parties have
completed nearly all discovery from fact witnesses and have begun, but not
finished, expert witness discovery.

Both defendants and plaintiffs have filed summary judgment motions.
Defendants motion seeks judgment as to plaintiffs entire claim. Plaintiffs
motion seeks a determination that certain of the defendants class period
statements were false.

On September 8, 2003, the Court heard defendants motion to disqualify two
of the lead plaintiffs and to modify the definition of the plaintiff class.
This motion is now under submission.

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On September 10, 2003, the Court issued an order vacating the hearing
date for the parties summary judgment motions. On September 22, 2003, the
Court issued another order staying all discovery until further notice of the
Court and vacating the trial date, which had been November 4, 2003.

The lawsuits seek 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.

On October 16, 2000, a lawsuit was filed against the Company and the
individual defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the
California Superior Court, San Luis Obispo County. This lawsuit is titled
Bertram v. Terayon Communications Systems, Inc. (Bertram). The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action for
unlawful business practices, unfair and fraudulent business practices, and
false and misleading advertising. Plaintiffs purport to bring the action on
behalf of themselves and as representatives of all persons or entities in the
State of California and such other persons or entities outside California that
have been and are adversely affected by defendants activity, and as the Court
shall determine is not inconsistent with the exercise of the Courts
jurisdiction. Plaintiffs seek equitable and injunctive relief. Defendants
removed the Bertram case to the United States District Court, Central District
of California and, on January 19, 2001, filed a motion to dismiss the
complaint. A hearing on defendants motion was held March 26, 2001 and the
court granted Defendants motion to dismiss the action and denied Plaintiffs
motion requesting remand. On April 5, 2001, Defendants moved for an order
requiring further proceedings, if any to take place in the Northern District of
California. Plaintiffs did not oppose this motion and eventually entered into a
stipulation to go forward in the Northern District. On July 9, 2001, a status
conference was held in this case before Judge Patel. Plaintiffs did not appear
for the conference, and the court requested that defendants submit an order
dismissing the Bertram action with prejudice, which the defendants have
submitted to the court. On August 7, 2002, the court held another conference
at which it entered an order dismissing the Bertramcase. The courts order
permits the individual plaintiffs in the Bertramcase to pursue any claims that
they may have as members of the purported class in the related, consolidated
class action discussed above. Plaintiffs have appealed this order and filed
their opening brief in the Court of Appeals. Defendants answering brief is
due on November 24, 2003, and plaintiffs optional reply brief is due 14 days
after service of defendants brief.

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. However, these litigation matters could prove
to be costly and time consuming to defend, and there can be no assurances about
the eventual outcome.

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

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

Since the Campbelland OBriencases were filed, the parties have taken
steps to have these cases consolidated in the California Superior Court, County
of Santa Clara. On October 4, 2002, the California

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##### Table of Contents



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Brien
case submitted certain materials to the California Superior Court, County of
Santa Clara to effectuate that transfer, which is now complete. The OBrien
case is now consolidated with the Campbellcase.

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

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics filed a claim with the Tel Aviv District Court in
Israel against the Company and Radwiz Ltd., or Radwiz, the Companys
subsidiary, alleging that damages of NIS 25,000,000 (approximately $5.0 million
US dollars) were inflicted on them by the Companys alleged failure to comply
with its contractual obligations to accept and pay for components manufactured
by Flextronics in the first quarter of 2001 pursuant to projections it had
received from Radwiz. The Company filed a statement of defense denying the
allegations, after which the parties accepted the Courts recommendation to
transfer the case to non-binding mediation. On September 29, 2003, the
Company settled the dispute with Flextronics and paid to Flextronics $1,475,000
as part of the settlement.

On January 19, 2003, Omniband Group Limited, a Russian company, or
Omniband, filed a request for arbitration with the Zurich Chamber of Commerce,
claiming damages in an amount of $2,094,970 allegedly caused by the Companys
breach of an agreement to sell to Omniband certain equipment pursuant to an
agreement between Omniband and Radwiz, dated February 22, 2000. The Company
believes that the allegations are baseless and intends to present a vigorous
defense in the arbitration proceedings.

The Company, as well as its customers, has received letters from third
parties claiming that the Companys technology and products infringe on the
third parties patents. The Company has consulted with its patent counsel and
is in the process of reviewing the allegations made by such third parties. The
Company does not know whether the third parties will pursue their claims of
patent infringement in court, and if they do, whether the Company would be
found to infringe the third parties patents. If the Company is found to have
infringed such third party patents, the Company could be subject to substantial
damages and/or an injunction preventing us from selling our products and
conducting our business. Additionally, such third parties and additional third
parties could assert infringement claims against the Company in the future. Any
such claim of patent infringement, whether meritorious or not, could be
time-consuming, result in costly litigation, cause product shipment delays or
require the Company to enter into royalty or licensing agreements. Such royalty
or licensing agreements may not be available on terms acceptable to the Company
or at all.

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



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

Since late 2000, the worldwide telecom and satellite industries have
experienced severe downturns that have resulted in significantly reduced
purchases of new broadband equipment. Because of this overall drop in demand,
the Company has refocused its efforts on the cable industry, and has
significantly reduced its investment in the telecom and satellite businesses.
Consequently, beginning in 2003, the Companys previously reported Telecom
segment no longer meets the quantitative threshold for disclosure and the
Company now operates as one business segment. Therefore, operating segment
disclosure for the three and nine months ended September 30, 2003 is not
provided.

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##### Table of Contents



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

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

Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2002
    
    2002Cable Broadband Access Segment:Total Cable revenues
    
    $
    22,006
    
    
    $
    95,834Depreciation expense
    
    $
    3,012
    
    
    $
    8,079Operating loss
    
    $
    (28,214
    )
    
    $
    (58,111
    )Telecom Broadband Access Segment:Total Telecom revenues
    
    $
    2,469
    
    
    $
    8,266Depreciation expense
    
    $
    313
    
    
    $
    980Operating loss
    
    $
    (4,248
    )
    
    $
    (10,683
    )Total revenues
    
    $
    24,475
    
    
    $
    104,100Total depreciation expense
    
    $
    3,325
    
    
    $
    9,059Operating loss:Operating loss by reportable
segments
    
    $
    (32,462
    )
    
    $
    (68,794
    )Unallocated amounts:Interest and other income
(expense), net
    
    
    804
    
    
    
    (3,908
    )Gain on early retirement of debt
    
    
    15,813
    
    
    
    49,089Income tax expense
    
    
    (127
    )
    
    
    (134
    )Net loss
    
    $
    (15,972
    )
    
    $
    (23,747
    )


Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Revenues by product:CMTS products
    
    $
    16,825
    
    
    $
    6,523
    
    
    $
    29,979
    
    
    $
    26,215Subscriber products
    
    
    15,654
    
    
    
    11,249
    
    
    
    46,320
    
    
    
    54,822Video products
    
    
    4,577
    
    
    
    4,233
    
    
    
    11,109
    
    
    
    14,531Other products
    
    
    572
    
    
    
    2,470
    
    
    
    3,087
    
    
    
    8,532Total revenues
    
    $
    37,628
    
    
    $
    24,475
    
    
    $
    90,495
    
    
    $
    104,100Revenues by geographic areas:United States
    
    $
    16,653
    
    
    $
    11,974
    
    
    $
    47,832
    
    
    $
    26,925Canada
    
    
    370
    
    
    
    1,375
    
    
    
    1,106
    
    
    
    11,942Europe
    
    
    5,173
    
    
    
    2,211
    
    
    
    15,873
    
    
    
    14,835


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Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Israel
    
    
    638
    
    
    
    591
    
    
    
    1,449
    
    
    
    859Japan
    
    
    11,047
    
    
    
    6,147
    
    
    
    17,859
    
    
    
    34,107Asia, excluding Japan
    
    
    3,246
    
    
    
    1,621
    
    
    
    5,856
    
    
    
    14,434South America
    
    
    501
    
    
    
    556
    
    
    
    520
    
    
    
    998Total
    
    $
    37,628
    
    
    $
    24,475
    
    
    $
    90,495
    
    
    $
    104,100


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


September 30,
    
    December 31,2003
    
    2002Long-lived assets:United States
    
    $
    21,162
    
    
    $
    28,169Canada
    
    
    813
    
    
    
    787Europe
    
    
    197
    
    
    
    170Israel
    
    
    3,140
    
    
    
    3,442Asia
    
    
    158
    
    
    
    207South America
    
    
    
    
    
    
    118Total long-lived assets
    
    
    25,470
    
    
    
    32,893Total current assets
    
    
    191,989
    
    
    
    242,817Total assets
    
    $
    217,459
    
    
    $
    275,710


Three customers accounted for 10% or more of total revenues (29%, 13%, and
13%) for the three months ended September 30, 2003. 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 (20%, 17%, and 12%) for the nine months ended September 30, 2003. One
customer accounted for 10% or more of total revenues (32%) for the nine months
ended September 30, 2002. No other customer accounted for more than 10% of
revenues during these periods.



|4. |  | Restructuring Charges and Asset Write-offs
|-- |  | ------------------------------------------

Restructuring

2003 Restructuring

During the first quarter of 2003, the Companys Board of Directors
approved a restructuring plan to continue to conform the expense and revenue
levels and to better position the Company for future growth and eventual
profitability. The Company incurred restructuring charges in the amount of
$2.7 million related to employee termination costs. As of September 30, 2003,
the employment of 81 employees has been terminated throughout the Company, and
the Company paid $2.7 million in termination costs. In the second quarter of
2003, the Company reversed $86,000 of previously accrued termination costs
due to a change in estimate. At September 30, 2003, no restructuring charges
remain accrued.

14



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##### Table of Contents



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

Involuntary TerminationsTotal charge
    
    $
    2,745Recovery of charge
    
    
    (86
    )Cash payments
    
    
    (2,659
    )Balance at September 30, 2003
    
    $
    


2002 Restructuring

During the third quarter of 2002, the Companys Board of Directors
approved a restructuring plan to conform the expense and revenue levels and to
better position the Company for future growth and eventual profitability. The
Company incurred restructuring charges in the amount of $3.6 million of which
$2.3 million related to employee termination costs and the remaining $1.3
million related to costs for excess leased facilities. At September 30, 2003,
restructuring charges of $1.2 million remain accrued. As of September 30, 2003,
the employment of 153 employees has been terminated throughout the Company, and
the Company paid $2.2 million in termination costs and $0.2 million in excess
facility costs. During 2002, we reclassified $0.1 million of
excess termination costs to leased facilities due to a change in
estimate. The Company anticipates the remaining restructuring accrual,
primarily relating to excess leased facilities, will be utilized for servicing
operating lease payments or negotiated buyout of operating lease commitments,
through 2005.

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

Excess LeasedInvoluntary
    
    Facilities andTerminations
    
    Cancelled Contracts
    
    TotalBalance at December 31, 2002
    
    $
    88
    
    
    $
    1,422
    
    
    $
    1,510Cash Payments
    
    
    (88
    )
    
    
    (219
    )
    
    
    (307
    )Balance at September 30, 2003
    
    $
    
    
    
    $
    1,203
    
    
    $
    1,203


2001 Restructuring

During 2001, the Companys Board of Directors approved a restructuring
plan to streamline the Companys organizational structure worldwide. The
Company incurred restructuring charges in the amount of $12.7 million in fiscal
year 2001 of which $3.6 million remained accrued at September 30, 2003. Of
the total restructuring charges recorded during fiscal year 2001, $3.2 million
related to employee termination costs throughout the Company, and the remaining
$9.5 million related primarily to costs for excess leased facilities. During
2003, the Company reversed $0.3 million of previously accrued termination costs
due to a change in estimate. The Company anticipates utilizing the remaining
restructuring accrual, which relates to servicing operating lease payments or
negotiated buyout of operating lease commitments, through 2005.

15



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##### Table of Contents



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

Excess Leased Facilities andCancelled Contracts
    
    TotalBalance at December 31, 2002
    
    $
    5,243
    
    
    $
    5,243Recovery of charge
    
    
    (261
    )
    
    
    (261
    )Cash Payments
    
    
    (1,348
    )
    
    
    (1,348
    )Balance at September 30, 2003
    
    $
    3,634
    
    
    $
    3,634


Asset Write-offs

For
the nine months ended September 30, 2003, the Company wrote off
$0.4 million of fixed assets, which were determined to have no remaining useful
life. The Company wrote-off $17,000 of fixed assets in the three months ended
September 30, 2003. For the three and nine months ended September 30, 2002,
the Company wrote off $1.4 million of fixed assets, which were determined to
have no remaining useful life. Additionally, in the second quarter of
2002, the Company recorded a $4.0 million charge to write-off
goodwill.



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

In December 2001, the Company entered into co-marketing arrangements with
Shaw Communications Inc., or Shaw and Rogers Communications Inc., or Rogers,
which was then a related party (see Note 6). The Company paid $7.5 million to
Shaw and $0.9 million to Rogers, and recorded these amounts as other current
assets. In July 2002, the Company began amortizing these prepaid assets and
charging them against Cable revenues in accordance with EITF 01-09, Accounting
for Consideration given by a Vendor to a Customer or Reseller in Connection
with the Purchase or Promotion of the Vendors Products. The Company will
charge the remaining $1.4 million of amortization of these assets against
revenues in the next quarter ending December 31, 2003. Amounts charged against
revenues in the three and nine months ended September 30, 2003, totaled
approximately $1.4 million and $4.2 million, respectively. The amount charged
against revenues in the three and nine months ended September 30, 2002, totaled
approximately $1.4 million.



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

Lewis Solomon, a member of the Companys Board of Directors and chairman
of the Companys Audit Committee is also a member of the Board of Directors of
Harmonic, Inc., or Harmonic. In April 2002, the Company entered into a
reseller agreement with Harmonic to sell certain of the Companys products. The
agreement appoints Harmonic as an authorized, non-exclusive reseller of certain
of the Companys video products. For the three and nine months ended September
30, 2003, related party revenue includes $0.5 million and $1.5 million,
respectively, of revenue from Harmonic. The Company recorded $0.3 million and
$0.4 million, respectively of revenue related to Harmonic for the three and
nine months ended September 30, 2002.

Alek Krstajic, a member of the Companys Board of Directors, was the
Senior Vice President of Interactive Services, Sales and Product Development
for Rogers until January 2003. Beginning April 1, 2003, the Company no longer
recognize revenue related to Rogers as related party revenue as Rogers was no
longer considered to be a related party. In the three months ended March 31,
2003, the Company recognized $1.4 million of Rogerss related party revenue,
net of amortization of co-marketing expense (See Note 5). For the three and
nine months ended September 30, 2002, the Company recognized revenue

16



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##### Table of Contents



of $0.3 million and $6.2 million, respectively in connection with product
shipments to Rogers, net of amortization of co-marketing expense beginning in
the third quarter of 2002.

Cost of related party product revenues in the Companys consolidated
statements of operations consists of direct and indirect product costs.
Accounts receivable from Harmonic totaled approximately $0.2 million at
September 30, 2003. Accounts receivable from Rogers totaled approximately $0.4
million at September 30, 2002. Accounts receivable from Harmonic totaled
approximately $0.1 million at September 30, 2002. None of the related parties
is a supplier to the Company.



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

The Company provides for estimated product warranty expenses when it sells
the related products. Because warranty estimates are forecasts that are based
on the best available information  mostly historical claims experience -
claims costs may differ from amounts provided. An analysis of changes in the
liability for product warranties for the nine months ended September 30, 2003,
is as follows (in thousands):

AdditionsCharged to
    
    Charges forBalance at December
    
    Costs and
    
    Warranty Services
    
    Balance at31, 2002
    
    Expenses
    
    Provided
    
    September 30, 2003Warranty
reserve
    
    $
    8,607
    
    
    
    1,350
    
    
    
    (3,748
    )
    
    $
    6,209




|8. |  | Sale of Certain Assets
|-- |  | ----------------------

In July 2003, the Company entered into an agreement with Verilink
Corporation, or Verilink, to sell certain assets to Verilink for up to a
maximum of $0.9 million. The Company received $0.45 million in July 2003 and
will receive additional payments totaling up to $0.45 million through December
31, 2004. The assets were originally acquired through the Companys
acquisition of Access Network Electronics, or ANE in February 2000.
Additionally, Verilink agreed to purchase at least $2.1 million of related
inventory from the Company on or before December 31, 2004.

As part of this agreement, Verilink agreed to assume all warranty
obligations related to ANE products sold prior to, on, or after July 2003. The
Company agreed to reimburse Verilink for up to $2.4 million of certain warranty
obligations for ANE products sold prior to July 2003. Further,
Verilink assumed the obligation for one of the Companys
operating leases, previously accrued as restructuring, resulting in a
recovery of restructuring charges of $0.3 million (see
Note 4).



|8. |  | Subsequent Event
|-- |  | ----------------

On
October 7, 2003, the Company filed a registration statement on
Form S-3 with the Securities and Exchange Commission, or SEC.
This shelf registration statement, which was declared effective by
the SEC on November 4, 2003, will allow the Company to issue
various types of securities, including common stock, preferred stock,
debt securities and warrants to purchase common stock from time to
time up to an aggregate of $125.0 million, subject to market
conditions and its capital needs. On November 7, 2003, the
Company filed a prospectus supplement with reference to its
intention to offer 10,800,000 shares of common stock, which would result in gross
proceeds of $75.0 million.

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

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

Overview

We develop, market and sell cable modem termination systems, or CMTSs,
customer premise equipment, or CPE, including cable modems, and digital video
equipment. Our CMTS and CPE products enable cable operators to provision,
deliver and manage cost-effective broadband Internet access and Voice over
Internet Protocol (VoIP). Our digital video equipment allows cable and
satellite operators to provide advanced digital video services to subscribers.
We focus on the development and deployment of cable broadband access
technologies that will improve on cable operators return on investment by
leveraging their existing infrastructure to deliver broadband services to
residential and commercial subscribers at lower expense and provide new
services. We sell our products to cable operators and other providers of
broadband services through direct sales forces in North America, Europe and
Asia. We also distribute our products through resellers and system integrators.

We generate our revenues principally from sales of our three major product
groups, CMTS, CPE, and digital video equipment, either directly to broadband
service providers or through resellers. Our total revenues depend in large
part upon capital expenditure trends in the broadband services industry
generally, which declined beginning in 2001, and have only recently begun to
improve. Our revenues, which to date have been predominantly derived from CPE
cable modem sales, have been adversely affected by intense competition in the
CPE market, which has resulted in a substantial decline in revenues due to the
erosion of the average sale prices, or ASPs, of these products. In addition,
there has been an increasing adoption of DOCSIS (data over cable service
interface specification) standards based equipment over the past few years. As
it became apparent that our customers were increasingly purchasing only DOCSIS
certified or qualified equipment, we have undertaken a transition from our
historical focus of our proprietary Synchronous Code Division Multiple Access,
or S-CDMA technology to developing, marketing and selling DOCSIS-based
products. As of September 30, 2003 we believe this transition has been largely
completed. Our future operating results will depend on our continued success in
growing revenues from products other than the legacy S-CDMA products.

Our gross margins fluctuate from period to period primarily as a result of
the mix of products we sell. Specifically, we derive substantially higher
margins from sales of our CMTS and digital video equipment products than we do
from sales of CPE products, which are subject to intense price competition, as
discussed above. While we are working to mitigate pressures on our gross
margins by continuing to focus on product manufacturing cost reductions,
especially for our CPE products, we also expect further decreases in our CPE
ASPs to continue to adversely affect gross margins. To the extent that our
product costs decline slower than ASP declines, our margins will be adversely
affected. . We believe our ability to achieve profitability in the long term
depends on our ability to achieve overall gross margins of approximately 35% to
40%. To the extent that sales of CPE products comprise a greater proportion of
our total revenues, our ability to achieve this target gross margin will be
adversely affected.

In addition, because our markets are characterized by rapid technological
change, short product life cycles and substantial fluctuations in capital
expenditures by our customers, we must regularly assess our valuation of
inventory and our long-term purchasing commitments to our vendors and, when
appropriate, record charges or accrue provisions for excess and obsolete
inventory and vendor cancellation charges. To the extent inventory we deemed
excess or obsolete is sold or vendor cancellation charges are reduced, we
reverse these accruals, and the reversals are reflected in our statements of
operations as credits to cost of product revenues.

We had a net loss of $7.2 million and $16.0 million for the three months
ended September 30, 2003 and September 30, 2002, respectively, and a net loss
of $44.3 million ($0.60 per share) and $23.7

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million ($0.33 per share) for the nine months ended September 30, 2003 and
September 30, 2002, respectively. In the nine months ended September 30, 2002,
we recorded $49.1 million in gain on early retirement of debt in connection
with the repurchase of $109.1 million aggregate principal amount of our 5%
Convertible Subordinated Notes due 2007, or Convertible Notes, for
approximately $57.6 million in cash. We did not repurchase any Convertible
Notes in the nine months ended September 30, 2003. On a per share basis, the
gain on early retirement of debt in the 2002 period was $0.67. We had an
accumulated deficit of $981.5 million as of September 30, 2003. Our operating
expenses are based in part on our current 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 $3.0 million to $5.0
million on capital expenditures during the year ending December 31, 2003.
Anticipated capital expenditures consist of purchases of computer hardware,
furniture and leasehold improvements for our facilities, and software and
equipment. We expect to continue to incur losses for the foreseeable future.

Critical Accounting Policies

Inventory Valuation.We record losses on commitments to purchase
inventory in accordance with Statement 10 of Chapter 4 of Accounting Release
Bulletin No. 43. Our policy for valuation of inventory and commitments to
purchase inventory, including the determination of obsolete or excess
inventory, requires us to perform a detailed assessment of inventory at each
balance sheet date which includes a review of, among other factors, an estimate
of future demand for products within specific time horizons, generally six
months or less as well as product lifecycle and product development plans.
Given the rapid technological change in the technology and communications
equipment industries as well as significant, unpredictable changes in capital
spending by our customers, we believe that assessing the value of inventory
using generally a six month time horizon is appropriate.

The estimates of future demand that we use in the valuation of inventory
are the basis for the revenue forecast, which is also consistent with our
short-term manufacturing plan. Based on this analysis, we reduce the cost of
inventory that we specifically identify and consider obsolete or excessive to
fulfill future sales estimates. We define excess inventory as inventory that
will no longer be used in the manufacturing process. Excess inventory is
generally defined as inventory in excess of projected usage, and is determined
using our best estimate of future demand at the time, based upon information
then available.

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

Results of Operations

Three and Nine Months Ended September 30, 2003 and 2002

Revenues

(in thousands)% Change for thethree months
    
    % Change for theFor the three months ended
    
    For the nine months ended
    
    ended
    
    nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002
    
    2002/2003
    
    2002/2003Product revenues
    
    $
    37,628
    
    
    $
    24,475
    
    
    $
    90,495
    
    
    $
    104,100
    
    
    
    54
    %
    
    
    (13
    )%


We sell our products directly to broadband service providers, and to a
lesser extent, resellers and system integrators. Revenues related to product
sales are recognized when: (1) persuasive evidence of an

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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.

Our total revenues increased 54% to $37.6 million for the three months
ended September 30, 2003 from $24.5 million in the same period in 2002. Our
CMTS product revenue increased by $10.3 million in the three months ended
September 30, 2003 compared to the same period in 2002 due to increasing sales
of DOCSIS products partially offset by declining sales of S-CDMA CMTS products.
Our lower-margin Subscriber (CPE) product revenue increased by a smaller $4.5
million in the three months ended September 30, 2003 compared to the same
period in 2002 but only represented 42% of our total revenues for the 2003
period compared to 46% for the 2002 period. In both periods, unit volume
increases more than offset reductions in ASPs. Sales of our video products
remained flat in the three months ended September 30, 2003 compared to the same
period in 2002. Three customers accounted for 10% or more of total revenues
(29%, 13%, and 13%) for the three months ended September 30, 2003. Two
customers accounted for 10% or more of total revenues (25% and 14%) for the
three months ended September 30, 2002.

Revenues decreased 13% to $90.5 million for the nine months ended
September 30, 2003 from $104.1 million in the same period in 2002. This
decrease in total revenues was primarily due to the slowdown in the general
economy, constraints on technology-related capital spending by cable service
providers, and increased competition that began in the second half of 2002 and
continued into the first three months of 2003. Three customers accounted for
10% or more of total revenues (20%, 17%, and 12%) for the nine months ended
September 30, 2003. One customer accounted for 10% or more of total revenues
(32%) for the nine months ended September 30, 2002.

Related Party Revenues

(in thousands)% Change for the
    
    % Change for theFor the three months ended
    
    For the nine months ended
    
    three months ended
    
    nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002
    
    2002/2003
    
    2002/2003Related party
revenues:Rogers
    
    $
    
    
    
    $
    492
    
    
    $
    1,606
    
    
    $
    6,368
    
    
    
    
    
    
    
    (75
    )%Harmonic
    
    
    460
    
    
    
    316
    
    
    
    1,474
    
    
    
    436
    
    
    
    46
    %
    
    
    238
    %Co-marketing
agreement
    
    
    
    
    
    
    (153
    )
    
    
    (153
    )
    
    
    (153
    )
    
    
    
    
    
    
    Total related party
revenues
    
    $
    460
    
    
    $
    655
    
    
    $
    2,927
    
    
    $
    6,651
    
    
    
    (30
    )%
    
    
    (56
    )%


Related party revenues in 2002 and the first quarter of 2003 included
revenues from Rogers and Harmonic. Alek Krstajic, a member of our board of
directors, was the Senior Vice President of Interactive Services, Sales and
Product Development for Rogers until January 2003. Effective in the second
quarter of 2003, Rogers is no longer a related party to us. Consequently,
revenues from Rogers are not included in related party revenue beginning in the
second quarter of 2003. Harmonic is a related party, and revenue generated from
Harmonic continues to be included in related party revenues as Lewis Solomon,
another member of our board of directors, is also a member of the board of
directors of Harmonic.

Related party revenues decreased 30% to $0.5 million for the three months
ended September 30, 2003 from $0.7 million in the same period in 2002 primarily
because Rogers was not a related party to us in the third quarter of 2003.
Related party revenues decreased 56% to $2.9 million for the nine months ended
September 30, 2003 from $6.7 million in the same period in 2002. The decline in
related party revenues in 2003 compared to 2002 was primarily due to the
overall decreased sales to Rogers, Rogers no longer being a related party to us
beginning in the second quarter of 2003, as well as the same economic and
competitive pressures discussed above. None of our related parties is a
supplier to us.

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In December 2001, we entered into co-marketing arrangements with Shaw and
Rogers. We paid $7.5 million to Shaw and $0.9 million to Rogers, and recorded
these amounts as other current assets. In July 2002, we began amortizing these
prepaid assets and charging them against revenues in accordance with EITF
01-09, Accounting for Consideration given by a Vendor to a Customer or
Reseller in Connection with the Purchase or Promotion of the Vendors
Products. We will charge the remaining $1.4 million of amortization of these
assets against revenues in the next quarter through December 31, 2003. Amounts
charged against revenues in the three and nine months ended September 30, 2003,
totaled approximately $1.4 million and $4.2 million, respectively.

Cost of Goods Sold and Gross Profit

(in thousands)% Change for the
    
    % Change for theFor the three months ended
    
    For the nine months ended
    
    three months ended
    
    nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002
    
    2002/2003
    
    2002/2003Cost of product
revenues
    
    $
    27,296
    
    
    $
    23,632
    
    
    $
    69,500
    
    
    $
    72,085
    
    
    
    16
    %
    
    
    (4
    )%Cost of related
party product
revenues
    
    
    138
    
    
    
    547
    
    
    
    1,262
    
    
    
    6,255
    
    
    
    (75
    )%
    
    
    (80
    )%Total cost of goods
sold
    
    $
    27,434
    
    
    $
    24,179
    
    
    $
    70,762
    
    
    $
    78,340
    
    
    
    13
    %
    
    
    (10
    )%Gross profit
    
    $
    10,194
    
    
    $
    296
    
    
    $
    19,733
    
    
    $
    25,760
    
    
    
    3,344
    %
    
    
    (23
    )%


Cost of goods sold consists of direct product costs as well as the
indirect costs of our manufacturing operations. Cost of related party product
revenues also consists of direct and indirect product costs. The cost of
manufacturing includes contract manufacturing, test and quality assurance for
products, warranty costs and associated costs of personnel and equipment. Cost
of goods sold and gross margin for the three and nine months ended September
30, 2003 included a favorable impact stemming from reversal of approximately
$2.0 million and $8.1 million, respectively, of inventory provisions, which
were previously recorded as cost of goods sold. Cost of goods sold and gross
margin for the three and nine months ended September 30, 2002, included a
favorable impact stemming from reversal of approximately $0.6 million and $13.1
million of inventory provisions, which were previously recorded as cost of
goods sold. We reversed these provisions as we were able to negotiate downward
certain vendor cancellation claims to terms more favorable to us, and were able
to sell inventory originally considered to be excess or obsolete.

We achieved a gross profit of $10.2 million or 27% of revenues for the
three months ended September 30, 2003 compared to $0.3 million or 1% of
revenues for the three months ended September 30, 2002. The increase in gross
profit was primarily attributable to higher sales overall and a favorable
product mix, driven by higher sales of higher margin CMTS products. We achieved
a gross profit of $19.7 million or 22% of revenues for the nine months ended
September 30, 2003 compared to $25.8 million or 25% of revenues for the nine
months ended September 30, 2002. The 23% decrease in gross profit in the nine
months ended September 30, 2003 was partially attributable to a 13% decrease in
revenue as compared to the same period in 2002 as a result of a continuing
decline in ASPs particularly for cable modems since the beginning of 2002, as
well as a reduction in the number of CMTS units sold during the nine month
period of 2003 as we were transitioning from proprietary products to DOCSIS
based products.

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Operating Expenses

(in thousands)% Change for the
    
    % Change for theFor the three months ended
    
    For the nine months ended
    
    three months ended
    
    nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002
    
    2002/2003
    
    2002/2003Research and
development
    
    $
    9,363
    
    
    $
    14,315
    
    
    $
    32,797
    
    
    $
    45,959
    
    
    
    (35
    )%
    
    
    (29
    )%Sales and marketing
    
    $
    6,452
    
    
    $
    9,026
    
    
    $
    19,741
    
    
    $
    28,020
    
    
    
    (29
    )%
    
    
    (30
    )%General and
administrative
    
    $
    2,783
    
    
    $
    4,467
    
    
    $
    9,510
    
    
    $
    11,653
    
    
    
    (38
    )%
    
    
    (18
    )%


Research and Development. Research and development expenses consist
primarily of personnel costs, internally designed prototype material
expenditures, outside engineering consultants, equipment and supplies required
to develop and enhance our products. Research and development expenses
decreased 35% to $9.4 million or 25% of sales for the three months ended
September 30, 2003, compared to $14.3 million or 58% of sales for the three
months ended September 30, 2002. The decrease in research and development
expenses was attributable to $1.5 million of reductions in employee related
expenses due to the lower headcount related to the restructuring in March 2003,
partially offset by an increase of $0.1 million attributable to the Executive
Compensation Plan. The decrease in research and development expense also
included reductions of $0.2 million of outside engineering consultants and $2.3
million of reductions in purchases of materials, costs incurred to develop
prototypes, and other research and development expenses. Additionally, we
reduced research and development efforts by $1.0 million for the three months
ended September 30, 2003 due to significantly reduced emphasis on our Telecom
related product lines. Research and development expenses decreased 29% to
$32.8 million or 36% of sales for the nine months ended September 30, 2003,
compared to $46.0 million or 44% of revenue for the nine months ended September
30, 2002. The decrease in research and development expenses was attributable
to $3.8 million of reductions in employee related expenses, partially offset by
an increase of $0.1 million attributable to the Executive Compensation Plan.
The decrease in research and development expense also included reductions of
$0.7 million of outside engineering consultants and $5.5 million of reductions
in purchases of materials, costs incurred to develop prototypes, and other
research and development expenses. Additionally, we have reduced research and
development efforts by $3.3 million due to significantly reduced emphasis on
our Telecom related product lines. We believe it is critical to continue to
make significant investments in research and development to create innovative
technologies and products that meet the current and future requirements of our
customers. Accordingly, we intend to continue our investment in research and
development primarily related to DOCSIS standards-based and other products. We
expect our total dollar amount of research and development expenditures to be
slightly higher in the fourth quarter of 2003 as we escalate work on new
product development initiatives in our CMTS and Video businesses.

Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions for sales personnel, marketing and support personnel,
and costs related to trade shows, consulting and travel. Sales and marketing
expenses decreased 29% to $6.5 million or 17% of revenue for the three months
ended September 30, 2003, compared to $9.0 million or 37% of revenue for the
three months ended September 30, 2002. The decrease in sales and marketing
expenses was due in part to $1.3 million in reduced employee expenses due to
lower headcount related to the restructuring, partially offset by an increase
of $0.1 million attributable to the Executive Compensation Plan. The decrease
in sales and marketing expenses also included $0.2 million of decreased
spending for outside consultants, $0.1 million of decreased travel costs, and
$1.1 million of overall sales and marketing cost reductions. Sales and

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marketing expenses decreased 30% to $19.7 million or 22% of revenue for
the nine months ended September 30, 2003, compared to $28.0 million or 27% of
revenue for the nine months ended September 30, 2002. The decrease in sales
and marketing expenses was primarily due to $5.3 million in reduced employee
expenses due to lower headcount related to the restructuring, partially offset
by an increase of $0.3 million attributable to the Executive Compensation Plan.
The decrease in sales and marketing expenses also included $0.7 million of
decreased spending for outside consultants, $0.8 million of decreased travel
costs, and $2.1 million of overall sales and marketing cost reductions.
Additionally, the cost related to the operation of the corporate aircraft
increased $0.3 million to $2.8 million in the first nine months of 2003 from
$2.5 million in the first nine months of 2002.

General and Administrative. General and administrative expenses consist
primarily of compensation and benefits for administrative officers and support
personnel, travel expenses and legal, accounting and consulting fees. General
and administrative expenses decreased 38% to $2.8 million or 7% of revenue for
the three months ended September 30, 2003, compared to $4.5 million or 18% of
revenue for the three months ended September 30, 2002. The decrease was due in
part to $0.7 million in reduced employee expenses due to lower headcount
related to the restructuring, partially offset by an increase of $0.3 million
attributable to the Executive Compensation Plan. The decrease in general and
administrative expenses also included reductions of $1.7 million of spending
for outside consultants, partially offset by $0.4 million of overall general
and administrative cost increases. General and administrative expenses
decreased 18% to $9.5 million or 11% of revenue for the nine months ended
September 30, 2003, compared to $11.7 million or 11% of revenue for the first
nine months ended September 30, 2002. The decrease was primarily due to $1.3
million in reduced employee expenses due to lower headcount related to the
restructuring, partially offset by an increase of $0.5 million attributable to
the Executive Compensation Plan, $2.5 million of decreased spending for outside
consultants, partially offset by $0.3 million of severance expense related to
the termination of an officer and $0.8 million of overall general and
administrative cost increases. We expect our total dollar amount of general
and administrative expenditures to be slightly higher in the fourth quarter of
2003.

Restructuring Costs and Asset Write-offs

(in thousands)
    
    For the three months ended
    
    For the nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Restructuring
charges (recovery)
    
    $
    (261
    )
    
    $
    3,541
    
    
    $
    2,398
    
    
    $
    3,541Long-lived asset
write-offs
    
    
    17
    
    
    
    1,409
    
    
    
    405
    
    
    
    5,381Restructuring costs
and asset
write-offs
    
    
    (244
    )
    
    
    4,950
    
    
    
    2,803
    
    
    
    8,922


2003 Restructuring Costs

During the first quarter of 2003, our Board of Directors approved a
restructuring plan to conform our expense and revenue levels and to better
position us for future growth and eventual profitability. We incurred
restructuring charges in the amount of $2.7 million related to employee
termination costs. At September 30, 2003, no restructuring charges remain
accrued. As of September 30, 2003, the employment of 81 of our employees has
been terminated, and we paid $2.7 million in termination costs. In the second
quarter of 2003, we reversed $86,000 of previously accrued termination costs
due to this restructuring. We believe we will realize annualized savings of
approximately $8 million to $12 million from these actions combined with
related operational savings, including the curtailment of certain programs and
discretionary expenditures.

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

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InvoluntaryTerminationsTotal charge
    
    $
    2,745Recovery of charge
    
    
    (86
    )Cash payments
    
    
    (2,659
    )Balance at September 30, 2003
    
    $
    


Asset Write-offs

For the nine months ended September 30, 2003, we wrote off $0.4 million of
fixed assets, which were determined to have no remaining useful life. We
wrote-off $17,000 of fixed assets in the three months ended September 30, 2003.
For the three and nine months ended September 30, 2002, we wrote off $1.4
million of fixed assets, which were determined to have no remaining useful
life. Additionally, in the second quarter of 2002, the Company recorded a $4.0
million charge to write-off goodwill.

Other Restructuring Activities

During 2002 and 2001, our Board of Directors approved two restructuring
plans to conform the expense and revenue levels and to better position us for
future growth and eventual profitability. Additionally, in the third quarter
of 2003 we reversed $0.3 million of costs from a previous restructuring in 2001
due to a change in estimate.

The following table summarizes the costs and activities during 2003,
related to the 2002 and 2001 restructuring (in thousands):

Excess LeasedInvoluntary
    
    Facilities andTerminations
    
    Cancelled Contracts
    
    TotalBalance at December 31, 2002
    
    $
    88
    
    
    $
    6,665
    
    
    $
    6,753Recovery of charge
    
    
    
    
    
    
    (290
    )
    
    
    (290
    )Cash Payments
    
    
    (88
    )
    
    
    (1,538
    )
    
    
    (1,626
    )Balance at September 30, 2003
    
    $
    
    
    
    $
    4,837
    
    
    $
    4,837


We anticipate 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.

Non-operating Expenses

(in thousands)% Change for the
    
    % Change for theFor the three months ended
    
    For the nine months ended
    
    three months ended
    
    nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002
    
    2002/2003
    
    2002/2003Interest income
    
    $
    583
    
    
    $
    1,526
    
    
    $
    2,394
    
    
    $
    5,636
    
    
    
    (62
    )%
    
    
    (58
    )%Interest expense
    
    $
    (787
    )
    
    $
    (990
    )
    
    $
    (2,438
    )
    
    $
    (5,347
    )
    
    
    (21
    )%
    
    
    (54
    )%Other income
(expense)
    
    $
    1,238
    
    
    $
    268
    
    
    $
    1,038
    
    
    $
    (4,197
    )
    
    
    362
    %
    
    
    (125
    )%


Interest Income. Interest income decreased 62% to $0.6 million for the
three months ended September 30, 2003 from $1.5 million in the same period in
2002. Interest income decreased 58% to $2.4

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million for the nine months ended September 30, 2003 from $5.6 million in
the same period in 2002. The decrease in interest income was primarily due to
lower cash balances due to the usage of cash for operations, lower interest
rates, as well as lower invested average cash balances due largely to the use
of cash to repurchase Convertible Subordinated Notes (Notes) in 2001 and 2002.

Interest Expense.Interest expense, which relates primarily to interest
on our Notes due in 2007, decreased 21% to $0.8 million for the three months
ended September 30, 2003 from $1.0 million in the same period in 2002. Interest
expense decreased 54% to $2.4 million for the nine months ended September 30,
2003 from $5.3 million in the same period in 2002, primarily due to the
repurchase of a total of $434.9 million of the Notes in 2001 and 2002.

Other Income (Expense).Other income (expense) is generally comprised of
realization of foreign currency translations and permanent gains or losses on
investments. Other income (expense) in the three months ended September 30,
2003 was $1.2 million, primarily comprised of a $0.7 million gain on the sale
of the Miniplex product line and related inventory as well as a $0.6 million
reversal of a liability associated with an overseas government grant which we
believe is now satisfied. In addition to the items noted above, other income
in the nine months ended September 30, 2003 was partially offset by
approximately $0.3 million in foreign currency translation losses. Other
income (expense) for the nine months ended September 30, 2002 included a
write-down of a $4.5 million long-term investment.

Income Taxes

(in thousands)
    
    For the three months ended
    
    For the nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Income taxes
    
    $
    (84
    )
    
    $
    (127
    )
    
    $
    (214
    )
    
    $
    (134
    )


We have generated operating losses since our inception. In the three and
nine months ended September 30, 2003 and September 30, 2002, we recorded an
income tax expense, which was related to foreign taxes.

Net Loss and Net Loss Per Share

(in thousands)
    
    For the three months ended
    
    For the nine months endedSeptember 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Net loss
    
    $
    (7,210
    )
    
    $
    (15,972
    )
    
    $
    (44,338
    )
    
    $
    (23,747
    )Net loss per share,
basic and diluted
    
    $
    (0.10
    )
    
    $
    (0.22
    )
    
    $
    (0.60
    )
    
    $
    (0.33
    )


Our net loss was $7.2 million in the three months ended September 30, 2003
compared to a net loss of $16.0 million in the three months ended September 30,
2002. Our net loss was $44.3 million in the nine months ended September 30,
2003 compared to a net loss of $23.7 million in the nine months ended September
30, 2002. Our net loss per share was $(0.10) for the three months ended
September 30, 2003 compared $(0.22) in the three months ended September 30,
2002. Our net loss per share was $(0.60) for the nine months ended September
30, 2003 compared $(0.33) in the nine months ended September 30, 2002.

In the nine months ended September 30, 2002, we recorded $49.1 million in
gain on early retirement of debt in connection with the repurchase of $109.1
million aggregate principal amount of our 5% Convertible Subordinated Notes due
2007, or Convertible Notes, for approximately $57.6 million in cash. We did
not repurchase any Convertible Notes in the nine months ended September 30,
2003. On a per share basis, the gain on early retirement of debt in the 2002
period was $0.67.

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

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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. On February 24, 2003, the court
certified the plaintiffs proposed class. Since then, the parties have
completed nearly all discovery from fact witnesses and have begun, but not
finished, expert witness discovery.

Both defendants and plaintiffs have filed summary judgment motions.
Defendants motion seeks judgment as to plaintiffs entire claim. Plaintiffs
motion seeks a determination that certain of the defendants class period
statements were false.

On September 8, 2003, the Court heard defendants motion to disqualify two
of the lead plaintiffs and to modify the definition of the plaintiff class.
This motion is now under submission.

On September 10, 2003, the Court issued an order vacating the hearing date
for the parties summary judgment motions. On September 22, 2003, the Court
issued another order staying all discovery until further notice of the Court
and vacating the trial date, which had been November 4, 2003.

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

On October 16, 2000, a lawsuit was filed against us and the individual
defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the California
Superior Court, San Luis Obispo County. This lawsuit is titled Bertram v.
Terayon Communications Systems, Inc. (Bertram). The Bertram complaint contains
factual allegations similar to those alleged in the federal securities class
action lawsuit. The complaint asserts causes of action for unlawful business
practices, unfair and fraudulent business practices, and false and misleading
advertising. Plaintiffs purport to bring the action on behalf of themselves and
as representatives of all persons or entities in the State of California and
such other persons or entities outside California that have been and are
adversely affected by 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 and filed their opening brief in the Court
of Appeals. Defendants answering brief is due on November 24, 2003, and
plaintiffs optional reply brief is due 14 days after service of defendants
brief.

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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 our 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, which is now complete. The OBriencase is now consolidated with the
Campbellcase.

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

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics filed a claim with the Tel Aviv District Court in
Israel against us and Radwiz, our subsidiary, alleging that damages of NIS
25,000,000 (approximately $5.0 million US dollars) were inflicted on them by
our alleged failure to comply with our contractual obligations to accept and
pay for components manufactured by Flextronics in the first quarter of 2001
pursuant to projections it had received from Radwiz. We filed a statement of
defense denying the allegations, after which the parties accepted the Courts
recommendation to transfer the case to non-binding mediation. On September
29, 2003, we settled the dispute with Flextronics and paid to Flextronics $1.5
million as part of the settlement.

On January 19, 2003, Omniband filed a request for arbitration with the
Zurich Chamber of Commerce, claiming damages in an amount of $2.1 million
allegedly caused by our breach of an agreement to sell to Omniband certain
equipment pursuant to an agreement between Omniband and Radwiz, dated February
22, 2000. We believe that the allegations are baseless and intend to present a
vigorous defense in the arbitration proceedings.

We, as well as our customers, have received letters from third parties
claiming that our technology and products infringe on the third parties
patents. We have consulted with our patent counsel and are in the process of
reviewing the allegations made by such third parties. We do not know whether
the third parties will pursue their claims of patent infringement in court, and
if they do, whether we would be found to infringe the third parties patents.
If we are found to have infringed such third party patents, we could be subject
to substantial damages and/or an injunction preventing us from selling our
products and conducting our business. Additionally, such third parties and
additional third parties could assert infringement claims against us in the
future. Any such claim of patent infringement, 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.

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

Liquidity and Capital Resources

At September 30, 2003, we had approximately $42.4 million in cash and cash
equivalents and $107.0 million in short-term investments. As of September 30,
2003, we had approximately $68.4 million of long-term
obligations, principally relating to
our 5% Convertible Subordinated Notes.

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

Through September 30, 2003, we had repurchased approximately $434.9
million of the Notes for $171.0 million in cash and $17.9 million in stock,
resulting in a gain on early retirement of debt of approximately $234.4 million
net of related unamortized issuance costs of $11.6 million. We did not
repurchase any Notes during the first nine months of 2003.

Cash used in operating activities for the nine months ended September 30,
2003 was $57.1 million compared to $56.5 million used in the same period in
2002. For the nine months ended September 30, 2003, significant uses of cash by
operating activities included a $44.3 million net loss, an
increase in accounts receivable of $13.0 million, and a reduction of
vendor cancellation charges of $11.3 million partially offset by $7.2
million in depreciation expense, and reductions in inventory and
other assets. For the nine months ended September 30, 2002, cash used
by operating activities included a $23.7 million net loss, a $49.1
million gain on early redemption of debt and a $21.7 million
reduction in accounts payable partially offset by $9.1 million in
depreciation expense, a $20.2 million increase in accounts
receivable and reductions in inventory.

Cash used by investing activities for the nine months ended September 30,
2003 was $20.7 million, compared to cash provided by investing activities of
$138.0 million in the same period in 2002. Investing activities consisted
primarily of the purchase and sale of short-term investments and fixed assets.

Cash provided by financing activities was $2.3 million for the nine months
ended September 30, 2003, compared to cash used by financing activities of
$54.2 million in the same period in 2002. Financing activities primarily
consisted of cash received through the exercise of stock options and shares
issued through the stock purchase plan. Additionally. In the first nine months
of 2002, we repurchased Notes for $57.6 million in cash.

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

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The following summarizes our contractual obligations at September 30,
2003, and the effect such obligations are expected to have on our liquidity and
cash flows in future periods (in millions):

Payments Due by PeriodLess than
    
    1-3
    
    4-5
    
    After 5Total
    
    1 year
    
    years
    
    years
    
    yearsCapital Lease Obligations
    
    $
    0.1
    
    
    $
    0.1
    
    
    $
    
    
    
    $
    
    
    
    $
    Unconditional Purchase Obligations
    
    
    53.0
    
    
    
    53.0
    
    
    
    
    
    
    
    
    
    
    
    Long Term Debt
    
    
    68.4
    
    
    
    
    
    
    
    1.5
    
    
    
    65.0
    
    
    
    1.9Operating Lease Obligations
    
    
    26.0
    
    
    
    6.8
    
    
    
    9.8
    
    
    
    6.1
    
    
    
    3.3Aircraft Lease
    
    
    4.9
    
    
    
    1.5
    
    
    
    3.0
    
    
    
    0.4
    
    
    
    Total Contractual Commitments
    
    $
    152.4
    
    
    $
    61.4
    
    
    $
    14.3
    
    
    $
    71.5
    
    
    $
    5.2


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, 2003, we had $53.0 million of purchase obligations,
of which $3.9 million are included on the balance sheet as accrued vendor
cancellation charges. The remaining obligations are expected to become payable
at various times through the first quarter of 2004.

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

Amount of Commitment Expiration Per PeriodTotalAmounts
    
    Less than
    
    1-3
    
    4-5
    
    Over 5Committed
    
    1 year
    
    years
    
    years
    
    yearsDeposits
    
    $
    0.5
    
    
    $
    0.3
    
    
    $
    
    
    
    $
    
    
    
    $
    0.2Standby Letters of Credit
    
    
    8.7
    
    
    
    1.2
    
    
    
    
    
    
    
    7.5
    
    
    
    Total Commercial Commitments
    
    $
    9.2
    
    
    $
    1.5
    
    
    $
    
    
    
    $
    7.5
    
    
    $
    0.2


On October 7, 2003, we filed a registration statement on Form S-3 with the
Securities and Exchange Commission, or SEC. This shelf registration statement,
which was declared effective by the SEC on November 4, 2003, will allow us to
issue various types of securities, including common stock, preferred stock,
debt securities and warrants to purchase common stock from time to time, up to
an aggregate of $125.0 million, subject to market conditions and our capital
needs. On November 7, we filed a prospectus supplement
announcing our intention to sell 10,800,000 shares of our common
stock, which would result in gross proceed of $75.0 million.

We believe that our current cash balances will be sufficient to satisfy
our cash requirements for at least the next 12 months. This estimate is a
forward-looking statement that involves risks and uncertainties, and actual
results may vary as a result of a number of factors, including those discussed
under the risk factor Our Operating Results May Fluctuate below and
elsewhere. We may need to raise additional funds in order to support more rapid
expansion, develop new or enhanced services, respond to competitive pressures,
acquire complementary businesses or technologies or respond to unanticipated
requirements. We may seek to raise additional funds through private or public
sales of securities, strategic relationships, bank debt, financing under
leasing arrangements or otherwise. If additional funds are raised through the
issuance of equity securities, the percentage ownership of our existing
stockholders will be reduced, stockholders may experience additional dilution
or such equity securities may have rights, preferences or privileges senior to
those of the holders of our common stock. There can be no assurance that
additional financing will be available on acceptable terms, if at all. If
adequate funds are not available or are not available on acceptable terms, we
may be unable to continue operations, develop our products, take advantage of
future

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

Impact of Recently Issued Accounting Standards

In May 2003, the FASB issued SFAS No. 150, Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity
which establishes standards for how an issuer of financial instruments
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) if, at inception, the monetary value of the obligation is based
solely or predominantly on a fixed monetary amount known at inception,
variations in something other than the fair value of the issuers equity shares
or variations inversely related to changes in the fair value of the issuers
equity shares. SFAS No. 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. The adoption of SFAS
No. 150 did not have a material impact on our financial position or results of
operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133
on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. This
statement is effective for contracts entered into or modified after June 30,
2003, and did not have a material impact on our financial position or results
of operations.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. Interpretation No. 46 clarifies the application
of Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. This Interpretation
is applicable in the quarter ending December 31, 2003, for interests acquired
in variable interest entities prior to February 1, 2003. This Interpretation
requires variable interest entities to be consolidated if the equity investment
at risk is not sufficient to permit an entity to finance its activities without
support from other parties or the equity investors lack specified
characteristics. We believe that the adoption of this Interpretation will not
have a material impact on our financial statements.

In November 2002, the EITF reached a consensus on Issue No. 00-21,
Revenue Arrangements with Multiple Deliverables. EITF Issue No. 00-21
provides guidance on how to account for certain arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF Issue No. 00-21 did not have any significant impact on our
financial position or results of operations

RISK FACTORS

We have a history of losses and may continue to incur losses in the future.

It is difficult to predict our future operating results. We began shipping
products commercially in June 1997, and we have been shipping products in
volume since the first quarter of 1998. As of September 30, 2003, we had an
accumulated deficit of $981.5 million. We believe that we will continue to
experience challenges in selling our products at a profit and continue to
operate with net losses for the foreseeable future. Moreover, we have had
declining revenue since 2000. In the nine months ended September 30, 2003, our
revenues decreased 13% from the same period in 2002. As a result of the
operating deficiencies, we have had to use available cash and cash equivalents
to supplement the operation of our business. Cash used in operating activities
for the nine months ended September 30, 2003 was $57.1 million as compared to
$56.5 million used in the same period in 2002. Additionally, we generally are
unable to significantly

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reduce our short-term expenses in order to compensate for unexpected decreases
in anticipated revenues or delays in generating anticipated revenues. For
example, we have commitments with some of our suppliers to purchase their
products. In the past, we have been unable to use all of the products that we
purchased and as a result have taken vendor cancellation charges. We may have
to take additional charges in the future if we are unable to use all of the
products that we purchase from our suppliers. Further, we have been
experiencing and will continue to experience declining average selling prices,
or ASPs, of our products. We record an inventory charge to reduce our inventory
to the lower of cost or market if average selling prices fall below the cost of
these products. In addition, we have significant operating lease commitments
for facilities and equipment that generally cannot be cancelled in the
short-term without substantial penalties.

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

We may experience fluctuations in our operating results and face
unpredictability in our future revenues.

Our quarterly revenues have fluctuated and are likely to continue to fluctuate
significantly in the future due to a number of factors, many of which are
outside our control. Factors that affect our revenues include, among others,
the following:



| |  |  | variations in the timing of orders and shipments of our products;
| | - |  | -----------------------------------------------------------------



| |  |  | variations in the size of the orders by our customers and pricing
concessions on volume sales;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | competitive market conditions;
| | - |  | ------------------------------



| |  |  | unpredictable sales cycles;
| | - |  | ---------------------------



| |  |  | new product introductions by competitors or by us;
| | - |  | --------------------------------------------------



| |  |  | delays in our introduction of new products;
| | - |  | -------------------------------------------



| |  |  | delays in our introduction of added features to our products;
| | - |  | -------------------------------------------------------------



| |  |  | delays in reducing the cost of our products;
| | - |  | --------------------------------------------



| |  |  | delays in the commercialization of products that are competitive in the
marketplace;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | delays in our receipt of and cancellation of orders forecasted by
customers;
| | - |  | ----------------------------------------------------------------------------



| |  |  | variations in capital spending budgets of cable operators and other
broadband service providers;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | international conflicts, including the continuing conflict in Iraq and acts
of terrorism, and the impact of adverse economic, market and political
conditions worldwide; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ability of our products to be qualified or certified as meeting industry
specifications.
| | - |  | ----------------------------------------------------------------------------------------

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

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| |  |  | the ASPs of our products;
| | - |  | -------------------------



| |  |  | the costs of manufacturing our products; and
| | - |  | --------------------------------------------



| |  |  | the effectiveness of our cost reduction measures.
| | - |  | -------------------------------------------------

We often recognize a substantial portion of our revenues in the last month of
the quarter. We establish our expenditure levels for product development and
other operating expenses based on projected sales levels and expenses are
relatively fixed, particularly in the short-term. For example, a significant
percentage of these operating expenses are fixed due to operating leases for
our facilities and equipment. Also, we have commitments with some of our
suppliers to purchase their products. As of September 30, 2003, $53.0 million
of purchase obligations were outstanding. Accordingly, variations in timing of
sales can cause significant fluctuations in operating results. In addition,
because a significant portion of our business is derived from orders placed by
a limited number of large customers, the timing of such orders can also cause
significant fluctuations in our operating results. Our expenses for any given
quarter are typically based on expected sales and if sales are below
expectations, our operating results may be adversely impacted by our inability
to adjust spending to compensate for the shortfall. Moreover, our research and
development expenses fluctuate in response to new product development, changing
industry requirements and customer demands.

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

We are dependent on a small number of customers and our business could be
harmed by the loss of any of these customers or reductions in their purchasing
volumes.

Our customers have undergone and continue to undergo significant consolidation
in both North America and internationally, as a limited number of cable
operators control an increasing number of systems. For example, the top ten
cable operators in the United States own and operate systems that service
approximately 82% of homes that receive cable services in the United States. As
a result of the consolidation among cable operators, our revenue has been and
will continue to be dependent on sales to the few leading cable operators
worldwide. For example, three of our customers accounted for 10% or more of
total revenues (29%, 13% and 13%) for the three months ended September 30,
2003. Two of our customers accounted for 10% or more of total revenues (25% and
14%) for the three months ended September 30, 2002. Three of our customers
accounted for 10% or more of total revenues (20%, 17% and 12%) for the nine
months ended September 30, 2003. One of our customers accounted for 10% or more
of total revenues (32%) for the nine months ended September 30, 2002. We may
not succeed in attracting new customers as many of our potential customers have
pre-existing relationships with our current or potential competitors and the
continued consolidation of the cable industry reduces the number of potential
customers. To attract new customers, we may be faced with intense price
competition, which may affect our gross margins. Our sales are made on a
purchase order or system contract basis, and none of our customers has entered
into a long-term agreement requiring it to purchase our products. Moreover, we
do not typically require our customers to purchase a minimum quantity of our
products, and our customers can generally cancel their orders on short notice
without significant penalties. The loss of any of our customers can have a
material adverse effect on our results of operations. Further, any reduction in
orders from a given customer can likewise have a material adverse affect on our
results of operations.

The sales cycle for certain of our products is lengthy, which makes forecasting
of our customer orders and revenue difficult.

The sales cycle for certain of our products, such as our CMTS, is lengthy,
often lasting nine months to

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

There are many risks associated with our participation in industry standards.

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

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

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

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

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successful, we may face some of the same risks associated with our contribution
of intellectual property to CableLabs DOCSIS intellectual property pool.

We need to certify and qualify our new and existing products to meet industry
specifications in order to remain competitive.

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

There is no guarantee that our products will be DOCSIS, EuroDOCSIS or
PacketCable certified or qualified. If we are unable to certify or qualify our
products as DOCSIS, EuroDOCSIS or PacketCable compliant in a timely manner, we
may be unable to sell our products and may lose some or all of any advantage we
might otherwise have had, and our future operating results may be adversely
affected.

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

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

Average selling prices of broadband equipment continue to decline, which is
decreasing our gross margins.

The broadband equipment market has been characterized by erosion of product
ASPs. We expect this erosion to continue. The ASPs for our products are likely
to continue to decline due to competitive pricing pressures, promotional
programs and customers possessing strong negotiating positions and who require
price reductions as a condition of purchase. In addition, we believe that the
widespread adoption of industry specifications, such as the DOCSIS and
EuroDOCSIS specifications, is further eroding ASPs as cable modems and other
similar CPE become commodity products. Decreasing ASPs could result in
decreased revenues, even if the number of units sold increases. Decreasing ASPs
may also require us to sell our products at much lower gross margin than in the
past, and in fact, we may sell products at a loss. The primary reason that our
gross profits have declined year-over-year is the decline in product ASPs. As a
result, we may experience substantial period-to-period fluctuations in future
revenue, gross margin and

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operating results due to ASP erosion. Therefore, we must continue to develop
and introduce on a timely basis and a cost-effective manner new products or
next- generation products with enhanced functionalities that can be sold at
higher gross margins. Our failure to do this could cause our revenues and gross
margin to decline further.

We must achieve cost reductions to attain profitability.

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

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

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

Broadband services delivered by cable operators have not achieved widespread
market acceptance, and other competing service providers exist.

Our success will depend upon the widespread acceptance of broadband services
delivered by cable operators. The markets for these services are growing but
are not fully developed. Additionally, these markets may not grow as cable
operators have a limited amount of available bandwidth over which they can
offer new services, such as high-speed Internet access, high definition
television, or HDTV, video on demand, or VOD, and telephony. Cable operators
may elect not to provide any or all of these new services to their customers or
may not aggressively market these services to their customers. If cable
operators elect not to deploy such new services or if customers elect not to
subscribe to such services, it may affect our ability to sell products to cable
operators as their existing equipment may meet their current infrastructure
demands. We depend on cable operators to provide new services and maintain
their infrastructure in such a manner that allows us to continue to sell
products to them.

Cable operators must also compete with other service providers in the delivery
of services to their customers. Telecoms and satellite operators are
aggressively competing with the cable industry to deliver broadband services
via digital subscriber lines, or DSL, or satellite broadcast technologies. We
cannot accurately predict the future growth rate or the ultimate size of the
market for broadband services delivered via cable. The success of telecoms and
satellite operators may slow or hamper the continued acceptance of

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cable operators in delivering broadband services, which in turn may impact
demand for our products by cable operators.

We need to develop additional distribution channels to market and sell our
products.

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

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

We depend on cable industry capital spending for a substantial portion of our
revenue and any decrease or delay in capital spending by cable operators would
negatively impact our resources, operating results and financial condition.

Historically, almost all of our sales had been derived from sales to cable
operators, and we expect these sales to constitute a significant portion of net
sales for the foreseeable future. Demand for our products will depend on the
magnitude and timing of capital spending by cable operators. These capital
spending patterns are dependent on a variety of factors including:



| |  |  | the availability of financing;
| | - |  | ------------------------------



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



| |  |  | the status of federal, local and foreign government regulation and
deregulation of the telecommunications industry;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | overall demand for broadband services and the acceptance of new data, video
and voice services;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | evolving industry specifications and network architectures;
| | - |  | -----------------------------------------------------------



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

The timing of deployment of our equipment can be subject to a number of other
risks, including the availability of skilled engineering and technical
personnel, the availability of other equipment such as fiber optic cable and
the need for local zoning and licensing approvals. We believe that changes in
our

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customers deployment plans have, and may in the future delay, the receipt of
new orders. Since the majority of our sales have been to relatively few
customers, a delay in equipment deployment at any one customer has in the past
and could have a material adverse effect on our sales in a particular quarter.

We may fail to accurately forecast customer demand for our products.

The nature of the cable industry makes it difficult for us to accurately
forecast demand for our products. Our inability to forecast accurately the
actual demand for our products may result in too much or too little supply of
products or an over/under capacity of manufacturing or testing resources at any
given point in time. The existence of any one or more of these situations could
have a negative impact on our business, operating results or financial
condition. We had purchase obligations of approximately $53.0 million as of
September 30, 2003, primarily to purchase materials and components used to
manufacture our products. We must fulfill these obligations even if demand for
our products is lower than we anticipate.

We may not be able to manage expenses and inventory risks associated with
meeting the demand of our customers.

From time to time, we receive indications from our customers as to their future
plans and requirements to ensure that we will be prepared to meet their demand
for our products. If actual orders differ materially from these indications,
our ability to manage inventory and expenses may be affected. In addition, if
we fail to meet customers supply expectations, we may lose business from such
customers. If we enter into purchase commitments to acquire materials, or
expend resources to manufacture products and such products are not purchased by
our customers, our business and operating results could suffer.

We may have financial exposure to litigation.

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 directors for certain actions taken on our behalf.

In order to limit financial exposure arising from litigation and/or our
obligation to indemnify our officers and directors, we have historically
purchased directors and officers insurance, or D&O Insurance. However, the
availability of D&O Insurance is becoming more difficult for companies to
attain as a number of insurance underwriters no longer offer D&O Insurance and
the remaining insurance underwriters offering D&O Insurance have significantly
increased the premiums of such coverage. In recent years, we have experienced a
significant increase in the cost of our D&O Insurance, and there can be no
assurance that D&O Insurance will be available to us in the future or, if D&O
Insurance is available, it may be prohibitively expensive. Additionally, some
insurance underwriters who offered D&O Insurance in the past have been placed
into liquidation or may be, at some future point, placed into liquidation. In
October 2001, one of the insurance underwriters from which we purchased D&O
Insurance, Reliance Insurance Co., or Reliance, was placed into liquidation by
the state of Pennsylvania. Reliance was the underwriter for one excess layer of
our D&O Insurance for the period covering the claims made against us and our
officers in the pending securities litigation. Because Reliance is in
liquidation, we will be responsible for the amount insured under the Reliance
policy, which is approximately $2.5 million.

We are dependent on key third-party suppliers and any failure by them to
deliver components could limit our ability to satisfy customer demand.

We manufacture all of our products using components or subassemblies procured
from third-party suppliers. Some of these components are available from a sole
source and others are available from limited sources. A majority of our sales
are from products containing one or more components that are available only
from sole source suppliers. Additionally, some of our components are custom
parts that are produced to our specifications, and it may be difficult to move
the manufacturing of such components from one vendor to another vendor.

Any interruption in the operations of our vendors of sole source or custom
product parts could adversely

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affect our ability to meet our scheduled product deliveries to customers. If we
are unable to obtain a sufficient supply of components from our current
sources, we could experience difficulties in obtaining alternative sources or
in altering product designs to use alternative components. Resulting delays or
reductions in product shipments could damage customer relationships and expose
us to potential damages that may arise from our inability to supply our
customers with products. Further, a significant increase in the price of one or
more of these components could harm our gross margin or operating results.
Additionally, we attempt to limit this risk by maintaining safety stocks of
these components, subassemblies and modules. As a result of this investment in
inventories, we have in the past and in the future may be subject to risk of
excess and obsolete inventories, which could harm our business. In this regard,
our gross margins and operating results could be adversely affected by excess
and obsolete inventory.

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 the assembly and testing of our products, we do not
directly control product delivery schedules or product quality. Any product
shortages or quality assurance problems could increase the costs of
manufacturing, assembling or testing our products. In addition, as
manufacturing volume increases, we will need to procure and assemble additional
testing equipment and provide it to our contract manufacturers. The production
and assembly of testing equipment typically requires significant lead times. We
could experience significant delays in the shipment of our products if we are
unable to provide this testing equipment to our contract manufacturers in a
timely manner.

We are dependent upon international sales and there are many risks associated
with international operations.

We expect sales to customers outside of the United States to continue to
represent a significant percentage of our revenues for the foreseeable future.
For the three months ended September 30, 2003 and September 30, 2002,
approximately 56% and 51%, respectively, of our net revenues were from
customers outside of the U.S. For the nine months ended September 30, 2003 and
September 30, 2002, approximately 47% and 74%, respectively, of our net
revenues were from customers outside of the U.S. International sales are
subject to a number of risks, including the following:



| |  |  | changes in foreign government regulations and communications standards;
| | - |  | -----------------------------------------------------------------------



| |  |  | import and export license requirements, tariffs and taxes;
| | - |  | ----------------------------------------------------------



| |  |  | trade barriers;
| | - |  | ---------------



| |  |  | difficulty in protecting intellectual property;
| | - |  | -----------------------------------------------



| |  |  | difficulty in collecting accounts receivable;
| | - |  | ---------------------------------------------

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| |  |  | currency fluctuations;
| | - |  | ----------------------



| |  |  | the burden of complying with a wide variety of foreign laws, treaties and
technical standards;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | difficulty in staffing and managing foreign operations; and
| | - |  | -----------------------------------------------------------



| |  |  | political and economic instability.
| | - |  | -----------------------------------

If our customers are affected by currency devaluations or general economic
downturns, such as the economic downturns affecting many Asian, European and
Latin American economies, their ability to purchase our products could be
reduced significantly. Payment cycles for international customers typically are
longer than those for customers in North America.

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

Furthermore, foreign countries may decide to prohibit, terminate or delay the
construction of new cable infrastructures for a variety of reasons. These
reasons include environmental issues, economic downturns and availability of
favorable pricing for other communications services or the availability and
cost of related equipment. Any such action by foreign countries would reduce
the market for our products.

Our business may be affected by conditions in Israel.

We have significant operations in Israel. Our operations in Israel consist
primarily of research and development, and to a lesser extent sales and
manufacturing. Revenues generated by our business in Israel were $0.6 million
for the three months ending September 30, 2003 and September 30, 2002,
respectively. Revenues generated by our business in Israel were $1.4 million
and $0.9 million for the nine months ending September 30, 2003 and September
30, 2002, respectively. Our research and development operations may be
significantly affected by conditions in Israel. Since the establishment of the
State of Israel in 1948, a number of armed conflicts have taken place between
Israel and its Arab neighbors and a state of hostility, varying in degree and
intensity, has led to security and economic problems for Israel. Hostilities
within Israel have continued to escalate over the past year, which could
disrupt some of our operations. We could be adversely affected by any major
hostilities involving Israel. As a result of the hostilities and unrest
presently occurring within Israel, the future of the peace efforts between
Israel and its Arab neighbors is uncertain. A number of our employees based in
Israel are currently obligated to perform annual military reserve duty and are
subject to being called to active duty at any time under emergency
circumstances. We cannot assess the full impact of these requirements and the
hostilities on our workforce, business or operations if conditions should
change, and we cannot predict the effect of any expansion or reduction of these
obligations or the hostilities.

We may be unable to provide adequate customer support.

Our ability to achieve our planned sales growth and retain current and future
customers will depend in part upon the quality of our customer support
operations. Our customers generally require significant support and training
with respect to our products, particularly in the initial deployment and
implementation stages. Spikes in demand of our support services may cause us to
be unable to serve our customers. We may not have adequate personnel to provide
the levels of support that our customers may require during initial

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product deployment or on an ongoing basis especially during peak periods. Our
inability to provide sufficient support to our customers could delay or prevent
the successful deployment of our products. In addition, our failure to provide
adequate support could harm our reputation and relationships with our customers
and could prevent us from selling product to existing customers or gaining new
customers.

Our industry is highly competitive with many larger and more established
competitors.

The market for our products is extremely competitive and is characterized by
rapid technological change. Our direct competitors include Cisco Systems, ADC,
Arris, BigBand Networks, Motorola, Thomson Consumer Electronics (which markets
products under the brand name RCA), Scientific-Atlanta and Toshiba.
Additionally, we face competition from early stage companies with access to
significant financial backing that may improve existing technologies or develop
new technologies. The principal competitive factors in our market include the
following:



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



| |  |  | price;
| | - |  | ------



| |  |  | size and stability of operations;
| | - |  | ---------------------------------



| |  |  | breadth of product line;
| | - |  | ------------------------



| |  |  | sales and distribution capabilities;
| | - |  | ------------------------------------



| |  |  | technical support and service;
| | - |  | ------------------------------



| |  |  | relationships with providers of service providers; and
| | - |  | ------------------------------------------------------



| |  |  | compliance with industry standards.
| | - |  | -----------------------------------

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

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

We are dependent on key personnel.

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

Highly skilled employees with the education and training that we require,
especially employees with significant experience and expertise in video, 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

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development of our business. We do not have key person insurance coverage for
the loss of any of our employees. Any officer or employee can terminate his or
her relationship with us at any time. Our employees are not bound by
non-competition agreements with us.

Our business is subject to the risks of product returns, product liability and
product defects.

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

We may be unable to adequately protect or enforce our intellectual property
rights.

We rely on a combination of patent, trade secret, copyright and trademark laws
and contractual restrictions to establish and protect proprietary rights in our
products. Even though we seek to establish and protect proprietary rights in
our products, there are risks. We cannot be assured that any patent, trademark,
copyright or other intellectual property rights owned by us will not be
invalidated, circumvented or challenged, that such intellectual property rights
will provide competitive advantages to us or that any of our pending or future
patent applications will be issued with the scope of the claims sought by us,
if at all. We cannot be assured that others will not develop technologies that
are similar or superior to our technology, duplicate our technology or design
around the patents that we own. In addition, effective patent, copyright and
trade secret protection may be unavailable or limited in certain foreign
countries in which we do business or may do business in the future.

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

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

We believe that the future success of our business will depend on our ability
to translate the technological expertise and innovation of our employees into
new and enhanced products. 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,

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may not prove sufficient to prevent misappropriation of our trade secrets or
technology or deter independent third-party development of similar
technologies. In addition, the laws of some foreign countries may not protect
our intellectual property rights to the same extent as the laws of the United
States. We may, in the future, take legal action to enforce our patents and
other intellectual property rights, to protect our trade secrets, to determine
the validity and scope of the proprietary rights of others, or to defend
against claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could negatively effect our
business, operating results, financial position and liquidity.

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

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

Our business and our customers are subject to regulation.

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

Our products are subject to safety approvals and certifications.

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

We are vulnerable to earthquakes, disruptions to our power supply, 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 California operations may
also be subject to disruptions in power supply, such as occurred in 2001. Our
business may also be impacted by labor issues related to our operations and/or
those of our suppliers, service providers, or customers. Such an interruption
could harm our operating results. We may not carry sufficient business
interruption insurance to compensate for any losses that we may sustain as a
result of any natural disasters or other unexpected events.

Our indebtedness could adversely affect our financial condition; we may incur
substantially more debt.

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As of September 30, 2003, we had approximately $68.4 million of long-term
obligations. This level of indebtedness may adversely affect our stockholders
by:



| |  |  | making it more difficult for us to satisfy our obligations with respect to
our indebtedness;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | increasing our vulnerability to general adverse economic and industry
conditions;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | limiting our ability to obtain additional financing;
| | - |  | ----------------------------------------------------



| |  |  | requiring the dedication of a substantial portion of our cash flow from
operations to the payment of principal of, and interest on, our indebtedness,
thereby reducing the availability of our cash flow to fund our growth
strategy, working capital, capital expenditures and other general corporate
purposes;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | limiting our flexibility in planning for, or reacting to, changes in our
business and the industry; and
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | placing us at a competitive disadvantage relative to our competitors with
less debt.
| | - |  | ------------------------------------------------------------------------------------

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

Threatened terrorist attacks may negatively impact all aspects of our
operations, revenues, costs and stock price.

The events of September 11, 2001, as well as future events occurring in
response to or in connection with them, including, without limitation, future
terrorist attacks against United States targets, or military or trade
disruptions impacting our domestic or foreign suppliers of components required
for the manufacturing of our products, may cause delays or losses of customer
orders. More generally, any of these events could cause consumer confidence and
spending to decrease or result in increased volatility in the United States and
worldwide financial markets. They also could result in economic recession in
the United States or abroad. Any of these occurrences could have a significant
impact on our operating results, revenues and costs.

We may not be able to raise additional funds to continue operating our
business.

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

Our restructuring efforts could result in the erosion of employee morale, legal
actions against us and management distractions and could impair our ability to
respond rapidly to growth opportunities in the future.

As a result of the significant economic downturn and the related uncertainties
in the technology sector, we have implemented a number of restructuring plans,
including the most recent in March 2003, which has resulted in personnel
reduction. These reductions could result in an erosion of morale and affect the
focus and productivity of our remaining employees, including those directly
responsible for revenue generation, which in turn may affect our revenue in the future.
Additionally, employees directly affected by the

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reductions may seek future employment with our
business partners, customers or competitors. Although all employees are
required to sign a proprietary information agreement with us at the time of
hire, there can be no assurances that the confidential nature of our
proprietary information will be maintained in the course of such future
employment. Our employees are not bound by non-competition agreements with us.
Additionally, we may face wrongful termination, discrimination, or other claims
from employees affected by the reduction related to their employment and
termination. We could incur substantial costs in defending ourselves or our
employees against such claims, regardless of the merits of such actions.
Furthermore, such matters could divert the attention of our employees,
including management, away from our operations, harm productivity, harm our
reputation and increase our expenses. We cannot assure you that our
restructuring efforts will be successful, and we may need to take additional
restructuring efforts, including additional personnel reduction, in the future.

We may dispose of existing product lines, which may adversely impact our future
results.

On an ongoing basis, we evaluate our various product offerings in order to
determine whether any should be discontinued or, to the extent possible,
divested. Moreover, the worldwide downturn in the telecommunications industry
led us to reassess our business strategy, which in turn caused us to
discontinue investment in certain product lines. Specifically, we have reduced
our investment in the telecom and satellite spaces, sold our Miniplex product
line, and shutdown our Mainsail product line. Beginning in July 2003, we
entered into two transactions to further decrease our telecom business. In July
2003, we discontinued our Mainsail line of products and entered into an
agreement with a third party to supply warranty services for the Mainsail
products. In July 2003, we entered into an agreement with Verilink Corporation,
or Verilink, to sell certain telecom assets to Verilink, supply Verilink
certain telecom inventory, and assign all telecom warranty obligations to
Verilink with the exception of $2.4 million, which we will continue to be
responsible for.

We cannot assure you that we correctly forecasted the right product lines to
discontinue or that our decision to discontinue various investments and product
lines is prudent if market conditions change. In addition, we cannot assure you
that the discontinuance of various product lines will reduce our operating
expenses. Furthermore, future plans to discontinue existing product lines
entail various risks, including the risks that we will not be able to find a
buyer for a product line or the purchase price obtained will not be equal to
the book value of the assets for the product line.

We need to develop and introduce new and enhanced products in a timely manner
to remain competitive.

The markets in which we operate are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and relatively short product life. The pursuit of necessary technological
advances and the development of new products require substantial time and
expense. For example, we made ten acquisitions during the period between 1999
and 2000. Due to various economic conditions, none of the products from our
acquired businesses have achieved the level of market acceptance that was
forecasted at the time of their acquisitions. Additionally, certain product
groups have not achieved the level of technological development needed to be
marketable or to expand the market. As a result, we recorded an aggregate of
approximately $576.8 million related to impairment charges and write-down of
in-process research and development related to the acquired technologies, both
of which negatively impacted our operating results.

To compete successfully in the markets in which we operate, we must design,
develop, manufacture and sell new or enhanced products that provide
increasingly higher levels of performance and reliability. However, we may not
be able to successfully develop or introduce these products, if our products
are not (i) cost-effective, (ii) brought to market in a timely manner, (iii) in
accordance with evolving industry standards and architecture or (iv) fail to
achieve market acceptance. There is no assurance that the technologies we are
currently developing or intend to develop will achieve feasibility, or that
even if we are successful, the developed product will be accepted by the
market. We may not be able to recover the costs of existing and future product
developments and our failure to do so may materially and adversely impact our
business, financial condition and results of operations.

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

Most of our sales are on an open credit basis, with payment terms of 30 to 60
days typically in the United States, and because of local customs or
conditions, longer in some markets outside the United States. Beyond our open
credit arrangements, we have also experienced a request for customer financing
and facilitation of leasing arrangements, which we have not provided to date
and do not expect to provide in the future. We expect demand for enhanced open
credit terms, for example, longer payment terms, customer financing and leasing
arrangements to continue and believe that such arrangements are a competitive
factor in obtaining business. Our decision not to provide these types of
financing arrangements may adversely affect our ability to sell product, and
therefore, our revenue, operations and business.

Because of the current slowdown in the global economy, our exposure to credit
risks relating to sales on an open-credit basis has increased. Although we
monitor and attempt to mitigate the associated risk, there can be no assurance
that our efforts will be effective in reducing credit risk. Additionally, there
have been significant insolvencies and bankruptcies among our customers, which
have and may continue to cause us to incur economic and financial losses. For
example, we recorded a loss of $0.9 million related to the settlement of all
outstanding accounts receivables due from Net Servicos, a customer in the third
quarter of 2002. There can be no assurance that additional losses would not be
incurred and that such losses would not be material. Although these losses have
generally not been material to date, future losses, if incurred, could harm our
business and have a material adverse effect on our operating results and
financial condition.

We have and we may seek to expand our business through acquisitions;
acquisitions could disrupt our business operations and harm our operating
results.

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

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



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



| |  |  | diversion of managements attention from normal daily operations of the
business;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | potential difficulties in completing projects associated with in-process
research and development;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | difficulties in entering markets in which we have no or limited direct
prior experience and where competitors in such markets have stronger market
positions;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | initial dependence on unfamiliar supply chains or relatively small supply
partners;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | insufficient revenues to offset increased expenses associated with
acquisitions; and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | the potential loss of key employees of the acquired companies.
| | - |  | --------------------------------------------------------------

Acquisitions may also cause us to:



| |  |  | issue common stock that would dilute our current stockholders percentage
ownership;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | assume liabilities;
| | - |  | -------------------



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

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| |  |  | incur amortization expenses related to certain intangible assets;
| | - |  | -----------------------------------------------------------------



| |  |  | incur large and immediate write-offs; or
| | - |  | ----------------------------------------



| |  |  | become subject to litigation.
| | - |  | -----------------------------

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

We made ten acquisitions during the period between 1999 and 2000. Due to
various economic conditions, none of the products from our acquired businesses
have achieved the level of market acceptance that was forecasted at the time of
their acquisitions. Additionally, certain product groups have not achieved the
level of technological development needed to be marketable or to expand the
market. We recorded impairment losses of approximately $4.0 million and $572.8
million of intangible assets related to these acquisitions in December 31, 2002
and 2001. As of September 30, 2003, no intangible assets from these
acquisitions remain.

Various export licensing requirements could materially and adversely affect our
business or require us to significantly modify our current business practices.

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

New laws and regulations affecting corporate governance may impede our ability
to retain and attract board members and executive officers, and increase the
costs associated with being a public company.

On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley
Act of 2002. The new act is designed to enhance corporate responsibility
through new corporate governance and disclosure obligations, increase auditor
independence, and tougher penalties for securities fraud. In addition, the
Securities and Exchange Commission and the Nasdaq National Market have adopted
rules in furtherance of the act and are considering adopting others. This act
and the related new rules and regulations will likely have the effect of
increasing the complexity and cost of our corporate governance and the time our
executive officers spend on such issues, and may increase the risk of personal
liability for our board members, chief executive officer, chief financial
officer and other executives involved in our corporate governance process. As a
result, it may become more difficult for us to attract and retain board members
and executive officers. In addition, we have experienced, and will continue to
experience, increased costs associated with being a public company, including
additional professional and independent auditor fees.

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:

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| |  |  | actual or anticipated variations in quarterly operating results;
| | - |  | ----------------------------------------------------------------



| |  |  | announcements of technological innovations;
| | - |  | -------------------------------------------



| |  |  | new products or services offered by us or our competitors;
| | - |  | ----------------------------------------------------------



| |  |  | changes in financial estimates by securities analysts;
| | - |  | ------------------------------------------------------



| |  |  | conditions or trends in the broadband services industry;
| | - |  | --------------------------------------------------------



| |  |  | changes in the economic performance and/or market valuations of Internet,
online service or broadband service industries;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | our announcement of significant acquisitions, strategic partnerships, joint
ventures or capital commitments;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | adoption of industry standards and the inclusion or compatibility of our
technology with such standards;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | adverse or unfavorable publicity regarding us or our products;
| | - |  | --------------------------------------------------------------



| |  |  | additions or departures of key personnel;
| | - |  | -----------------------------------------



| |  |  | sales of common stock; and
| | - |  | --------------------------



| |  |  | other events or factors that may be beyond our control.
| | - |  | -------------------------------------------------------

In addition, the stock markets in general, and the Nasdaq National Market and
the stock price of broadband services and technology companies in particular,
have experienced extreme price and volume volatility. 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.

We have adopted a stockholder rights plan, which, together with provisions in
our charter documents and Delaware law, may delay or prevent an acquisition of
us, which could decrease the value of our stock.

We adopted a stockholder rights plan pursuant to which we distributed one right
for each outstanding share of common stock held by stockholders of record as of
February 20, 2001. Because the rights may substantially dilute the stock
ownership of a person or group attempting a take-over of us, even if such a
change in control is beneficial to our stockholders, without the approval of
our board of directors, the plan could make it more difficult for a third party
to acquire us, or a significant percentage of our outstanding capital stock,
without first negotiating with our board of directors. Additionally, provisions
of our Certificate of Incorporation and our Bylaws could make it more difficult
for a third party to acquire control of us in a transaction not approved by our
Board of Directors, and we have also opted out of the anti-takeover provisions
of Section 203 of the Delaware General Corporation Law, which could also have
the effect of delaying or preventing our acquisition by a third party.




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-

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term investments, consisting primarily of
investment grade securities, substantially all of which mature within the next
twenty-four months. A hypothetical 50 basis point increase in interest rates
would result in an approximate $209,000 decline (less than 1%) in the fair
value of our available-for-sale securities.

Foreign Currency Risk.

A substantial majority of our revenue, expense and capital purchasing
activity are transacted in U.S. dollars. However, we do enter into transactions
from Belgium, United Kingdom, Hong Kong, Korea, Canada, Brazil, Japan and
Israel denominated in local currencies. A hypothetical adverse change of 10% in
exchange rates would result in a decline in income before taxes of
approximately $11,000.

All of the potential changes noted above are based on sensitivity analyses
performed on our financial positions at September 30, 2003. Actual results may
differ materially.




ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by report, we carried out an
evaluation, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information required to be presented in this report.

There has been no change in our internal controls over financial reporting
that occurred during our most recent fiscal quarter that has materially
affected or is reasonably likely to materially affect our internal controls
over financial reporting.




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



| | 31.1 |  | Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------

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| | 31.2 |  | Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------



| | 32.1 |  | Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------



| | 32.2 |  | Certification of the Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------

(b)   REPORTS ON FORM 8-K

The Company furnished the following Current Reports on Form 8-K
during the three months ended September 30, 2003:



| | 1. |  | On July 3, 2003, the Company filed a report on Form
8-K announcing revised guidance for the Companys financial
results for the second quarter ended June 30, 2003.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2. |  | On July 16, 2003, the Company filed a report on Form
8-K announcing that the Company had been selected as a Platinum
Partner of the National Cable Television Cooperative and the
appointment of Douglas Sabella as Chief Operating Officer of the
Company.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. |  | On July 28, 2003, the Company filed a report on Form
8-K announcing that the Company had been selected as the primary
supplier of cable modems for the Arizona cable television
systems of Cox Communications, a conference call was scheduled
for July 30, 2003 to release the financial results for the
quarter ended June 30, 2003, that Mark Slaven, the Chief
Financial Officer of 3Com Corporation, had joined the Companys
Board of Directors, and that its TJ715x cable modem was
certified as meeting the DOCSIS 2.0 specification by CableLabs.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. |  | On July 31, 2003, the Company filed a report on Form
8-K announcing the Companys preliminary results for the second
quarter ended June 30, 2003.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| | 5. |  | On August 21, 2003, the Company filed a report on
Form 8-K announcing that it had shipped one million DOCSIS® 2.0
(Data Over Cable Service Interface Specification) cable modems
to cable television operators worldwide.
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 6. |  | On September 18, 2003, the Company filed a report on
Form 8-K announcing that Liwest, the second largest cable
television operator in Austria, is using the Companys complete
Euro-DOCSIS 2.0 (Data Over Cable Service Interface
Specification) based cable data system to deliver its 24Speed
broadband service.
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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SIGNATURES

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

Date: November 10, 2003
    
    TERAYON COMMUNICATION SYSTEMS, INCBy /s/ Arthur T. TaylorArthur T. TaylorChief Financial Officer


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EXHIBIT INDEX

(a)  EXHIBITS



| | 31.1 |  | Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------



| | 31.2 |  | Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------



| | 32.1 |  | Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------



| | 32.2 |  | Certification of the Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- |  | -------------------------------------------------------------------------------------------------------

51