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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 June 30, 2003
OR

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

FOR THE TRANSITION PERIOD FROM _______________TO _______________.



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TERAYON COMMUNICATION SYSTEMS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


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

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



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

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

As of
July 31, 2003, registrant had outstanding 74,455,259 shares of
Common Stock.



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TABLE OF CONTENTS



|                              |                                                                                               |  |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                              | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                              | ITEM 4. CONTROL AND PROCEDURES                                                               
|PART II. OTHER INFORMATION   
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5. OTHER INFORMATION                                                                    
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|EXHIBIT INDEX                
|EXHIBIT 10.10                
|EXHIBIT 10.24                
|EXHIBIT 10.25                
|EXHIBIT 10.26                
|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

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

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

|                                      |                                          |                           |                                            |           |         |             |        |              |         |         |  | 
|------------------------------------- | ---------------------------------------- | ------------------------- | ------------------------------------------ | --------- | ------- | ----------- | ------ | ------------ | ------- | ------- |  | 
|                                      |                                          |                           |                                            |           |         | June 30,    |        | December 31,
|                                      |                                          |                           |                                            |           |         | 2003        |        | 2002        
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          |                           |                                            |           |         | (unaudited) |        |              |         |        
|ASSETS                                |                                          |                           |                                            |           |         |             |        |             
|Current assets:                       |                                          |                           |                                            |           |         |             |        |             
|                                      | Cash and cash equivalents                |                           | $                                          | 68,466    |         |             | $      | 117,079      |        
|                                      | Short-term investments                   |                           |                                            | 93,440    |         |             |        | 89,424       |        
|                                      | Accounts receivable, net                 |                           |                                            | 23,200    |         |             |        | 16,355       |        
|                                      | Accounts receivable from related parties |                           |                                            | 565       |         |             |        | 842          |        
|                                      | Inventory                                |                           |                                            | 7,328     |         |             |        | 8,257        |        
|                                      | Other current assets                     |                           |                                            | 6,800     |         |             |        | 10,860       |        
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          | Total current assets      |                                            |           | 199,799 |             |        |              | 242,817 |        
|Property and equipment, net           |                                          |                           | 13,621                                     |           |         |             | 17,906 |             
|Restricted
cash and other assets, net |                                          |                           | 12,474                                     |           |         |             | 14,987 |             
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          | Total assets              |                                            | $         | 225,894 |             |        | $            | 275,710 |        
|                                      |                                          |                           |                                            |           |         |             |        |             
|LIABILITIES AND STOCKHOLDERS EQUITY  |                                          |                           |                                            |           |         |             |        |             
|Current liabilities:                  |                                          |                           |                                            |           |         |             |        |             
|                                      | Accounts payable                         |                           | $                                          | 19,833    |         |             | $      | 23,920       |        
|                                      | Accrued payroll and related expenses     |                           |                                            | 6,279     |         |             |        | 6,227        |        
|                                      | Deferred revenues                        |                           |                                            | 1,544     |         |             |        | 497          |        
|                                      | Accrued warranty                         |                           |                                            | 8,173     |         |             |        | 8,607        |        
|                                      | Accrued restructuring                    |                           |                                            | 5,506     |         |             |        | 6,754        |        
|                                      | Accrued vendor cancellation charges      |                           |                                            | 6,519     |         |             |        | 13,865       |        
|                                      | Other accrued liabilities                |                           |                                            | 6,780     |         |             |        | 8,609        |        
|Other current obligations             |                                          |                           | 1,524                                      |           |         |             | 1,509  |             
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          | Total current liabilities |                                            |           | 56,158  |             |        |              | 69,988  |        
|Long-term obligations                 |                                          |                           | 3,878                                      |           |         |             | 3,499  |             
|Convertible subordinated notes        |                                          |                           | 65,081                                     |           |         |             | 65,081 |             
|Commitments and contingencies         |                                          |                           |                                            |           |         |             |        |             
|Stockholders equity:                 |                                          |                           |                                            |           |         |             |        |             
|                                      | Common stock                             |                           |                                            | 74        |         |             |        | 73           |        
|                                      | Additional paid in capital               |                           |                                            | 1,078,777 |         |             |        | 1,078,144    |        
|                                      | Accumulated deficit                      |                           |                                            | (974,335  | )       |             |        | (937,207     | )      
|                                      | Deferred compensation                    |                           |                                            | (32       | )       |             |        | (25          | )      
|                                      | Treasury stock, at cost                  |                           |                                            | (773      | )       |             |        | (773         | )      
|                                      | Accumulated other comprehensive loss     |                           |                                            | (2,934    | )       |             |        | (3,070       | )      
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          |                           | Total stockholders equity                 |           |         | 100,777     |        |              |         | 137,142 | 
|                                      |                                          |                           |                                            |           |         |             |        |             
|                                      |                                          |                           | Total liabilities and stockholders equity |           | $       | 225,894     |        |              | $       | 275,710 | 
|                                      |                                          |                           |                                            |           |         |             |        |             

See accompanying notes.

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

|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |        |        |        | 
|------------------------------------------------------- | --------------------------------------------------- | ------------------------ | ------------------------ | ------ | ------------------ | ------ | ---------------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | 
|                                                        |                                                     |                          |                          |        | Three Months Ended |        | Six Months Ended
|                                                        |                                                     |                          |                          |        | June 30,           |        | June 30,        
|                                                        |                                                     |                          |                          |        |                    |        |                 
|                                                        |                                                     |                          |                          |        | 2003               |        | 2002             |        | 2003   |        | 2002   
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |        
|Product revenues                                        |                                                     | $                        | 29,964                   |        |                    | $      | 22,126           |        |        | $      | 50,556  |        |        | $      | 73,685  |       
|Related party product revenues                          |                                                     |                          | 635                      |        |                    |        | 281              |        |        |        | 2,311   |        |        |        | 5,940   |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|                                                        |                                                     | Total revenues           |                          |        | 30,599             |        |                  |        | 22,407 |        |         |        | 52,867 |        |         |        | 79,625 |       
|Cost of product revenues                                |                                                     |                          | 23,577                   |        |                    |        | 22,417           |        |        |        | 42,383  |        |        |        | 49,008  |       
|Cost of related party product revenues                  |                                                     |                          | 159                      |        |                    |        | 17               |        |        |        | 945     |        |        |        | 5,153   |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|                                                        |                                                     | Total cost of goods sold |                          |        | 23,736             |        |                  |        | 22,434 |        |         |        | 43,328 |        |         |        | 54,161 |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|                                                        | Gross profit (loss)                                 |                          |                          | 6,863  |                    |        |                  | (27    | )      |        |         | 9,539  |        |        |         | 25,464 |       
|Operating expenses:                                     |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|                                                        | Research and development                            |                          |                          | 10,432 |                    |        |                  | 14,704 |        |        |         | 23,434 |        |        |         | 31,644 |       
|                                                        | Sales and marketing                                 |                          |                          | 6,560  |                    |        |                  | 10,141 |        |        |         | 13,290 |        |        |         | 18,994 |       
|                                                        | General and administrative                          |                          |                          | 3,000  |                    |        |                  | 3,552  |        |        |         | 6,728  |        |        |         | 7,186  |       
|                                                        | Restructuring
costs (recovery) and asset write-offs |                          |                          | (115   | )                  |        |                  | 3,972  |        |        |         | 3,046  |        |        |         | 3,972  |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|                                                        |                                                     |                          | Total
operating expenses |        |                    | 19,877 |                  |        |        | 32,369 |         |        |        | 46,498 |         |        |        | 61,796 | 
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|Loss from operations                                    |                                                     |                          | (13,014                  | )      |                    |        | (32,396          | )      |        |        | (36,959 | )      |        |        | (36,332 | )     
|Interest income                                         |                                                     |                          | 909                      |        |                    |        | 2,013            |        |        |        | 1,811   |        |        |        | 4,110   |       
|Interest expense                                        |                                                     |                          | (814                     | )      |                    |        | (2,177           | )      |        |        | (1,651  | )      |        |        | (4,357  | )     
|Other expense                                           |                                                     |                          | (160                     | )      |                    |        | (4,400           | )      |        |        | (200    | )      |        |        | (4,465  | )     
|Gain on early retirement of debt                        |                                                     |                          |                         |        |                    |        | 33,276           |        |        |        |        |        |        |        | 33,276  |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|Loss before income tax expense                          |                                                     |                          | (13,079                  | )      |                    |        | (3,684           | )      |        |        | (36,999 | )      |        |        | (7,768  | )     
|Income tax expense                                      |                                                     |                          | 60                       |        |                    |        | 1                |        |        |        | 129     |        |        |        | 7       |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|Net loss                                                |                                                     | $                        | (13,139                  | )      |                    | $      | (3,685           | )      |        | $      | (37,128 | )      |        | $      | (7,775  | )     
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|Net loss per share, basic and diluted                   |                                                     | $                        | (0.18                    | )      |                    | $      | (0.05            | )      |        | $      | (0.50   | )      |        | $      | (0.11   | )     
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       
|Shares used in per share calculation, basic and diluted |                                                     |                          | 73,721                   |        |                    |        | 72,761           |        |        |        | 73,715  |        |        |        | 72,682  |       
|                                                        |                                                     |                          |                          |        |                    |        |                  |        |        |        |         |        |        |        |         |       

See accompanying notes.

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

|                                                                            |                                                 |   |          |                  |   |      |          |         |   | 
|--------------------------------------------------------------------------- | ----------------------------------------------- | - | -------- | ---------------- | - | ---- | -------- | ------- | - | 
|                                                                            |                                                 |   |          | Six Months Ended
|                                                                            |                                                 |   |          | June 30,        
|                                                                            |                                                 |   |          |                 
|                                                                            |                                                 |   |          | 2003             |   | 2002
|                                                                            |                                                 |   |          |                  |   |     
|Operating activities:                                                       |                                                 |   |          |                  |   |      |          |        
|Net loss                                                                    |                                                 | $ | (37,128  | )                |   | $    | (7,775   | )      
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                 |   |          |                  |   |      |          |        
|                                                                            | Depreciation                                    |   |          | 5,155            |   |      |          | 5,734   |  
|                                                                            | Write-off and amortization of intangible assets |   |          |                 |   |      |          | 3,972   |  
|                                                                            | Amortization related to stock options           |   |          | 8                |   |      |          | 366     |  
|                                                                            | Gain on early retirement of debt                |   |          |                 |   |      |          | (33,276 | )
|                                                                            | Provision
(recovery) of inventory reserve       |   |          | (5,828           | ) |      |          | 9,032   |  
|                                                                            | Write-off and disposal of fixed assets          |   |          | 485              |   |      |          | 1,115   |  
|Changes in operating assets and liabilities:                                |                                                 |   |          |                  |   |      |          |        
|                                                                            | Accounts receivable                             |   |          | (6,845           | ) |      |          | 21,324  |  
|                                                                            | Accounts receivable from related parties        |   |          | 277              |   |      |          | 3,705   |  
|                                                                            | Inventory                                       |   |          | 8,560            |   |      |          | 4,550   |  
|                                                                            | Other
current and non-current assets            |   |          | 6,573            |   |      |          | (11,312 | )
|                                                                            | Accounts payable                                |   |          | (4,087           | ) |      |          | (9,775  | )
|                                                                            | Accrued payroll and related expenses            |   |          | 52               |   |      |          | (727    | )
|                                                                            | Deferred revenues                               |   |          | 1,047            |   |      |          | (1,316  | )
|                                                                            | Accrued warranty                                |   |          | (434             | ) |      |          | 109     |  
|                                                                            | Accrued restructuring                           |   |          | (1,248           | ) |      |          | (1,797  | )
|                                                                            | Accrued vendor cancellation charges             |   |          | (8,685           | ) |      |          | (753    | )
|                                                                            | Other accrued liabilities                       |   |          | (1,836           | ) |      |          | (3,795  | )
|                                                                            | Interest payable                                |   |          |                 |   |      |          | (1,156  | )
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Net cash used in operating activities                                       |                                                 |   | (43,934  | )                |   |      | (21,775  | )      
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Investing activities:                                                       |                                                 |   |          |                  |   |      |          |        
|Purchases of short-term investments                                         |                                                 |   | (107,058 | )                |   |      | (204,524 | )      
|Proceeds from sales and maturities of short-term investments                |                                                 |   | 102,631  |                  |   |      | 243,310  |        
|Purchases of property and equipment                                         |                                                 |   | (1,355   | )                |   |      | (3,198   | )      
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Net cash provided by (used in) investing activities                         |                                                 |   | (5,782   | )                |   |      | 35,588   |        
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Financing activities:                                                       |                                                 |   |          |                  |   |      |          |        
|Principal payments on capital leases                                        |                                                 |   | (63      | )                |   |      | (88      | )      
|Proceeds from issuance of common stock                                      |                                                 |   | 619      |                  |   |      | 3,302    |        
|Retirement of debt                                                          |                                                 |   |         |                  |   |      | (39,220  | )      
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Net
cash provided (used in) by financing activities                         |                                                 |   | 556      |                  |   |      | (36,006  | )      
|Effect of exchange rate changes                                             |                                                 |   | 547      |                  |   |      | (1,556   | )      
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Net decrease in cash and cash equivalents                                   |                                                 |   | (48,613  | )                |   |      | (23,749  | )      
|Cash and cash equivalents at beginning of period                            |                                                 |   | 117,079  |                  |   |      | 100,274  |        
|                                                                            |                                                 |   |          |                  |   |      |          |        
|Cash and cash equivalents at end of period                                  |                                                 | $ | 68,466   |                  |   | $    | 76,525   |        
|                                                                            |                                                 |   |          |                  |   |      |          |        

See accompanying notes.

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



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

Description of Business

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

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

Basis of Presentation

The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation of the financial
statements at June 30, 2003 and for the three and six months ended June 30,
2003 and 2002 have been included.

Results for the three and six months ended June 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.

Stock-based compensation

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

The following table illustrates the effect on net 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 |        | Six months ended
|                                                                         |                                                                                            |   | June 30            |        | June 30,        
|                                                                         |                                                                                            |   |                    |        |                 
|                                                                         |                                                                                            |   | 2003               |        | 2002             |   | 2003    |        | 2002
|                                                                         |                                                                                            |   |                    |        |                  |   |         |        |     
|Net
loss, as reported                                                    |                                                                                            | $ | (13,139            | )      |                  | $ | (3,685  | )      |      | $ | (37,128 | )       |   | $ | (7,775  | )      
|Add:                                                                     | Stock-based compensation
under APB 25                                                      |   |                    | 3      |                  |   |         | 171    |      |   |         | 8       |   |   |         | 366     |  
|Deduct:                                                                  | Stock
option compensation expense determined under fair value-based
method                 |   |                    | (5,411 | )                |   |         | (8,937 | )    |   |         | (11,588 | ) |   |         | (19,235 | )
|                                                                         | Employee stock purchase
plan compensation expense determined
under fair value-based method |   |                    | (301   | )                |   |         | (535   | )    |   |         | (1,280  | ) |   |         | (1,304  | )
|                                                                         |                                                                                            |   |                    |        |                  |   |         |        |      |   |         |         |   |   |         |        
|Pro forma net loss                                                       |                                                                                            | $ | (18,848            | )      |                  | $ | (12,986 | )      |      | $ | (49,998 | )       |   | $ | (27,948 | )      
|                                                                         |                                                                                            |   |                    |        |                  |   |         |        |      |   |         |         |   |   |         |        
|Pro
forma net loss per share, basic and
diluted                          |                                                                                            | $ | (0.26              | )      |                  | $ | (0.18   | )      |      | $ | (0.68   | )       |   | $ | (0.38   | )      
|                                                                         |                                                                                            |   |                    |        |                  |   |         |        |      |   |         |         |   |   |         |        
|Shares used in
computing pro forma net loss per share,
basic and diluted |                                                                                            |   | 73,721             |        |                  |   | 72,761  |        |      |   | 73,715  |         |   |   | 72,682  |        

Inventory

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

|                |  |          |       |              |  |   |       | 
|--------------- |  | -------- | ----- | ------------ |  | - | ----- | 
|                |  | June 30, |       | December 31,
|                |  | 2003     |       | 2002        
|                |  |          |       |             
|Finished goods  |  | $        | 5,180 |              |  | $ | 5,915 | 
|Work-in-process |  |          | 294   |              |  |   | 769   | 
|Raw materials   |  |          | 1,854 |              |  |   | 1,573 | 
|                |  |          |       |              |  |   |       | 
|                |  | $        | 7,328 |              |  | $ | 8,257 | 
|                |  |          |       |              |  |   |       | 

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Purchase Obligations

The Company has purchase obligations to certain of its suppliers that
support the Companys ability to manufacture its products. The obligations
require the Company to purchase minimum quantities of the suppliers products
at a specified price. Cost of goods sold for the three and six months ended
June 30, 2003, included a reversal of $3.3 million and $6.2 million,
respectively of special charges taken in previous periods for vendor cancellation charges and
inventory considered to be in excess and obsolete. The Company was able to
reverse the provision, for excess and obsolete inventory during the
three and
six months ended June 30, 2003, as it was able to sell inventory. In addition, the Company was able to negotiate certain vendor cancellation claims to terms more favorable to the
Company. Cost of goods sold for the three and six months ended June 30, 2002,
included a reversal of special charges of $1.1 million and $12.5 million,
respectively. The Company was able to reverse the provision for
excess and obsolete inventory during the three and six months ended
June 30, 2002, as it was able to
sell the related inventory.

On February 26,
2003, the Company entered into an agreement with Solectron
Corporation (Solectron) to settle all outstanding obligations under two
manufacturing agreements between the Company and Solectron. Under the terms of
the settlement agreement, the Company paid Solectron approximately $3.9
million, and each party released 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.

As of June 30, 2003, the Company had $58.5 million of purchase
obligations, of which $6.5 million are included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times throughout 2003.

Net Loss Per Share

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

|                                                              |  |                    |         |                  |  |      |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------- |  | ------------------ | ------- | ---------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                              |  | Three Months Ended |         | Six Months Ended
|                                                              |  | June 30,           |         | June 30,        
|                                                              |  | 2003               |         | 2002             |  | 2003 |        | 2002
|                                                              |  |                    |         |                  |  |      |        |     
|Net loss                                                      |  | $                  | (13,139 | )                |  | $    | (3,685 | )    |  | $ | (37,128 | ) |  | $ | (7,775 | )
|                                                              |  |                    |         |                  |  |      |        |      |  |   |         |   |  |   |        |  
|Shares used in
computing basic
and diluted net
loss per share |  |                    | 73,721  |                  |  |      | 72,761 |      |  |   | 73,715  |   |  |   | 72,682 |  
|                                                              |  |                    |         |                  |  |      |        |      |  |   |         |   |  |   |        |  
|Basic and
diluted net loss
per share                          |  | $                  | (0.18   | )                |  | $    | (0.05  | )    |  | $ | (0.50   | ) |  | $ | (0.11  | )
|                                                              |  |                    |         |                  |  |      |        |      |  |   |         |   |  |   |        |  

Options to purchase 17,394,492 and 18,787,939 shares of common stock were
outstanding at June 30, 2003 and June 30, 2002, respectively, and warrants to
purchase 425,593 and 2,408,300 shares of common stock were outstanding at June
30, 2003 and June 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):

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|                             |                                                                     |   |                    |      |                  |   |        |        |      |   |         |      |   |   |        |        |  
|---------------------------- | ------------------------------------------------------------------- | - | ------------------ | ---- | ---------------- | - | ------ | ------ | ---- | - | ------- | ---- | - | - | ------ | ------ | -
|                             |                                                                     |   | Three Months Ended |      | Six Months Ended
|                             |                                                                     |   | June 30,           |      | June 30,        
|                             |                                                                     |   | 2003               |      | 2002             |   | 2003   |        | 2002
|                             |                                                                     |   |                    |      |                  |   |        |        |     
|Net loss                     |                                                                     | $ | (13,139            | )    |                  | $ | (3,685 | )      |      | $ | (37,128 | )    |   | $ | (7,775 | )     
|                             | Cumulative translation adjustments                                  |   |                    | 516  |                  |   |        | (1,321 | )    |   |         | 547  |   |   |        | (1,556 | )
|                             | Change
in unrealized gain (loss) on available-
for-sale investments |   |                    | (188 | )                |   |        | 376    |      |   |         | (411 | ) |   |        | (499   | )
|                             |                                                                     |   |                    |      |                  |   |        |        |      |   |         |      |   |   |        |       
|Total comprehensive net loss |                                                                     | $ | (12,811            | )    |                  | $ | (4,630 | )      |      | $ | (36,992 | )    |   | $ | (9,830 | )     
|                             |                                                                     |   |                    |      |                  |   |        |        |      |   |         |      |   |   |        |       

Impact of Recently Issued Accounting Standards

In May
2003, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 150, Accounting
For Certain Financial Instruments with Characteristics of Both
Liabilities and Equity'' (SFAS No. 150) 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 is not expected to 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 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 is not expected to have a material impact on the Companys financial
position or results of operations.

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.

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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 are now beginning expert witness discovery.
In addition, both plaintiffs and defendants have filed summary judgment motions that are scheduled for
hearing on September 8, 2003. Defendants motion seeks judgment as to plaintiffs entire claim. Plaintiffs
motion seeks a determination that certain of the defendants class period statements were false. Trial is
scheduled to begin on November 4, 2003.

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

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

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

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

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

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

The
Company believes that there are many defects in the Campbell and
OBrien derivative complaints.

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics (Israel) Ltd., an Israeli company, (Flextronics)
filed a claim with the Tel Aviv District Court in Israel against the Company
and Radwiz Ltd, 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 January 19, 2003, Omniband Group Limited, a Russian company, (Omniband)
filed a request for arbitration with the Zurich Chamber of Commerce, claiming
damages in an amount of $2,094,970 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.

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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 six
months ended June 30, 2003 is not provided.

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

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

|                                  |                                          |          |        |                    |        |                  |        |         |        |  
|--------------------------------- | ---------------------------------------- | -------- | ------ | ------------------ | ------ | ---------------- | ------ | ------- | ------ | -
|                                  |                                          |          |        | Three months ended |        | Six months ended
|                                  |                                          |          |        | June 30,           |        | June 30,        
|                                  |                                          |          |        | 2002               |        | 2002            
|                                  |                                          |          |        |                    |        |                 
|Cable Broadband Access Segment:   |                                          |          |        |                    |        |                  |        |        
|                                  | Total Cable revenues                     |          | $      | 19,203             |        |                  | $      | 73,828  |       
|                                  | Depreciation expense                     |          | $      | 2,582              |        |                  | $      | 5,067   |       
|                                  | Operating loss                           |          | $      | (29,240            | )      |                  | $      | (29,897 | )     
|Telecom Broadband Access Segment: |                                          |          |        |                    |        |                  |        |        
|                                  | Total Telecom revenues                   |          | $      | 3,204              |        |                  | $      | 5,797   |       
|                                  | Depreciation expense                     |          | $      | 304                |        |                  | $      | 667     |       
|                                  | Operating loss                           |          | $      | (3,156             | )      |                  | $      | (6,435  | )     
|Total revenues                    |                                          | $        | 22,407 |                    |        | $                | 79,625 |        
|Total depreciation expense        |                                          | $        | 2,886  |                    |        | $                | 5,734  |        
|Operating loss:                   |                                          |          |        |                    |        |                  |        |        
|                                  | Operating loss by reportable
segments    |          | $      | (32,396            | )      |                  | $      | (36,332 | )     
|                                  | Unallocated amounts:                     |          |        |                    |        |                  |        |         |       
|                                  | Interest and other income
(expense), net |          |        | (4,564             | )      |                  |        | (4,712  | )     
|                                  | Gain on early retirement of debt         |          |        | 33,276             |        |                  |        | 33,276  |       
|                                  | Income tax expense                       |          |        | (1                 | )      |                  |        | (7      | )     
|                                  |                                          |          |        |                    |        |                  |        |         |       
|                                  |                                          | Net loss |        | $                  | (3,685 | )                |        | $       | (7,775 | )
|                                  |                                          |          |        |                    |        |                  |        |         |       

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|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |   |        |        |        | 
|----------------------------- |  | --------------------- | ------------------- | ----- | ------ | ------------------ | ------ | ---------------- | ----- | ----- | ------ | ---- | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                              |  |                       |                     |       |        | Three months ended |        | Six months ended
|                              |  |                       |                     |       |        | June 30,           |        | June 30,        
|                              |  |                       |                     |       |        | 2003               |        | 2002             |       | 2003  |        | 2002
|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |     
|Revenues by product:          |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |  
|                              |  |                       | CMTS products       |       | $      | 8,631              |        |                  | $     | 5,619 |        |      | $      | 13,199 |        |   | $      | 19,692 |       
|                              |  |                       | Subscriber products |       |        | 17,004             |        |                  |       | 9,764 |        |      |        | 30,649 |        |   |        | 43,573 |       
|                              |  |                       | Video products      |       |        | 3,699              |        |                  |       | 3,818 |        |      |        | 6,532  |        |   |        | 10,298 |       
|                              |  |                       | Other products      |       |        | 1,265              |        |                  |       | 3,206 |        |      |        | 2,487  |        |   |        | 6,062  |       
|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |   |        |        |       
|Total revenues                |  | $                     | 30,599              |       |        | $                  | 22,407 |                  |       | $     | 52,867 |      |        | $      | 79,625 |  
|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |   |        |        |       
|Revenues by geographic areas: |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |  
|                              |  | United States         |                     | $     | 17,672 |                    |        | $                | 6,261 |       |        | $    | 31,179 |        |        | $ | 14,951 |       
|                              |  | Canada                |                     |       | (309   | )                  |        |                  | 2,861 |       |        |      | 736    |        |        |   | 10,567 |       
|                              |  | Europe                |                     |       | 7,369  |                    |        |                  | 4,548 |       |        |      | 10,700 |        |        |   | 12,624 |       
|                              |  | Israel                |                     |       | 399    |                    |        |                  | 268   |       |        |      | 811    |        |        |   | 268    |       
|                              |  | Japan                 |                     |       | 3,646  |                    |        |                  | 7,009 |       |        |      | 6,812  |        |        |   | 27,960 |       
|                              |  | Asia, excluding Japan |                     |       | 1,811  |                    |        |                  | 1,455 |       |        |      | 2,610  |        |        |   | 12,813 |       
|                              |  | South America         |                     |       | 11     |                    |        |                  | 5     |       |        |      | 19     |        |        |   | 442    |       
|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |   |        |        |       
|                              |  |                       |                     | Total |        | $                  | 30,599 |                  |       | $     | 22,407 |      |        | $      | 52,867 |   |        | $      | 79,625 | 
|                              |  |                       |                     |       |        |                    |        |                  |       |       |        |      |        |        |        |   |        |        |       

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

|                     |               |   |                         |        |          |        |              |        |  |        | 
|-------------------- | ------------- | - | ----------------------- | ------ | -------- | ------ | ------------ | ------ |  | ------ | 
|                     |               |   |                         |        | June 30, |        | December 31,
|                     |               |   |                         |        | 2003     |        | 2002        
|                     |               |   |                         |        |          |        |             
|Long-lived assets:   |               |   |                         |        |          |        |              |       
|                     | United States |   | $                       | 21,831 |          |        | $            | 28,169 | 
|                     | Canada        |   |                         | 699    |          |        |              | 787    | 
|                     | Europe        |   |                         | 168    |          |        |              | 170    | 
|                     | Israel        |   |                         | 3,274  |          |        |              | 3,442  | 
|                     | Asia          |   |                         | 123    |          |        |              | 207    | 
|                     | South America |   |                         |       |          |        |              | 118    | 
|                     |               |   |                         |        |          |        |              |        | 
|                     |               |   | Total long-lived assets |        |          | 26,095 |              |        |  | 32,893 | 
|Total current assets |               |   | 199,799                 |        |          |        | 242,817      |       
|                     |               |   |                         |        |          |        |              |        | 
|Total assets         |               | $ | 225,894                 |        |          | $      | 275,710      |       
|                     |               |   |                         |        |          |        |              |        | 

Five customers accounted for 10% or more of total revenues (16%, 13%, 13%,
13%, and 12%) for the three months ended June 30, 2003. Three customers
accounted for 10% or more of total revenues (28%, 11%, and 10%) for the three
months ended June 30, 2002. Four customers accounted for 10% or more of total
revenues (20%, 13%, 12%, and 11%) for the six months ended June 30, 2003. One
customer accounted for 10% or more of total revenues (34%) for the six months
ended June 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 new restructuring plan to continue to conform the expense and
revenue levels and to better position the Company for future growth and
eventual profitability. The Company incurred restructuring charges in the
amount of $2.7 million related to employee termination costs. At June 30,
2003, restructuring charges of $7,000 remain accrued. As of June 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

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Company reversed $86,000 of previously accrued termination costs. The
Company anticipates that the remaining employee termination costs related to
employee benefits will be paid in the third quarter of 2003.

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

|                         |  |              |        |  
|------------------------ |  | ------------ | ------ | -
|                         |  | Involuntary 
|                         |  | Terminations
|                         |  |             
|Total charge             |  | $            | 2,745  |  
|Recovery of charge       |  |              | (86    | )
|Cash payments            |  |              | (2,652 | )
|                         |  |              |        |  
|Balance at June 30, 2003 |  | $            | 7      |  
|                         |  |              |        |  

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 June 30, 2003,
restructuring charges of $1.2 million remain accrued. As of June 30, 2003, the
employment of all 153 employees has been terminated throughout the Company, and
the Company paid $2.2 million in termination costs and $0.2 million in excess
facility costs. The Company anticipates the remaining restructuring accrual,
primarily relating to excess leased facilities, will be utilized for servicing
operating lease payments or negotiated buyout of operating lease commitments,
through 2005.

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

|                             |  |              |     |                     |  |               |       |   |  |   |       |  
|---------------------------- |  | ------------ | --- | ------------------- |  | ------------- | ----- | - |  | - | ----- | -
|                             |  |              |     |                     |  | Excess Leased |       |   |  |  
|                             |  | Involuntary  |     | Facilities and      |  |               |       |  
|                             |  | Terminations |     | Cancelled Contracts |  | Total        
|                             |  |              |     |                     |  |              
|Balance at December 31, 2002 |  | $            | 88  |                     |  | $             | 1,422 |   |  | $ | 1,510 |  
|Cash Payments                |  |              | (88 | )                   |  |               | (219  | ) |  |   | (307  | )
|                             |  |              |     |                     |  |               |       |   |  |   |       |  
|Balance at June 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 $4.3 million remained accrued at June 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. The
Company anticipates utilizing the remaining restructuring accrual, which
relates to servicing operating lease payments or negotiated buyout of operating
lease commitments, through 2005.

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

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|                             |  |                |       |       |  |   |       |  
|---------------------------- |  | -------------- | ----- | ----- |  | - | ----- | -
|                             |  | Excess Leased  |       |       |  |  
|                             |  | Facilities and |       |       |  |  
|                             |  | Cancelled      |       |       |  |  
|                             |  | Contracts      |       | Total
|                             |  |                |       |      
|Balance at December 31, 2002 |  | $              | 5,243 |       |  | $ | 5,243 |  
|Recovery of charge           |  |                | (29   | )     |  |   | (29   | )
|Cash Payments                |  |                | (918  | )     |  |   | (918  | )
|                             |  |                |       |       |  |   |       |  
|Balance at June 30, 2003     |  | $              | 4,296 |       |  | $ | 4,296 |  
|                             |  |                |       |       |  |   |       |  

Asset Write-offs

For the six months ended June 30, 2003, the Company wrote off $0.5 million
of fixed assets, which were determined to have no remaining useful life. The
Company did not write-off any fixed assets in the three months ended June 30,
2003. For the three and six months ended June 30, 2002, the Company wrote off
$1.1 million of fixed assets, which were determined to have no remaining useful
life.



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

In December 2001, the Company entered into co-marketing arrangements with
Shaw Communications, Inc. (Shaw) and Rogers Communications, Inc. (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 continue
to charge the amortization of these assets against revenues in each of the next
two quarters through December 31, 2003, the term of the related arrangements,
at the rate of $1.4 million per quarter. Amounts charged against revenues in
the three and six months ended June 30, 2003, totaled approximately $1.4
million and $2.8 million, respectively.



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

Lewis Solomon, a member of the Companys Board of Directors and chairman
of the Companys Audit Committee is also a member of the Board of Directors of
Harmonic, Inc. (Harmonic). In April 2002, the Company entered into a reseller
agreement with Harmonic to sell certain of the Companys products. The
agreement appoints Harmonic as an authorized, non-exclusive reseller of certain
of the Companys video products. For the three and six months ended June 30,
2003, related party revenue includes $0.6 million and
$1.0 million, respectively, of revenue
from Harmonic. The Company recorded $70,000 and $0.1 million, respectively of
revenue related to Harmonic for the three and six months ended June 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. For the three months ended June 30, 2003 the
Company did not recognize revenue related to Rogers as related party revenue as
Rogers was no longer considered to be a related party. For the six months ended June 30, 2003,
the Company recognized $1.3 million of Rogerss related party revenue, net of
amortization of co-marketing expense (See Note 5). For the three and six
months ended June 30, 2002, the Company recognized revenue of
$0.2 million and
$5.8 million, respectively in connection with product shipments to Rogers.

Cost of
related party product revenues in the Companys consolidated
statements of operations consists only of direct product costs. No
indirect costs are applied to the cost of related party product revenue. Accounts
receivable from Harmonic totaled
approximately $0.6 million at June 30, 2003. Accounts receivable from Rogers
totaled approximately $0.3 million at June 30, 2002. There were no

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accounts receivable from Harmonic at June 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 six months ended June 30, 2003, is as
follows (in thousands):

|                 |  |              |       |            |  |           |     |             |  |  |        |   |  |   |       | 
|---------------- |  | ------------ | ----- | ---------- |  | --------- | --- | ----------- |  |  | ------ | - |  | - | ----- | 
|                 |  |              |       |            |  | Additions |     | Charges for |  |  |        |  
|                 |  | Balance at   |       | Charged to |  | Warranty  |     | Balance at 
|                 |  | December
31, |       | Costs and  |  | Services  |     | June 30,   
|                 |  | 2002         |       | Expenses   |  | Provided  |     | 2003       
|                 |  |              |       |            |  |           |     |            
|Warranty
reserve |  | $            | 8,607 |            |  |           | 956 |             |  |  | (1,390 | ) |  | $ | 8,173 | 
|                 |  |              |       |            |  |           |     |             |  |  |        |   |  |   |       | 



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

In July 2003, the Company discontinued
its Mainsail line of products and entered into an agreement with a third party
to supply warranty services for the Mainsail products. The Company
does not expect this transaction to have a material impact on the
Companys results of operations.

In July 2003, the Company entered into an agreement with Verilink
Corporation (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 (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.

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

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

Overview

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

Since late 2000, the worldwide telecom and satellite industries have
experienced severe downturns that have resulted in significantly reduced
purchases of new broadband equipment. Because of this overall drop in demand,
we have refocused our efforts on the cable industry, and have significantly
reduced our investment in the telecom and satellite businesses. The
Telecom segment no longer meets the quantitative threshold for
disclosure. Consequently,
beginning in 2003, we operate as one business segment.

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

We had a net loss of $13.1 million and $3.7 million for the three months
ended June 30, 2003 and June 30, 2002, respectively, and a net loss of $37.1
million and $7.8 million for the six months ended June 30, 2003 and June 30,
2002, respectively. We had an accumulated deficit of
$974.3 million as of June 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

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

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Results of Operations

Three and Six Months Ended June 30, 2003 and 2002

Revenues

|                 |  |                      |        |                    |  |                  |        |                  |  |           |        |           |  |   |        |  |  |  |    |   |  |  |     |   
|---------------- |  | -------------------- | ------ | ------------------ |  | ---------------- | ------ | ---------------- |  | --------- | ------ | --------- |  | - | ------ |  |  |  | -- | - |  |  | --- | --
|                 |  | For the three months |        | For the six months |  | % Change for the |        | % Change for the
|                 |  | ended                |        | ended              |  | three months     |        | six months ended
|                 |  | June 30,             |        | June 30,           |  | ended June 30,   |        | June 30         
|                 |  | 2003                 |        | 2002               |  | 2003             |        | 2002             |  | 2002/2003 |        | 2002/2003
|                 |  |                      |        |                    |  |                  |        |                  |  |           |        |          
|Product revenues |  | $                    | 30,599 |                    |  | $                | 22,407 |                  |  | $         | 52,867 |           |  | $ | 79,625 |  |  |  | 37 | % |  |  | (34 | )%

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

Revenues consist primarily of sales of products to new and existing customers providing broadband services.
Our revenues increased 37% to $30.6 million for the three months ended June 30, 2003 from $22.4 million in
the same period in 2002. This increase in total revenues is primarily due to increased sales of DOCSIS CMTS
and modems in North America and Asia, sales of our legacy S-CDMA modems, and Multigate circuit-switched cable
telephony systems. Five customers accounted for 67% of our total revenues for the three months ended June 30,
2003. Three customers accounted for 49% of our total revenues for the three months ended June 30, 2002.

Revenues decreased 34% to $52.9 million for the six months ended June 30, 2003 from $79.6 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.
Additionally, our decrease in revenue in the first six months of 2003 continues to reflect the challenge of
transitioning from our proprietary products to standards-based products during a period of difficult market
conditions including significant declines in the Average Selling Prices (ASPs) of our modems over the past
two years. However, this decrease was partially offset by an increase in the volume of modems sold in the
second quarter of 2003. Four customers accounted for 56% of our total revenues for the six months ended
June 30, 2003. One customer accounted for 34% of our total revenues for the six months ended June 30, 2002.

During
2002, the cable industry moved to purchasing more standards-based
DOCSIS CMTS, cable modem, and voice products, which caused
declines in sales of our proprietary-based S-CDMA products. As such,
we are transitioning from being a
manufacturer of proprietary products to developing, producing and
marketing DOCSIS-based products. This transition will be largely
complete by the end of 2003.

In 2002, we faced increasingly strong competition from multiple vendors, which unfavorably impacted our
revenues. Further, in 2002, the intensely competitive nature of the market for broadband products resulted
in significant price erosion. Consequently, since 2002, we have been unfavorably impacted by declines in
ASPs, particularly for our modems. In recent months, we have seen the
rate of decline in modem ASPs moderate, however, ASPs are
down significantly for the six months ended June 30, 2003 as compared to June 30, 2002. A key component of
our strategy is to decrease the cost of manufacturing our products to offset the declines in ASPs. We have
begun to execute on this strategy and intend to continue to implement cost reduction efforts, including
design changes and manufacturing efficiencies. However, there is no guarantee that our ongoing efforts in
cost reduction will be successful or that they will keep pace with the anticipated continued decline in ASPs.

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|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  |               |     |             |  |  |      |   
|----------------------- | ---------------------------- |  | -------------------- | --- | ------------------ |  | ---------- | --- | ------- |  | --------- | ----- | --------- |  | - | ----- |  |  | ------------- | --- | ----------- |  |  | ---- | --
|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  | % Change      |     | % Change   
|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  | for the three |     | for the six
|                        |                              |  | For the three months |     | For the six months |  | months     |     | months 
|                        |                              |  | ended                |     | ended              |  | ended June |     | ended  
|                        |                              |  | June 30,             |     | June 30,           |  | 30,        |     | June 30
|                        |                              |  | 2003                 |     | 2002               |  | 2003       |     | 2002    |  | 2002/2003 |       | 2002/2003
|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |          
|Related party
revenues: |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  |               |     |             |  |  |     
|                        | Rogers revenues              |  | $                    |    |                    |  | $          | 211 |         |  | $         | 1,454 |           |  | $ | 5,820 |  |  |               |    |             |  |  | (75) | % 
|                        | Harmonic revenues            |  |                      | 635 |                    |  |            | 70  |         |  |           | 1,010 |           |  |   | 120   |  |  |               | 807 | %           |  |  | 742  | % 
|                        | Co-marketing
agreement       |  |                      |    |                    |  |            |    |         |  |           | (153  | )         |  |   |      |  |  |               |    |             |  |  |     |   
|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  |               |     |             |  |  |      |   
|                        | Total related party
revenues |  | $                    | 635 |                    |  | $          | 281 |         |  | $         | 2,311 |           |  | $ | 5,940 |  |  |               | 126 | %           |  |  | (61  | )%
|                        |                              |  |                      |     |                    |  |            |     |         |  |           |       |           |  |   |       |  |  |               |     |             |  |  |      |   

Related party revenues in 2002 and the first quarter of 2003 include
revenues from Rogers Communications, Inc. (Rogers) and Harmonic, Inc.
(Harmonic). Alek Krstajic, a member of our board of directors, was the Senior
Vice President of Interactive Services, Sales and Product Development for
Rogers until January 2003. Effective in 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 in the second quarter of 2003.
Harmonic is a related company and revenue generated from Harmonic is
included in the related party revenue as Lewis Solomon,
another member of our board of directors, is also a member of the board of directors
of Harmonic.

Related
party revenues increased 126% to $0.6 million for the three months
ended June 30, 2003 from $0.3 million in the same period in 2002 due to
increased sales to Harmonic. Related party revenues decreased 61% to $2.3
million for the six months ended June 30, 2003 from $5.9 million in the same
period in 2002. The decline in related party revenues in 2003 compared to 2002
is primarily due to decreased sales to Rogers, Rogers no longer being a related
party to us 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.

In December 2001, we entered into co-marketing arrangements with Shaw
Communications, Inc. (Shaw) and Rogers Communications, Inc. (Rogers). We paid
$7.5 million to Shaw and $0.9 million to Rogers, and recorded these amounts as
other current assets. In July 2002, we began amortizing these prepaid assets
and charging them against revenues in accordance with EITF 01-09, Accounting
for Consideration given by a Vendor to a Customer or Reseller in Connection
with the Purchase or Promotion of the Vendors Products. We will continue to
charge the amortization of these assets against revenues in each of the next
two quarters through December 31, 2003 at the rate of $1.4 million per
quarter. Amounts charged against revenues in the three and six months ended
June 30, 2003, totaled approximately $1.4 million and $2.8 million,
respectively.

Cost of Goods Sold

|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |           |   |        |        |  |  |               |     |             |  |     |     |   
|------------------------ | -------------------------------------- | - | -------------------- | ------ | ------------------ | - | ---------- | ------ | ------- | - | --------- | ------ | --------- | - | ------ | ------ |  |  | ------------- | --- | ----------- |  | --- | --- | --
|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |           |   |        |        |  |  | % Change      |     | % Change   
|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |           |   |        |        |  |  | for the three |     | for the six
|                         |                                        |   | For the three months |        | For the six months |   | months     |        | months 
|                         |                                        |   | ended                |        | ended              |   | ended June |        | ended  
|                         |                                        |   | June 30,             |        | June 30,           |   | 30,        |        | June 30
|                         |                                        |   | 2003                 |        | 2002               |   | 2003       |        | 2002    |   | 2002/2003 |        | 2002/2003
|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |          
|Cost of product
revenues |                                        | $ | 23,577               |        |                    | $ | 22,417     |        |         | $ | 42,383    |        |           | $ | 49,008 |        |  |  | 5             | %   |             |  | (14 | )% 
|                         | Cost of related
party product
revenues |   |                      | 159    |                    |   |            | 17     |         |   |           | 945    |           |   |        | 5,153  |  |  |               | 835 | %           |  |     | (82 | )%
|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |           |   |        |        |  |  |               |     |             |  |     |     |   
|                         | Total cost of goods
sold               |   | $                    | 23,736 |                    |   | $          | 22,434 |         |   | $         | 43,328 |           |   | $      | 54,161 |  |  |               | 6   | %           |  |     | (20 | )%
|                         |                                        |   |                      |        |                    |   |            |        |         |   |           |        |           |   |        |        |  |  |               |     |             |  |     |     |   

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Cost of goods sold consists of direct product costs as well as the cost of
our manufacturing operations. The cost of manufacturing includes contract
manufacturing, test and quality assurance for products, warranty costs and
associated costs of personnel and equipment. Cost of goods sold for the three
and six months ended June 30, 2003, included a reversal of $3.3 million and
$6.2 million, respectively of special charges previously taken for vendor cancellation
charges and inventory considered to be in excess and obsolete. We were able to negotiate downward certain vendor cancellation claims to terms
more favorable to us. Cost of goods sold
for the three and six months ended June 30, 2002, included a reversal of
special charges of $1.1 million and $12.5 million, respectively. We were able
to reverse these provisions, as we were able to sell inventory originally
considered to be in excess and obsolete. Additionally, we wrote-off
$5.8 million
and $9.0 million, respectively of inventory considered to be in excess and
obsolete in the six months ended June 30, 2003 and June 30,
2002. Cost of related party product revenues consists only of direct
product costs. No indirect costs are applied to the cost of related
party product revenue.

Gross Profit

|                    |  |                      |       |                    |  |            |     |         |  |           |       |           |  |   |        |  |  |               |   |             |  |  |     |   
|------------------- |  | -------------------- | ----- | ------------------ |  | ---------- | --- | ------- |  | --------- | ----- | --------- |  | - | ------ |  |  | ------------- | - | ----------- |  |  | --- | --
|                    |  |                      |       |                    |  |            |     |         |  |           |       |           |  |   |        |  |  | % Change      |   | % Change   
|                    |  |                      |       |                    |  |            |     |         |  |           |       |           |  |   |        |  |  | for the three |   | for the six
|                    |  | For the three months |       | For the six months |  | months     |     | months 
|                    |  | ended                |       | ended              |  | ended June |     | ended  
|                    |  | June 30,             |       | June 30,           |  | 30,        |     | June 30
|                    |  | 2003                 |       | 2002               |  | 2003       |     | 2002    |  | 2002/2003 |       | 2002/2003
|                    |  |                      |       |                    |  |            |     |         |  |           |       |          
|Gross profit (loss) |  | $                    | 6,863 |                    |  | $          | (27 | )       |  | $         | 9,539 |           |  | $ | 25,464 |  |  |               |  |             |  |  | (63 | )%
|                    |  |                      |       |                    |  |            |     |         |  |           |       |           |  |   |        |  |  |               |   |             |  |  |     |   

We achieved a gross profit of $6.9 million or 22% of revenues for the
three months ended June 30, 2003 compared to a gross loss of $27,000 for the
three months ended June 30, 2002. We achieved a gross profit of $9.5 million
or 18% of revenues for the six months ended June 30, 2003 compared to a gross
profit of $25.5 million or 32% of revenues for the six months ended June 30,
2002. The increase in gross profit in the second quarter of 2003 was primarily
attributable to a corresponding 37% increase in revenue in the same
period in 2003 due to
increased sales of higher margin CMTS and video products. This increase in
gross profit was also related to a $3.3 million reversal of special charges in
the second quarter of 2003 compared to a $1.1 million reversal of special
charges in the second quarter of 2002. We were able to reverse these provisions
as we were able to negotiate downward certain vendor cancellation claims to
terms more favorable to us, and were able to sell inventory originally
considered to be in excess and obsolete. The decrease in gross profit
in the six months ended
June 30, 2003 was primarily attributable to a 34% decrease in revenue in the
same period in 2002 related to a decline in ASPs since the beginning of 2002.
This decrease in gross profit was also related to a $6.2 million reversal of
special charges in the six months ended June 30, 2003 compared to a $12.5
million reversal of special charges in the six months ended June 30, 2002.
Although ASPs for our modems appear to have temporarily stabilized, during
2003, we may again see further decreases in our ASPs and continued pressure on
our margins. We hope to mitigate pressure on our margins by producing lower
cost products and increase revenues generated by our higher-margin head-end and
video products. Any ASP decreases, without a corresponding decrease in our
product costs, will likely have an adverse impact on our operating results
through at least 2003.

Operating Expenses

|                           |  |                      |        |                    |  |            |        |         |  |           |        |           |  |   |        |  |  |               |     |             |  |  |     |   
|-------------------------- |  | -------------------- | ------ | ------------------ |  | ---------- | ------ | ------- |  | --------- | ------ | --------- |  | - | ------ |  |  | ------------- | --- | ----------- |  |  | --- | --
|                           |  |                      |        |                    |  |            |        |         |  |           |        |           |  |   |        |  |  | % Change      |     | % Change   
|                           |  |                      |        |                    |  |            |        |         |  |           |        |           |  |   |        |  |  | for the three |     | for the six
|                           |  | For the three months |        | For the six months |  | months     |        | months 
|                           |  | ended                |        | ended              |  | ended June |        | ended  
|                           |  | June 30,             |        | June 30,           |  | 30,        |        | June 30
|                           |  | 2003                 |        | 2002               |  | 2003       |        | 2002    |  | 2002/2003 |        | 2002/2003
|                           |  |                      |        |                    |  |            |        |         |  |           |        |          
|Research and
development   |  | $                    | 10,432 |                    |  | $          | 14,704 |         |  | $         | 23,434 |           |  | $ | 31,644 |  |  |               | (29 | )%          |  |  | (26 | )%
|Sales and marketing        |  | $                    | 6,560  |                    |  | $          | 10,141 |         |  | $         | 13,290 |           |  | $ | 18,994 |  |  |               | (35 | )%          |  |  | (30 | )%
|General and
administrative |  | $                    | 3,000  |                    |  | $          | 3,552  |         |  | $         | 6,728  |           |  | $ | 7,186  |  |  |               | (16 | )%          |  |  | (6  | )%

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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 29% to $10.4 million or 34% of sales for the three months ended June
30, 2003, compared to $14.7 million or 66% of sales for the three months ended
June 30, 2002. The decrease in research and development expenses was
attributable to $1.7 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 adopted in the second quarter of 2003, and a reduction of
$0.1 million of outside engineering consultants. The decrease in research and
development expense also included $1.1 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 $1.5 million due to market conditions in the Telecom sector.
Research and development expenses decreased 26% to $23.4 million or 44% of
sales for the six months ended June 30, 2003, compared to $31.6 million or 40%
of revenue for the six months ended June 30, 2002. The decrease in research
and development expenses was attributable to $2.3 million of reductions in
employee related expenses, partially offset by an increase of $0.1 million
attributable to the Executive Compensation Plan adopted in the second quarter
of 2003,and a reduction of $0.5 million of outside engineering consultants. The
decrease in research and development expense also included $3.2 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 $2.3 million due to market conditions in the Telecom
sector. We believe it is critical to continue to make significant investments
in research and development to create innovative technologies and products that
meet the current and future requirements of our customers. Accordingly, we
intend to continue our investment in research and development primarily related
to DOCSIS standards-based and other products.

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 35% to $6.6 million or 21% of revenue for the three months
ended June 30, 2003, compared to $10.1 million or 45% of revenue for the three
months ended June 30, 2002. The decrease in sales and marketing expenses was
primarily due to $2.2 million in reduced employee expenses due to lower
headcount related to the restructuring, partially offset by an
increase of $0.2 million attributable to the Executive Compensation Plan adopted in the second
quarter of 2003, $0.2 million of decreased spending for outside consultants,
$0.4 million of decreased travel costs, and $0.8 million of overall sales and
marketing cost reductions. Additionally, the cost related to the operation of
the corporate aircraft decreased $0.1 million to $1.0 million in the three
months ended June 30, 2003 from $1.1 million in the three months June 30, 2002.
Sales and marketing expenses decreased 30% to $13.3 million or 25% of revenue
for the six months ended June 30, 2003, compared to $19.0 million or 24% of
revenue for the six months ended June 30, 2002. The decrease in sales and
marketing expenses was primarily due to $3.9 million in reduced employee
expenses due to lower headcount related to the restructuring, partially offset
by an increase of $0.2 million attributable to the Executive Compensation Plan
adopted in the second quarter of 2003, $0.5 million of decreased spending for
outside consultants, $0.7 million of decreased travel costs, and
$1.0 million
of overall sales and marketing cost reductions. Additionally, the cost related to the
operation of the corporate aircraft increased $0.2 million to $1.8 million in
the first six months of 2003 from $1.6 million in the first six 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 16% to $3.0 million or 10% of revenue for
the three months ended June 30, 2003, compared to $3.6 million or 16% of
revenue for the first three months ended June 30, 2002. The decrease was
primarily due to $0.8 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 adopted in the second
quarter of 2003, $0.3 million of decreased spending for outside consultants,
and $0.1 million of overall general and administrative cost
decreases, partially
offset by $0.3 million of severance expense related to the termination of an
officer. General and administrative expenses decreased 6% to $6.7 million or 13% of
revenue for the six months ended June 30, 2003, compared to $7.2 million or 9%
of revenue for the first six months ended June 30, 2002. The decrease was
primarily due 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 adopted in the second
quarter of 2003, $0.8 million of decreased spending for outside consultants,
partially offset by $0.3 million of severance expense related to the
termination of an officer, and $0.4 million of overall general and
administrative cost increases.

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Restructuring Costs and Asset Write-offs

|                                         |  |                      |      |                    |  |      |       |      |  |   |       |  |  |   |       | 
|---------------------------------------- |  | -------------------- | ---- | ------------------ |  | ---- | ----- | ---- |  | - | ----- |  |  | - | ----- | 
|                                         |  | For the three months |      | For the six months
|                                         |  | ended                |      | ended             
|                                         |  | June 30,             |      | June 30,          
|                                         |  | 2003                 |      | 2002               |  | 2003 |       | 2002
|                                         |  |                      |      |                    |  |      |       |     
|Restructuring
charges (recovery)         |  | $                    | (115 | )                  |  | $    | 2,857 |      |  | $ | 2,561 |  |  | $ | 2,857 | 
|Long-lived asset
write-offs              |  |                      |     |                    |  |      | 1,115 |      |  |   | 485   |  |  |   | 1,115 | 
|Restructuring costs
and asset
write-offs |  | $                    | (115 | )                  |  | $    | 3,972 |      |  | $ | 3,046 |  |  | $ | 3,972 | 
|                                         |  |                      |      |                    |  |      |       |      |  |   |       |  |  |   |       | 

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 June 30, 2003, restructuring charges of $7,000 remain
accrued. As of June 30, 2003, the employment of 81 employees has been
terminated throughout the Company, 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 as well as $29,000 of costs
from a previous restructuring in 2001. We anticipate that the remaining
employee termination costs related to employee benefits will be paid in the
third quarter of 2003. 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):

|                         |  |              |        |  
|------------------------ |  | ------------ | ------ | -
|                         |  | Involuntary 
|                         |  | Terminations
|                         |  |             
|Total charge             |  | $            | 2,745  |  
|Recovery of charge       |  |              | (86    | )
|Cash payments            |  |              | (2,652 | )
|                         |  |              |        |  
|Balance at June 30, 2003 |  | $            | 7      |  
|                         |  |              |        |  

Asset Write-offs

For the six months ended June 30, 2003, we wrote off $0.5 million of fixed
assets, which were determined to have no remaining useful life. We did not
write-off any fixed assets in the three months ended June 30, 2003. For the
three and six months ended June 30, 2002, we wrote off $1.1 million of fixed
assets, which were determined to have no remaining useful life.

Other Restructuring Activities

During
2002 and 2001, the Companys Board of Directors approved two
restructuring plans to conform the expense and revenue levels and to
better position the Company for future growth and eventual
profitability.

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



|                             |  |              |     |   |           |                |        |       |  |   |        |  
|---------------------------- |  | ------------ | --- | - | --------- | -------------- | ------ | ----- |  | - | ------ | -
|                             |  |              |     |   |           | Excess Leased  |        |       |  |   |       
|                             |  |              |     |   |           | Facilities and |        |       |  |   |       
|                             |  | Involuntary  |     |   | Cancelled |                |        |       |  |  
|                             |  | Terminations |     |   | Contracts |                |        | Total | 
|                             |  |              |     |   |           |                |       
|Balance at December 31, 2002 |  | $            | 88  |   |           | $              | 6,665  |       |  | $ | 6,753  |  
|Recovery of charge           |  |              |     |   |           |                | (29    | )     |  |   | (29    | )
|Cash Payments                |  |              | (88 | ) |           |                | (1,137 | )     |  |   | (1,225 | )
|                             |  |              |     |   |           |                |        |       |  |   |        |  
|Balance at June 30, 2003     |  | $            |    |   |           | $              | 5,499  |       |  | $ | 5,499  |  
|                             |  |              |     |   |           |                |        |       |  |   |        |  

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.

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Non-operating Expenses

|                 |  |                      |      |                    |  |            |        |         |  |           |        |           |  |   |        |   |  |               |     |             |  |  |     |   
|---------------- |  | -------------------- | ---- | ------------------ |  | ---------- | ------ | ------- |  | --------- | ------ | --------- |  | - | ------ | - |  | ------------- | --- | ----------- |  |  | --- | --
|                 |  |                      |      |                    |  |            |        |         |  |           |        |           |  |   |        |   |  | % Change      |     | % Change   
|                 |  |                      |      |                    |  |            |        |         |  |           |        |           |  |   |        |   |  | for the three |     | for the six
|                 |  | For the three months |      | For the six months |  | months     |        | months 
|                 |  | ended                |      | ended              |  | ended June |        | ended  
|                 |  | June 30,             |      | June 30,           |  | 30,        |        | June 30
|                 |  | 2003                 |      | 2002               |  | 2003       |        | 2002    |  | 2002/2003 |        | 2002/2003
|                 |  |                      |      |                    |  |            |        |         |  |           |        |          
|Interest income  |  | $                    | 909  |                    |  | $          | 2,013  |         |  | $         | 1,811  |           |  | $ | 4,110  |   |  |               | (55 | )%          |  |  | (56 | )%
|Interest expense |  | $                    | (814 | )                  |  | $          | (2,177 | )       |  | $         | (1,651 | )         |  | $ | (4,357 | ) |  |               | (63 | )%          |  |  | (62 | )%
|Other expense    |  | $                    | (160 | )                  |  | $          | (4,400 | )       |  | $         | (200   | )         |  | $ | (4,465 | ) |  |               | (96 | )%          |  |  | (96 | )%

Interest Income. Interest income decreased 55% to $0.9 million for the
three months ended June 30, 2003 from $2.0 million in the same period in 2002.
Interest income decreased 56% to $1.8 million for the six months ended June 30,
2003 from $4.1 million in the same period in 2002. The decrease in interest
income was primarily due to 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 63% to $0.8 million for the three months
ended June 30, 2003 from $2.2 million in the same period in 2002. Interest
expense decreased 62% to $1.7 million for the six months ended June 30, 2003
from $4.4 million in the same period in 2002, primarily due to the repurchase
of a total of $434.9 million of the Notes in 2001 and 2002.

Other Expense.Other expense is comprised primarily of realization of
foreign currency translations and permanent gains or losses on investments.
Other expense decreased 96% in the three and six months ended June 30, 2003
compared to the same periods in 2002, primarily due to a write-down of a $4.5
million in long-term investment, due to impairment, in the second quarter of
2002,as well as favorable currency rates in Brazil in 2003.

Income Taxes

|             |  |                            |     |                          |  |      |    |      |  |   |      |   |  |   |    |  
|------------ |  | -------------------------- | --- | ------------------------ |  | ---- | -- | ---- |  | - | ---- | - |  | - | -- | -
|             |  | For the three months ended |     | For the six months ended
|             |  | June 30,                   |     | June 30,                
|             |  | 2003                       |     | 2002                     |  | 2003 |    | 2002
|             |  |                            |     |                          |  |      |    |     
|Income Taxes |  | $                          | (60 | )                        |  | $    | (1 | )    |  | $ | (129 | ) |  | $ | (7 | )

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

Litigation

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

On
September 21, 2000, the lead plaintiffs filed a consolidated class action complaint containing factual
allegations nearly identical to those in the original lawsuits.  The consolidated class action complaint,
however, alleged claims on behalf of a class whose members purchased or otherwise acquired our securities
between November 15, 1999 and April 11, 2000.  On
October 30, 2000, defendants moved to dismiss the
consolidated class action complaint.  On March 14, 2001, after 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 are now beginning expert witness discovery.  In
addition, both plaintiffs and defendants have filed summary judgment motions that are scheduled for hearing
on September 8, 2003.  Defendants motion seeks judgment as to
plaintiffs entire claim.  Plaintiffs motion
seeks a determination that certain of the defendants' class period statements were false.  Trial is scheduled
to begin on November 4, 2003.

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

On
October 16, 2000, a lawsuit was filed against 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 Bertram case.  The courts order permits the individual plaintiffs in the Bertram case
to pursue any claims that they may have as members of the purported class in the related, consolidated class
action discussed above.  Plaintiffs have appealed this order, and the Court of Appeals has set a briefing
schedule for the appeal.

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

On
May 7, 2002, a shareholder filed a derivative lawsuit purportedly on behalf of us against five of 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 our behalf against three of our
current directors, one former officer and three former investors.
This lawsuit is titled OBrien vs. Rakib,
et al., and is pending in the California Superior Court, San Francisco County.  We are a nominal defendant
in this lawsuit, which alleges claims relating to essentially the same purportedly misleading statements that
 are at issue in the pending securities class action.  In that litigation, we dispute making any misleading
statements.  The derivative complaint also alleges claims relating to stock sales by certain of the director
and officer defendants.  The plaintiff in the OBrien case has dismissed the investor defendants without
prejudice.

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

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

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics (Israel) Ltd., an Israeli company (Flextronics)
filed a claim with the Tel Aviv District Court in Israel against us
and Radwiz Ltd.,
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
its contractual obligations to accept and pay for components manufactured by
Flextronics in the first quarter of 2001 pursuant to projections it had
received from Radwiz. We filed a statement of defense denying the allegations,
after which the parties accepted the Court s recommendation to transfer the
case to non-binding mediation.

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

We are currently a party to various other legal proceedings, in addition
to those noted above and may become involved from time to time in other legal
proceedings in the future. While we currently believe that the ultimate outcome
of these other proceedings, individually and in the aggregate, will not have a
material adverse effect on our financial position or overall trends in results
of operations, litigation is subject to inherent uncertainties. Were an
unfavorable ruling to occur in any of our legal proceedings, there exists the
possibility of a material adverse impact on our results of operations for the
period in which 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 June 30, 2003, we had approximately $68.5 million in cash and cash
equivalents and $93.4 million in short-term investments. As of June 30, 2003,
we had approximately $69.0 million of long-term obligations.

In July 2000, we issued $500 million of 5% Convertible Subordinated Notes (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 June 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 six months of 2003.

Cash used in operating activities for the six months ended June 30, 2003
was $43.9 million compared to $21.8 million used in the same period in 2002.
For the six months ended June 30, 2003,

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significant uses of cash by operating activities included a $37.1 million
net loss and a decrease of $5.9 million in accounts payable, accrued payroll
and other accrued liabilities partially offset by an $8.6 million
of increase in inventory, an increase of $6.6 million in accounts receivable,
and an increase of $6.6 million of other assets. For the six months ended June
30, 2002, cash used by operating activities included a $7.8 million net loss, a
decrease of $15.5 million in accounts payable, interest paid on the Notes,
accrued payroll, and other accrued liabilities partially offset by $29.6
million of cash provided by decreases in accounts receivables and inventory, as
well as $33.3 million of gain of early retirement of debt.

Cash used by investing activities for the six months ended June 30, 2003
was $5.8 million, compared to cash provided by investing activities of $35.6
million in the same period in 2002. Investing activities consisted primarily of
the purchase and sale of short-term investments and fixed assets.

Cash provided by financing activities was $0.6 million for the six months
ended June 30, 2003, compared to cash used by financing activities of $36.0
million in the same period in 2002. Financing activities primarily consisted of
cash received through the exercise of stock options and shares issued through
the stock purchase plan.

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

The following summarizes our contractual obligations at June 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 Period
|                                   |  |       |       |        |  | Less than              |      | 1-3   |  | 4-5   |      | After 5
|                                   |  | Total |       | 1 year |  | years                  |      | years |  | years
|                                   |  |       |       |        |  |                        |      |       |  |      
|Capital Lease Obligations          |  | $     | 0.1   |        |  | $                      | 0.1  |       |  | $     |     |         |  | $ |     |  |  | $ |     | 
|Unconditional Purchase Obligations |  |       | 58.5  |        |  |                        | 58.5 |       |  |       |     |         |  |   |     |  |  |   |     | 
|Long Term Debt                     |  |       | 67.1  |        |  |                        |     |       |  |       | 2.1  |         |  |   | 65.0 |  |  |   |     | 
|Operating Lease Obligations        |  |       | 33.6  |        |  |                        | 5.8  |       |  |       | 11.5 |         |  |   | 6.1  |  |  |   | 10.2 | 
|Aircraft Lease                     |  |       | 5.3   |        |  |                        | 1.5  |       |  |       | 3.0  |         |  |   | 0.8  |  |  |   |     | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |      | 
|Total Contractual Commitments      |  | $     | 164.6 |        |  | $                      | 65.9 |       |  | $     | 16.6 |         |  | $ | 71.9 |  |  | $ | 10.2 | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |      | 

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 June 30, 2003, we had $58.5 million of purchase
obligations, of which $6.5 million are included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times throughout 2003.

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

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

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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 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 Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity
(SFAS No. 150) 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 is not expected to 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 is not expected to have a material impact on our financial position
or results of operations.

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 our financial position or results of operations.

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RISK FACTORS

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

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

It is difficult to predict our future operating results. We began shipping
products commercially in June 1997, and we have been shipping products in
volume since the first quarter of 1998. As of June 30, 2003, we had an
accumulated deficit of $974.3 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 six months
ended June 30, 2003, our revenues decreased 34% from the same period in 2002.
For the six months ended June 30, 2003, we had a
$37.1 million net loss. 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 six months ended June 30, 2003 was
$43.9 million as compared to $21.8 million used in the same
period in 2002. Additionally, we generally are unable to reduce our expenses significantly in
the short term to compensate for any unexpected delay in generating or decrease
in anticipated revenues. For example, we have fixed commitments with some of
our suppliers that require us to purchase minimum quantities of their products
at a specified price irrespective of whether we can subsequently use such
quantities in our products. Because in the past, we have been unable to use all
of the products that we purchased from our suppliers, we have taken vendor
cancellation charges as a result of these fixed commitments, and we may have to
take additional charges in the future if we are unable to use all of the
products that we purchase from our suppliers. Further, we have been
experiencing and will continue to experience declining ASPs of our products.
We record an inventory charge to reduce our inventory to the lower of cost or
market if average selling prices fall below the cost of these products. In
addition, we have significant operating lease commitments for facilities and
equipment that generally cannot be cancelled in the short-term without
substantial penalties.

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

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

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

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



| |  |  | variations in the timing of orders and shipments of our products;                             
| | - |  | ----------------------------------------------------------------------------------------------
|
| |  |  | variations in the size of the orders by our customers and pricing concessions on volume sales;
|
| |  |  | new product introductions by competitors;                                                     
|
| |  |  | delays in our introduction of new products;                                                   
|
| |  |  | delays in our introduction of added features to our products;                                 

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

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



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

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 Cable Modem Termination
Systems (CMTSs), and lower margin, higher volume Customer Premise Equipment
(CPE), such as modems. In 2003 we expect that sales of our low-margin CPE will
continue to make up a significant portion of our revenues.

Our operating expenses generally vary from quarter to quarter depending on
the level of actual and anticipated business activities. However, a significant
percentage of these operating expenses are fixed due to operating leases for
our facilities and equipment. Also, we have fixed commitments with some of our
suppliers that require us to purchase minimum quantities of their products at a
specified price. As of June 30, 2003, $58.5 million of purchase obligations are
outstanding. Moreover, our research and development expenses fluctuate in
response to new product development, and changing industry requirements and
customer demands.

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

The markets we serve have undergone and are continuing to undergo
significant consolidation in both North America and internationally, as a
limited number of cable operators control an increasing number of systems. For
example, the top ten cable operators in the United States own and operate
systems that service approximately 81% of homes that receive cable services in
the United States, and the top ten cable operators in Europe own and operate
systems that service approximately 53% of homes that receive cable services in
Europe. As a result of the consolidation among cable operators, our revenue has
been and will continue to be dependent on sales to the few leading cable
operators worldwide and the continued consolidation may also reduce the number
of potential customers. For example, five customers accounted

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for 10% or more of total revenues (16%, 13%, 13%, 13%, and 12%) for the
three months ended June 30, 2003. Three customers accounted for 10% or more of
total revenues (28%, 11%, and 10%) for the three months ended June 30, 2002.
Four customers accounted for 10% or more of total revenues (20%, 13%, 12%, and
11%) for the six months ended June 30, 2003. One customer accounted for 10% or
more of total revenues (34%) for the six months ended June 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. Moreover, we do not typically
require our customers to purchase a minimum quantity of our products, and our
customers can generally cancel their orders on short notice without significant
penalties. The loss of any of our customers can have a material adverse effect
on our results of operations. Further, any reduction in orders from a given
customer can likewise have a material adverse affect on our results of
operations.

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

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

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

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

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

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

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

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

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

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

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

Developing products to meet these various industry specifications has
several risks. The first is the cost and effort to engineer standards-based
products and to then prepare them for compliance testing. Not only do we have
to certify or qualify new products, but any of our currently certified or
qualified products must be re-certified or re-qualified should they be changed
in any way. Second, there is no guarantee that these products will be certified
or qualified as meeting these specifications in a timely fashion, if ever.
Because most cable operators purchase only those products that have been
certified or qualified as meeting these specifications, it is highly unlikely
that we will be able to sell our products until they achieve

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certification or qualification, which can be a lengthy process. As a
result, we may incur significant research and development expenses to develop
new products that may not receive certification or qualification and we cannot
recoup the costs of these research and development expenses by marketing
uncertified or unqualified products. Moreover, a consequence of cable operators
only purchasing products certified or qualified as meeting industry
specifications is the increased competition between equipment vendors, which
has resulted in a steady and ongoing decline in equipment prices as vendors
compete for cable operators business. Third, there is no guarantee that we
will be able to support all future cable industry specifications, which will
likely have an adverse impact on our future revenues.

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

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

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 CMTS volume 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, and we cannot
be certain that our future efforts to implement operating expense reduction
will be successful. A large portion of our expenses, including rent, and
operating lease expenditures, is fixed and difficult to reduce or change.
Accordingly, if our revenue does not meet our expectations, we may not be able
to adjust our expenses quickly enough to compensate for the shortfall in
revenue. In that event, our business, financial condition and results of
operations could be materially and adversely affected.

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

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incurred significant cancellation charges related to volume purchase and
manufacturing agreements in the past and may incur such charges in the future.

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

Our success will depend upon the widespread penetration of broadband
services delivered by cable television operators. The markets for these
services are growing, but are not fully developed nor exploited. Additionally,
these markets may not grow as cable operators have a limited amount of
available bandwidth over which they can offer new services, such as high-speed
Internet access, High Definition Television (HDTV), Video on Demand, 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. RBOCs, CLECs, ILECs, satellite TV and
broadband service providers are aggressively competing with the cable industry
to deliver broadband services via DSL or satellite broadcast technologies. We
cannot accurately predict the future growth rate or the ultimate size of the
market for broadband services delivered via cable. The success of
RBOCs, CLECs, ILECs,
satellite TV and other broadband service providers may slow or hamper the
continued acceptance of cable operators in delivering broadband services, which
in turn may impact demand for our products by cable operators.

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

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

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



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

The vast majority of our sales are to large cable operators. However, we
currently have limited access to smaller or geographically diverse cable
operators. Although we intend to establish strategic relationships with leading
distributors worldwide to access these customers, we may not succeed in
establishing these relationships. Even if we do establish these relationships,
the distributors may not succeed in marketing our products to their customers.
Some of our competitors have already established, long-standing relationships
with these cable operators that may limit our and our distributors ability to
sell our products to those customers. Even if we were to sell our products to
those customers, it would likely

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not be based on long-term commitments, and those customers would be able
to terminate their relationships with us at any time without significant
penalties.

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

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

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



| |  |  | the availability of financing;                                                                                     
| | - |  | -------------------------------------------------------------------------------------------------------------------
|
| |  |  | annual budget cycles, as well as the typical
reduction in upgrade projects during the winter months;               
|
| |  |  | the status of federal, local and foreign government
regulation and deregulation of the telecommunications industry;
|
| |  |  | overall demand for broadband services;                                                                             
|
| |  |  | competitive pressures (including the availability of
alternative data transmission and access technologies);       
|
| |  |  | discretionary consumer spending patterns; and                                                                      
|
| |  |  | general economic conditions.                                                                                       

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

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

The nature of the cable industry makes it difficult for us to accurately
forecast demand for our products. Our inability to forecast accurately the
actual demand for our products may result in too much or too little supply of
products or an over/under capacity of manufacturing or testing resources at any
given point in time. The existence of any one or more of these situations could
have a negative impact on our business, operating results or financial
condition. We had purchase obligations of approximately $58.5 million as of
June 30, 2003, primarily to purchase minimum quantities of materials and
components used to manufacture our products. We must fulfill these obligations
even if demand for our products is lower than we anticipate.

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

We and/or our directors and officers are defendants in a number of
lawsuits, including securities litigation lawsuits. As a result, we may have
financial exposure to litigation as a defendant and because we are obligated to
indemnify our officers and members of our Board of Directors for certain
actions taken by

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

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

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

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

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

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

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

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

Most of our products are assembled and tested by contract manufacturers
using testing equipment that we provide. Currently, our modems are sole sourced
from our manufacturer in Thailand. As a result of our dependence on these
contract manufacturers for the assembly and testing of our products, we do not
directly control product delivery schedules or product quality. Any product
shortages or quality assurance problems could increase the costs of
manufacturing, assembling or testing our products. In addition, as

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manufacturing volume increases, we will need to procure and assemble
additional testing equipment and provide it to our contract manufacturers. The
production and assembly of testing equipment typically requires significant
lead times. We could experience significant delays in the shipment of our
products if we are unable to provide this testing equipment to our contract
manufacturers in a timely manner.

There Are Many Risks Associated with International Operations.

We expect sales to customers outside of the United States to continue to
represent a significant percentage of our revenues for the foreseeable future.
For the three months ended June 30, 2003 and June 30, 2002, approximately 42%,
and 72%, respectively, of our net revenues were from customers outside of the
U.S. For the six months ended June 30, 2003 and June 30, 2002, approximately
41%, and 81%, respectively, of our net revenues were from customers outside of
the U.S. International sales are subject to a number of risks, including the
following:



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

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

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 Israel 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 action like
this 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 $4.7 million
and $2.0 million for the three months ending June 30, 2003 and June 30, 2002,
respectively. Revenues generated by our business in Israel were $5.5 million
and $6.5 million for the six months ending June 30, 2003 and June 30, 2002,
respectively. Our research and development operations

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

We May Be Unable to Provide Adequate Customer Support.

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

Our Industry Is Highly Competitive with Many Established Competitors.

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



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

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

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

We Are Dependent on Key Personnel.

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

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

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

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

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

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

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

We also believe that companies may be increasingly subject to infringement
claims as distressed companies and individuals attempt to generate cash by
enforcing their patent portfolio against a wide range of products. We, as well
as our customers, have received letters from companies claiming that our
technology and products infringe on 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

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

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

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

Our Business and Our Customers Are Subject to Regulation.

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

Our Products Are Subject to Safety Approvals and Certifications.

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

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

Our corporate headquarters, as well as the majority of our research and
development activities and some manufacturing operations are located in
California, an area known for seismic activity. In addition, the operations of
some of our key suppliers are also located in this area and in other areas
known for seismic activity, such as Taiwan. An earthquake, or other significant
natural disaster, could result in an interruption in our business or the
operations of one or more of our key suppliers. Our business may also be

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impacted by labor issues related to our operations and/or those of our
suppliers, service providers, or customers. Such an interruption could harm our
operating results. We may not carry sufficient business interruption insurance
to compensate for any losses that we may sustain as a result of any natural
disasters or other unexpected events.

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

As of June 30, 2003, we had approximately $69.0 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.

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

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



| |  |  | actual or anticipated variations in quarterly operating results;                                                         
| | - |  | -------------------------------------------------------------------------------------------------------------------------
|
| |  |  | announcements of technological innovations;                                                                              
|
| |  |  | new products or services offered by us or our competitors;                                                               
|
| |  |  | changes in financial estimates by securities analysts;                                                                   
|
| |  |  | conditions or trends in the broadband services industry;                                                                 
|
| |  |  | changes in the economic performance and/or market valuations of
Internet, online service or broadband service industries;
|
| |  |  | our announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;             
|
| |  |  | adoption of industry standards and the inclusion or
compatibility of our technology with such standards;                 

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| |  |  | adverse or unfavorable publicity regarding us or our products;
| | - |  | --------------------------------------------------------------
|
| |  |  | additions or departures of key personnel;                     
|
| |  |  | sales of common stock; and                                    
|
| |  |  | other events or factors that may be beyond our control.       

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

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

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

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

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

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

As a result of the significant economic downturn and the related
uncertainties in the technology sector, we have implemented a number of
restructuring plans, including the most recent in March 2003, which has
resulted in personnel reduction. These reductions could result in an erosion of
morale, and affect the focus and productivity of our remaining employees,
including those directly responsible for revenue generation, which in turn may
affect our revenue in the future. Additionally, employees directly affected by
the reductions may seek future employment with our business partners, customers
or competitors. Although all employees are required to sign a proprietary
information agreement with us at the time of hire, there can be no assurances
that the confidential nature of our proprietary information will be maintained
in the course of such future employment. Our employees are not bound
by non-competition agreements with us. Additionally, we may face wrongful
termination, discrimination, or other

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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
(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.

Products Currently Under Development May Fail to Realize Anticipated Benefits.

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

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

Most of our sales are on an open credit basis, with payment terms of 30
days typically in the United States, and because of local customs or
conditions, longer in some markets outside the United States. 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

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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;
|
| |  |  | incur amortization expenses related to certain intangible assets;                                                                          
|
| |  |  | incur large and immediate write-offs; or                                                                                                   
|
| |  |  | become subject to litigation.                                                                                                              

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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 June 30, 2003, no intangible assets from these acquisitions
remain.

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

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

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

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

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 NASDAQ 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
companys 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 companys corporate
governance process. As a result, it may become more difficult for us
to attract and retain board members and executive officers involved
in the corporate governance process. 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.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk.

Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. The primary objective of our investment
activities is to preserve principal while maximizing yields without
significantly increasing risk. This is accomplished by investing in widely
diversified short-term investments, consisting primarily of investment grade
securities, substantially all of which mature

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within the next twenty-four months. A hypothetical 50 basis point increase
in interest rates would result in an approximate $142,000 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, and Israel denominated
in local currencies. A hypothetical adverse change of 10% in exchange rates
would result in a decline in income before taxes of approximately $0.4 million.

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




ITEM 4. CONTROL 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 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



| | (a) |  | The registrants 2003 Annual Meeting of Stockholders was held on
May 28, 2003.                                                                                                                                                          
| | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | The meeting involved the election of two officers: Selim
(Shlomo) Rakib and David M. Woodrow. The terms of the following directors continued after the meeting: Zaki Rakib, Christopher Schaepe,
Aleksander Krstajic, and Lewis Solomon.
|
| | (c) |  | There were two matters voted on at the Meeting. A brief
description of each of these matters, and the results of the votes
thereon, are as follows:                                                                                     

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

|                     |  |     |            |          |  |  |         | 
|-------------------- |  | --- | ---------- | -------- |  |  | ------- | 
|Nominee              |  | For |            | Withheld
|                     |  |     |            |         
|Selim (Shlomo) Rakib |  |     | 61,049,229 |          |  |  | 433,619 | 
|David M. Woodrow     |  |     | 61,079,649 |          |  |  | 403,199 | 



| | 2. |  | Ratification of the appointment of Ernst & Young
LLP as the registrants auditors for the fiscal
year ending December 31, 2003
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------

|           |  |         |         |         |  |  |        | 
|---------- |  | ------- | ------- | ------- |  |  | ------ | 
|For        |  | Against |         | Abstain
|           |  |         |         |        
|60,973,637 |  |         | 446,049 |         |  |  | 63,162 | 




ITEM 5. OTHER INFORMATION



| |  | None
| |  | ----




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



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

| |  |  |       |  |  |                                                                                                             
| |  |  | ----- |  |  | ------------------------------------------------------------------------------------------------------------
| |  |  | 10.4  |  |  | 1998 Employee Stock Purchase Plan, as amended on May 22, 2002 (1)                                           
| |  |  |       |  |  |                                                                                                             
| |  |  | 10.10 |  |  | 1999 Non-Officer Equity Incentive Plan, as amended May 28, 2003.                                            
| |  |  |       |  |  |                                                                                                             
| |  |  | 10.24 |  |  | Employment Agreement dated July 3, 2003, between Terayon
Communication Systems, Inc. and Doug Sabella.      
| |  |  |       |  |  |                                                                                                             
| |  |  | 10.25 |  |  | Employment Agreement dated September 28, 1999, between
Terayon Communication Systems, Inc. and Edward Lopez.
| |  |  |       |  |  |                                                                                                             
| |  |  | 10.26 |  |  | Executive
Compensation Plan, as adopted May 28,
2003.                                                       
| |  |  |       |  |  |                                                                                                             
| |  |  | 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.     



---

|(1) |  | Incorporated by reference to our Registration Statement
on Form S-8 filed on August 30, 2002.
|--- |  | ---------------------------------------------------------------------------------------------



| | (b) |  | REPORTS ON FORM 8-K                                                                                      
| | --- |  | ---------------------------------------------------------------------------------------------------------
|
| |     |  | During the three months ended June 30, 2003, the Company filed the
following Current Reports on Form 8-K:



| | 1. |  | On April 1, 2003, the Company filed a report on Form
8-K announcing the deployment of its DM3200 CherryPicker by
Time Warner Cables New York City division.                                                                                               
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | On April 16, 2003, the Company filed a report on Form
8-K announcing that its first quarter results would be announced
on April 29, 2003 and that two models of its TJ715 modem had
been certified by the Cable Television Laboratories, Inc. as
DOCSIS 2.0.
|
| | 3. |  | On April 30, 2003, the Company filed a report on Form
8-K announcing the Companys preliminary results for the first
quarter ended March 31, 2003.                                                                                                          

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| | 4. |  | On May 9, 2003, the Company filed a report on Form
8-K announcing the addition of redundancy to its BW3500 Cable
Modem Termination System.                                                                                                                                                                         
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 5. |  | On May 15, 2003, the Company filed a report on Form
8-K announcing the addition of new network interfaces to its DM
CherryPicker line of products and the demonstration of the
redundancy feature of its BW 32500 cable modem termination
system at the Cable-Tec Expo.                                            
|
| | 6. |  | On May 30, 2003, the Company filed a report on Form
8-K announcing that Hanvit I&B, a customer located in Korea,
deployed the Companys DOCSIS 2.0 cable data system and that its
DM 6400 Network CherryPicker won the advanced video category in
Communications Technology magazines 2003 Readers Choice
Awards.
|
| | 7. |  | On June 24, 2003, the Company filed a report on Form
8-K announcing the certification of its TJ 720x cable modem as
European Euro-DOCSIS 1.1 (Data Over Cable Service Interface
Specification) by TComLabs, a laboratory commissioned by the
Euro-DOCSIS Certification Board.                                      

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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: August 14, 2003 |  | TERAYON COMMUNICATION SYSTEMS, INC.
|                      |  |                                    
|                      |  | By /s/ Arthur T. Taylor            
|                      |  | Arthur T. Taylor                   
|                      |  | Chief Financial Officer            

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EXHIBIT INDEX

|      |  |                                                                                                             
|----- |  | ------------------------------------------------------------------------------------------------------------
|10.4  |  | 1998 Employee Stock Purchase Plan, as amended on May 22, 2002 (1)                                           
|      |  |                                                                                                             
|10.10 |  | 1999 Non-Officer Equity Incentive Plan, as amended May 28, 2003.                                            
|      |  |                                                                                                             
|10.24 |  | Employment Agreement dated July 3, 2003, between Terayon Communication Systems, Inc. and Doug Sabella.      
|      |  |                                                                                                             
|10.25 |  | Employment Agreement dated September 28, 1999, between Terayon Communication Systems, Inc. and Edward Lopez.
|      |  |                                                                                                             
|10.26 |  | Executive Compensation Plan, as adopted May 28, 2003.                                                       
|      |  |                                                                                                             
|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.     
|     
|(1)   |  | Incorporated by reference to our Registration
Statement on Form S-8 filed on August 30, 2002.