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UNITED STATES SECURITIES AND
    EXCHANGE COMMISSION
 Washington, D.C.
    20549
      Form 10-K
      (Mark One)þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE
    SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED
    DECEMBER 31, 2005ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF
    THE SECURITIES EXCHANGE ACT OF 1934FOR THE TRANSITION PERIOD
    FROM          TO          .   COMMISSION FILE NUMBER:
    0000-24647
      TERAYON COMMUNICATION SYSTEMS,
    INC.
 (Exact Name of Registrant as
    Specified in Its Charter)
  Delaware

77-0328533(State or Other Jurisdiction
    of
    Incorporation or Organization

(IRS Employer
    Identification No.)   2450 WALSH AVENUE
 SANTA CLARA, CALIFORNIA 95051
 (408) 235-5500
 (Address, Including Zip Code,
    and Telephone Number,
    Including Area Code, of the Registrants Principal
    Executive Offices)
      SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE
    ACT:
  Title of Each Class:

Name of Each Exchange on Which Registered:None

None   SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE
    ACT:
 COMMON STOCK, par value $0.001 per share
   o þ
  o þ
  o þ
  Regulation S-K Form 10-K Form 10-K. o
  Rule 12b-2
 o þ o
  Rule 12b-2).  Yes o þ
      DOCUMENTS
    INCORPORATED BY REFERENCE
  None




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##### 



INDEX
  TERAYON
    COMMUNICATION SYSTEMS, INC.
  PageNo.Introductory
    Note


2PART IItem 1.


Business


10Item 1A.


Risk
    Factors


20Item 1B.


Unresolved Staff
    Comments


42Item 2.


Properties


42Item 3.


Legal
    Proceedings


42Item 4.


Submission of
    Matters to a Vote of Security Holders


45PART IIItem 5.


Market for
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities


46Item 6.


Selected Financial
    Data


48Item 7.


Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


50Item 7A.


Quantitative and
    Qualitative Disclosures About Market Risk


106Item 8.


Financial
    Statements and Supplementary Data


108Item 9.


Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


186Item 9A.


Controls and
    Procedures


186Item 9B.


Other
    Information


194PART IIIItem 10.


Directors and
    Executive Officers of the Registrant


194Item 11.


Executive
    Compensation


198Item 12.


Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


203Item 13.


Certain
    Relationships and Related Transactions


204Item 14.


Principal
    Accountant Fees and Services


204PART IVItem 15.


Exhibits, Financial
    Statement Schedules


205Signatures


209EXHIBIT 10.18EXHIBIT 10.27EXHIBIT 10.28EXHIBIT 10.31EXHIBIT 10.32EXHIBIT 10.33EXHIBIT 10.34EXHIBIT 10.35EXHIBIT 21.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2EXHIBIT 99.1EXHIBIT 99.2EXHIBIT 99.3   INTRODUCTORY
    NOTE  Form 10-K (Form 10-K) Form 10-K
 2




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Background
    of the Restatement
    97-2, (SOP 97-2), SOP 81-1, (SOP 81-1), 00-21, 00-21), SOP 81-1, SOP 81-1.
  SOP 97-2, 00-21 Bulletin 90-1, SOP 97-2
   3




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Restatement
    of Historical Financial Statements
  .
  Revenue Recognition.
  Video Product and Post Contract Support. SOP 97-2 SOP 97-2,
  Thomson Contract. SOP 97-2 SOP 81-1,
 4




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SOP 81-1,
  Inventory Consignment.
  Other Revenue Adjustments.
  Allowance for Doubtful Accounts.
   5




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Deferred Revenues and Deferred Cost of Goods
    Sold.
  Use of Estimates.
  Access Network Electronics. ,
  Israel Restructuring Reserve.
 6




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License Fee. produced sold.
  Goods Received Not Invoiced.
  Other.
  Convertible Subordinated Notes.
   7




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7-year
     8




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For further discussion of the restatement adjustments and the
    net effects of all of the restatement adjustments on the
    Companys balance sheet and statements of operations,
    please refer to Item 7  Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations and Note 3 to the Consolidated Financial
    Statements.
  Reliance on Prior Consolidated Financial
    Statements. Form 10-K Form 10-Q Form 10-K. Form 10-K Form 10-K Form 10-Q
 9




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PART I  Item 1.
    Business  Overview
  ® digital-to-analog line-ups,
  Form 10-K Form 10-K
  (408) 235-5500.
  History
    of the Company
  data-over-satellite
     10




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Industry
    Dynamics
    Migration
    of cable operators to all-digital networks
    Ability
    to leverage network infrastructures to offer multiple products
    and services
    ®
  Network
    operators and content aggregators must combat ad skipping
    technologies
    Continued
    network investment to support new product requirements in
    competitive and emerging markets
   11




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Consolidation
    of the cable industry
      Business
  ® digital-to-analog line-ups,
    ®
 12




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Business
    Strategy
    
    capitalize on the increasing demand for advanced digital video
    services, including HDTV and video on demand, by leveraging our
    strengths in bandwidth management, ad insertion, grooming
    applications and products;
    continue to develop video applications with enhanced
    capabilities that meet the localization on-demand and
    personalized advertising needs of network operators, and to
    address emerging markets, such as mobile video;
    increase the distribution opportunities for our digital video
    products through reseller channels by developing new
    relationships and expanding existing system integration
    partnerships with partners such as Harmonic, Alcatel and
    Motorola; and
    improve margins through focused product cost-reduction efforts
    and by streamlining operational activities across our product
    lines.  IP-based
  Products
  voice-over-cable Internet-over-satellite
  ® digital-to-analog ® line-ups,
  ® digital-to-analog-back-to-digital
 13




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®
  digital-to-analog IP-based
  over-the-air
    Product
    research and development
        Customers
      
    Comcast;
    Cox Communications Inc. (Cox); 14




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
    TWC;
    EchoStar Communications Corporation; and
    Harmonic.    Market
    Competition
  ®
    
    quality of product performance, features and reliability;
    customer technical support and service;
    price;
    size and financial stability of operations;
    breadth of product line;
    sales and distribution capabilities;
    relationships with network operators and content
    aggregators; and
    meeting current or prospective industry or customer standards
    applicable to our products.    
    larger and more established selling and marketing capabilities;
    greater economies of scale;
    significantly greater financial, technical, engineering,
    marketing, distribution, customer support and other resources;
    greater name recognition and a larger installed base of
    customers; and
    well-established relationships with our existing and potential
    customers.   15




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Sales and
    Marketing
        International
    Sales
     16




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Customer
    Service and Technical Support
    Backlog
    Manufacturing
          Intellectual
    Property
     17




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and/or
    Employees
      Access to
    Our Reports
  Form 10-K, Form 10-Q, Form 8-K,
 18




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1-800-SEC-0330.
 19




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Item 1A.
    Risk
    Factors  The following is a summary description of some of the many
    risks we face in our business. You should carefully review 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. You should also consider the other
    information described in this report.
  Risks
    Related to the Restatement
  The restatement of our consolidated financial statements
    has had a material adverse impact on us, including increased
    costs, the delisting of our common stock from The NASDAQ Stock
    Market, the increased possibility of legal or administrative
    proceedings, and a default under our subordinated note
    agreement.
    
    We have incurred substantial unanticipated costs for accounting
    and legal fees in the year ended December 31, 2005 and
    continue to incur such costs in the year ended December 31,
    2006 in connection with the restatement. Although the
    restatement is complete, we expect to incur additional costs as
    indicated below.
    We face an increased risk of being subject to legal or
    administrative proceedings. In December 2005, the Commission
    issued a formal order of investigation in connection with our
    accounting review of certain customer transactions. This
    investigation has diverted and will continue to divert more of
    our managements time and attention and continue to cause
    us to incur substantial costs. Such investigations can also lead
    to fines or injunctions or orders with respect to future
    activities, as well as further substantial costs and diversion
    of managements time and attention.
    On June 23, 2006, a securities litigation lawsuit based on
    the events concerning the restatement was filed against us and
    certain of our current and former executive officers. In
    connection with this litigation and any further litigation that
    is pursued or other relief sought by persons asserting claims
    for damages allegedly resulting from or based on this
    restatement or events related thereto, we will incur defense
    costs that may include the amount of our deductible and defense
    costs exceeding our insurance coverage regardless of the
    outcome. Additionally, we may incur costs if the insurers of our
    directors and our liability insurers deny coverage for the costs
    and expenses related to any litigation. Likewise, such events
    may divert our managements time and attention away from
    the operation of the business. If we do not prevail in any such
    actions, we could be required to pay substantial damages or
    settlement costs.
    We were de-listed from The NASDAQ Stock Market because we were
    unable to file our periodic reports with the Commission on a
    timely basis. This failure was attributable to our inability to
    complete the restatement of our consolidated financial
    statements for prior periods. As previously disclosed on our
    Current Reports on
    Form 8-K
    filed on November 22, 2005 and January 20, 2006,
    NASDAQ notified us of its intention to de-list our common stock
    based on our failure to timely file our Quarterly Report on
    Form 10-Q
    for the quarter ended September 30, 2005, and our failure
    to solicit proxies and hold an annual shareholders meeting
    during 2005. On March 31, 2006, The NASDAQ Listing and
    Qualifications Panel determined to de-list our securities from
    The NASDAQ Stock Market effective as of the opening of business
    on April 4, 2006, and our common stock currently trades on
    the Pink Sheets. See our risk factor entitled Our common
    stock has been de-listed from The NASDAQ Stock Market and trades
    on the Pink Sheets. We may be unable to relist on The
    NASDAQ Stock Market because we may not be able to meet the
    initial listing requirements.
    Because we were unable to timely file our Quarterly Report on
    Form 10-Q
    for September 30, 2005, we defaulted on our Notes. On
    March 21, 2006, we paid off the entire principal amount of
    outstanding Notes, including all accrued and unpaid interest and
    related fees, for a total of $65.6 million. As a result,
    our repayment of the Notes reduced our unrestricted cash,
    decreased our liquidity and could materially impair our ability
    to operate our business especially if we are unable to generate
    positive cash flow from operations. 20




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
    The restatement may also result in other negative ramifications,
    including the potential loss of confidence by suppliers,
    customers, employees, investors, and security analysts, the loss
    of institutional investor interest and fewer business
    development opportunities.  Material
    weaknesses or deficiencies in our internal control over
    financial reporting could harm stockholder and business
    confidence in our financial reporting, our ability to obtain
    financing and other aspects of our business.
  Form 10-K, Form 10-K Form 10-K, Form 10-K.
      
    insufficient controls related to the identification, capture and
    timely communication of financially significant information
    between certain parts of the organization and the accounting and
    finance department to enable these departments to account for
    transactions in a complete and timely manner;
    lack of sufficient personnel with technical accounting
    experience in the accounting and finance department and
    inadequate review and approval procedures to prepare external
    financial statements in accordance with GAAP;
    failure in identifying the proper recognition of revenue in
    accordance with GAAP, including revenue recognized in accordance
    with American Institute of Certified Accountants Statement of
    Position (SOP)
    97-2,
    Software Revenue Recognition
    (SOP 97-2),
    SOP 81-1,
    Accounting for Performance of Construction-Type and
    Certain Production-Type Contracts
    (SOP 81-1),
    Financial Accounting Standards Board, Emerging Issues Task Force
    (EITF)
    00-21,
    Accounting for Revenue Arrangements with Multiple
    Deliverables (EITF
    00-21);
    the use of estimates, including monitoring and adjusting
    balances related to certain accruals and reserves, including
    allowance for doubtful accounts, legal charges, license fees,
    restructuring charges, taxes, warranty obligations, fixed assets
    and bond issue costs;
    lack of sufficient analysis and documentation of the application
    of GAAP; and
    ineffective controls over the documentation, authorization and
    review of manual journal entries and ineffective controls to
    ensure the accuracy and completeness of certain general ledger
    account reconciliations conducted in connection with period end
    financial reporting. 21




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Form 10-K.
            Our
    revenue recognition policy on digital video products has been
    corrected.
  SOP 97-2, 00-21.
  Our
    common stock has been de-listed from The NASDAQ Stock Market and
    trades on the Pink Sheets.
   22




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If we
    are not able to become or remain current in our filings with the
    Commission, we will face several adverse
    consequences.
  Form S-3 Form S-8, Form S-8
  Risks
    Related to Our Business
  We
    have a history of losses and may continue to incur losses in the
    future.
      We
    depend on capital spending from the cable, satellite and
    telecommunications industries for our revenues, and any decrease
    or delay in capital spending in these industries would
    negatively impact our revenues, financial condition and cash
    flows.
    
    Cable and satellite operators and telecom providers access
    to financing;
    Annual budget cycles, and the typical reduction in upgrade
    projects during the winter months;
    Impact of industry consolidation and financial restructuring; 23




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
    Federal, local and foreign government regulation of
    telecommunications and television broadcasting;
    Overall demand for communication services and acceptance of new
    video, voice and data services;
    Evolving industry standards and network architecture;
    Delays associated with the evaluation of new services, new
    standards, and system architectures by cable and satellite
    operators and telecom providers;
    An emphasis on generating revenue from existing customers by
    operators instead of new construction or network upgrades;
    Competitive pressures, including pricing pressures; and
    General economic conditions.    Due to
    the lengthy sale cycle involved in the sale of our products, our
    financial results may vary and should not be relied on as an
    indication of future performance.
    period-to-period
    We may
    continue to experience fluctuations in our operating results and
    face unpredictability in our future revenues.
  Period-to-period
 24




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
    The sales cycle and timing of significant customer orders, which
    are dependent on the capital spending budgets of cable and
    satellite operators, telecom providers and other customers;
    Variations in the size of the orders by our customers and
    pricing concessions on volume sales;
    Competitive market conditions, including pricing actions by our
    competitors;
    New product introductions or the introduction of added features
    or functionality to products by competitors or by us;
    Delays in our introduction of new products, in our introduction
    of added features or functionality to our products, or our
    commercialization of products that are competitive in the
    marketplace;
    International conflicts, including the continuing conflict in
    Iraq, and acts of terrorism, and the impact of adverse economic,
    market and political conditions worldwide;
    The ability of our products to be qualified or certified as
    meeting industry standards
    and/or
    customer standards;
    Changes in market demand;
    Economic and financial conditions specific to the cable,
    satellite and telecom industries, and general economic
    conditions;
    Timing of revenue recognition;
    Changes in domestic and international regulatory environments;
    Market acceptance of new and existing products;
    The mix of our customer base, sales channels and our products
    sold;
    The level of international sales; and
    Delays in our receipt of, or cancellation of, orders forecasted
    by customers.    
    The sales mix of our products, the volume of products
    manufactured, and the average selling prices (ASPs) of our
    products;
    The costs of manufacturing our products;
    Delays in reducing the cost of our products and the
    effectiveness of our cost reduction measures;
    The type of distribution channel through which we sell our
    products; and
    Our ability to manage excess and obsolete inventory.  Our
    expenses for any given quarter are based on expected sales and
    if sales are below expectations, our operating results may be
    adversely impacted by our inability to adjust spending to
    compensate for the shortfall in revenue.
   25




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Because
    our customer base is highly concentrated among a limited number
    of large customers, the loss of or reduced demand from these
    customers could have a material adverse effect on our business,
    financial condition and results of operations.
         26




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The
    reductions in workforce associated with our restructuring
    efforts could disrupt the operation of our business, distract
    our management from focusing on revenue-generating efforts,
    result in the erosion of employee morale, and impair our ability
    to respond rapidly to growth opportunities in the
    future.
    We are
    dependent on key personnel.
    Our
    future growth depends on developments in the digital video
    industry, on the adoption of new technologies and on several
    other industry trends.
  IP-based and/or
    
    Convergence, or the desire of certain network operators to
    deliver a package of video, voice and data services to
    consumers, also known as the triple play; 27




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
    The use of digital video applications by businesses, governments
    and educators;
    The entry of telecom providers into the video business to allow
    them to offer the triple play purchase of services;
    Efforts by regulators and governments in the United States and
    abroad to encourage the adoption of broadband and digital
    technologies; and
    The extent and nature of regulatory attitudes towards such
    issues as competition between operators, access by third parties
    to networks of other operators, and local franchising
    requirements for telecom companies to offer video.    The
    markets in which we operate are characterized by rapidly
    changing technology, and we need to develop and introduce new
    and enhanced products in a timely manner to remain
    competitive.
    
    Develop, in a timely manner, new products and applications that
    keep pace with developments in technology;
    Develop products that are cost effective;
    Meet evolving customer requirements;
    Enhance our current product and applications offerings; and
    Achieve market acceptance.   28




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Average
    selling prices of our digital video products may decline, which
    would materially and adversely affect our financial
    performance.
  period-to-period
  We
    must achieve cost reductions or increase revenues to attain
    profitability.
      Our
    repayment of our Notes could adversely affect our financial
    condition, and we may not be able to raise additional funds to
    continue operating our business.
     29




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Substantially
    all of our future revenue will be derived from the sale of our
    digital video products, and our operating results, financial
    conditions and cash flows will depend upon our ability to
    generate sufficient revenue from the sale of our digital video
    products.
    We may
    be unable to provide adequate customer support.
      The
    deployment process for our equipment may be lengthy and may
    delay the receipt of new orders and cause fluctuations in our
    revenues.
    We may
    have financial exposure to litigation.
  and/or
 30




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and/or
    The
    loss of existing reseller and system integrator relationships or
    the failure to establish new relationships or strategic
    partnerships could have a material adverse effect on our
    business, financial conditions and results of
    operations.
        We may
    fail to accurately forecast customer demand for our products,
    which could have a negative impact on our customer relationships
    and our revenues.
     31




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We may
    not be able to manage expenses and inventory risks associated
    with meeting the demand of our customers.
      We are
    dependent on a key third-party manufacturer and any failure of
    our manufacturer could materially adversely affect our financial
    condition and operating results.
        We are
    dependent upon international sales and there are many risks
    associated with international operations, any of which could
    harm our financial condition and results of
    operations.
   32




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
    Changes in foreign government regulations and communications
    standards;
    Import and export license requirements, tariffs and taxes, trade
    barriers and trade disputes;
    The uncertainty of laws and enforcement in certain countries
    relating to the protection of intellectual property;
    Difficulty in complying with environmental laws;
    Difficulty in collecting accounts receivable and longer payment
    cycles for international customers than those for customers in
    North America;
    Currency and exchange rate fluctuations;
    The burden of complying with a wide variety of foreign laws,
    treaties and technical standards;
    Difficulty in staffing and managing foreign operations;
    Specific social, political, labor and economic conditions, and
    political and economic changes in international markets; and
    Multiple and possibly overlapping tax structures, potentially
    adverse tax consequences.      We are
    subject to regulation by U.S. and foreign governments and
    qualification requirements by
    non-governmental
    agencies. If we are unable to obtain and maintain regulatory
    qualifications for our existing and future products, our
    financial results may be adversely affected.
     33




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The
    markets in which we operate are intensely competitive and many
    of our competitors are larger and more
    established.
      
    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 network operators and content
    aggregators; and
    Compliance with industry standards.    
    Larger and more established selling and marketing capabilities;
    Greater economies of scale;
    Significantly greater financial, technical, engineering,
    marketing, distribution, customer support and other resources;
    Greater name recognition and a larger installed base of
    customers; and
    Well-established relationships with our existing and potential
    customers. 34




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Our
    business is subject to the risks of warranty returns, product
    liability and product defects.
    We may
    be unable to adequately protect or enforce our intellectual
    property rights.
   35




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Third
    party claims of infringement or other claims against us could
    adversely affect our ability to market our products, require us
    to redesign our products or seek licenses from third parties,
    and seriously harm our operating results and disrupt our
    business.
     36




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We are
    exposed to the credit risk of our customers and to credit
    exposures in weakened markets, which could result in material
    losses.
      We
    have and we may seek to expand our business through acquisitions
    which could disrupt our business operations and harm our
    operating results.
    
    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.    
    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.   37




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Our
    products are subject to safety approvals and
    certifications.
    Compliance
    with current and future environmental regulations may be costly
    which could impact our future earnings.
  .
  Various
    export licensing requirements could materially and adversely
    affect our business or require us to significantly modify our
    current business practices.
   38




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Compliance
    with changing laws and regulations relating to corporate
    governance and public disclosure has resulted, and will continue
    to result, in the incurrence of additional
    expenses.
        Recent
    and proposed regulations related to equity compensation could
    adversely affect earnings, our ability to raise capital and
    affect our ability to attract and retain key
    personnel.
    Our
    stock price has been and is likely to continue to be highly
    volatile.
   39




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
    Actual or anticipated variations in quarterly operating results;
    Announcements of technological innovations;
    New products or services offered by us or our competitors;
    Changes in financial estimates by securities analysts;
    Conditions or trends in the broadband services and technologies
    industry;
    Changes in the economic performance
    and/or
    market valuations of technology, Internet, online service or
    broadband service industries;
    Announcement of significant acquisitions, strategic
    partnerships, joint ventures or capital commitments, by us or
    our current or potential competitors;
    Adoption of industry standards and the inclusion or
    compatibility of our technology with such standards;
    Adverse or unfavorable publicity regarding us or our products;
    Additions or departures of key personnel;
    Sales of common stock; and
    Other events or factors that may be beyond our control.    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
    rely on complex information technology systems and networks to
    operate our business. Any significant system or network
    disruption could have a material adverse impact on our
    operations, sales and financial performance.
   40




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We,
    our sole manufacturer and our customers are vulnerable to
    earthquakes, disruptions to power supply, labor issues and other
    unexpected events.
    and/or
  SPECIAL
    NOTE ON FORWARD-LOOKING STATEMENTS
  Form 10-K and/or
  
    Our belief that our current cash balances will be sufficient to
    satisfy our cash requirements for at least the next
    12 months;
    Our belief that we are well positioned to capitalize on the
    emerging digital video market because of the success our digital
    video products have had with the major U.S. cable operators
    and satellite providers, as well as our current success in
    digital ad insertion;
    Our belief that by focusing our business on higher margin
    digital video products, our margins may increase;
    Our belief that we are well positioned to capitalize on the
    growing demand for network operators to provide advanced video
    services to their subscribers;  
    Our belief that the ongoing migration of network operators and
    content aggregators to all-digital networks represents a
    significant opportunity for companies similar to ours with
    products and technologies that enable our customers to maximize
    their bandwidth, to utilize important new transport methods and
    to deploy new services;  
    Our belief that networks operators and content aggregators will
    increasingly rely on overlay to maintain or even increase their
    advertising revenues and that our digital video processing
    systems will enable them to do this more cost-effectively;
    Our belief that network operators will continue their
    investments in equipment to provide advanced services in a
    cost-effective manner to increase average revenues per unit from
    their subscribers; 41




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##### Table of Contents




    Our belief that there will be increasing competition to our
    digital video products, which may increase price competition and
    lead to decreased revenue and margins;
    Our expectation that research and development expenses will
    decrease in 2006; and
    Our expectation that general and administrative expenses will
    increase in 2006 due in part to the restatement process.  Forward-looking statements are not guarantees of future
    performance and involve risks and uncertainties, including those
    discussed in Item 1A of this Report. The forward-looking
    statements contained in this report are based on information
    that is currently available to us and expectations and
    assumptions that we deemed reasonable at the time the statements
    were made. We do not undertake any obligation to update any
    forward-looking statements in this report or in any of our other
    communications, except as required by law. All such
    forward-looking statements should be read as of the time the
    statements were made and with the recognition that these
    forward-looking statements may not be complete or accurate at a
    later date. The business risks discussed in Item 1A of this
    Report on
    Form 10-K,
    among other things, should be considered in evaluating our
    prospects and future financial performance.
  Item 1B.
    Unresolved
    Staff Comments    Item 2.
    Properties  sub-sublease sub-sublease
    Item 3.
    Legal
    Proceedings  In re Terayon Communication Systems,
    Inc. Securities Litigation.
 42




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##### Table of Contents



Bertram v. Terayon
    Communication Systems, Inc.
  Campbell v. Rakib In re
    Terayon Communication Systems, Inc. Derivative Litigation
       43




---



##### Table of Contents



44




---



##### Table of Contents



and/or
          Item 4.
    Submission
    of Matters to a Vote of Security Holders   45




---



##### Table of Contents



PART II  Item 5.
    Market
    for the Registrants Common Equity, Related Stockholder
    Matters and Issuer Purchases of Equity Securities    High


LowYear Ended December 31, 2005First Quarter

$
3.73


$
1.99Second Quarter

$
3.78


$
2.52Third Quarter

$
4.10


$
2.91Fourth Quarter

$
3.95


$
1.97Year Ended December 31, 2004First Quarter

$
6.25


$
2.96Second Quarter

$
3.99


$
1.66Third Quarter

$
2.38


$
1.44Fourth Quarter

$
2.98


$
1.52           Common StockAvailable for FutureCommon Stock



Issuance Underto be Issued

Weighted Average

Equity CompensationUpon Exercise of

Exercise Price of

Plans (ExcludingOutstanding Options

Outstanding Options

Securities Reflectedand Rights

and Rights

in Column (a))Plan Category

(a)

(b)

(c)Equity compensation plans approved
    by Terayon stockholders(1)


10,132,904


$
4.23



4,065,127Equity compensation plans not
    approved by Terayon stockholders(2)


2,899,082


$
6.70



1,465,798Total


13,031,986


$
4.78



5,530,925     (1)
    
    Includes options to purchase common stock outstanding under the
    Terayon Communication Systems, Inc. 1995 Stock Option Plan, as
    amended (1995 Plan), the Terayon Communication Systems, Inc.
    1997 Equity Incentive Plan, as amended (1997 Plan), and the
    Terayon Communication Systems, Inc. 1998 Non-Employee Directors
    Stock Option Plan, as amended (1998 Plan). Does not include
    600,371 shares of our common stock that were available for
    issuance under the Terayon Communication Systems, Inc. 1998
    Employee Stock Purchase Plan, as 46




---



##### Table of Contents



amended, which was also approved by our stockholders, including
    the Terayon Communication Systems, Inc. 1998 Employee Stock
    Purchase Plan Offering for Foreign Employees. The 1997 Plan was
    amended on June 13, 2000 to, among other things, provide
    for an increase in the number of shares of our common stock on
    each January 1 beginning January 1, 2001 through
    January 1, 2007, by the lesser of 5% of our common stock
    outstanding on such January 1 or 3,000,000 shares. In May
    2003, the 1997 Plan was amended to reduce the number of
    authorized shares in the 1997 Plan by 6,237,826 shares. In
    May 2005, the 1997 Plan was amended to reduce the number of
    authorized shares in the 1997 Plan by 4,000,000 shares.(2)
    
    Includes options to purchase common stock outstanding under the
    Terayon Communication Systems, Inc. 1999 Non-Officer Equity
    Incentive Plan, as amended (1999 Plan), Mainsail Equity
    Incentive Plan, TrueChat Equity Incentive Plan, and options
    issued outside of any equity incentive plan. See Note 10,
    Stockholders Equity, to Consolidated Financial
    Statements for additional information regarding the provisions
    of the 1999 Plan. 47




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##### Table of Contents



Item 6.
    Selected
    Financial Data  Form 10-K Form 10-Q Form 10-K.
    Year Ended December 31,2005


2004


2003


2002


2001(as restated)(1)


(as restated)(1)


(as restated)


(as adjusted)(5)(in thousands, except per share data)Consolidated statement of
    operations data:Revenues

$
90,664


$
136,484


$
130,187


$
130,730


$
279,481Cost of goods sold


55,635



101,887



103,835



101,808



263,117Gross profit


35,029



34,597



26,352



28,922



16,364Operating expensesResearch and development


17,650



33,199



42,634



58,696



79,927Sales and marketing


22,534



24,145



26,781



35,704



55,701General and administrative


20,356



12,039



11,934



15,639



33,163Goodwill amortization


















25,410Restructuring charges, executive
    severance and asset write-offs(2)


2,257



12,336



2,803



8,922



587,149Total operating expenses


62,797



81,719



84,152



118,961



781,350Loss from operations


(27,768
)


(47,122
)


(57,800
)


(90,039
)


(764,986
)Interest income (expense) and
    other income (expense), net


966



(59
)


1,891



(618
)


1,645Gain on early extinguishment of
    debt(3)














50,983



192,303Income tax benefit (expense)


(149
)


76



(316
)


(238
)


13,915Net loss

$
(26,951
)

$
(47,105
)

$
(56,225
)

$
(39,912
)

$
(557,123
)Basic and diluted net loss per
    share

$
(0.35
)

$
(0.62
)

$
(0.76
)

$
(0.55
)

$
(8.17
)Shares used in computing basic and
    diluted net loss per share(4)


77,154



75,751



74,074



72,718



68,164Consolidated Balance Sheet
    Data:Cash, cash equivalents and
    short-term investments

$
101,301


$
97,735


$
138,640


$
206,503


$
333,888Working capital


22,045



107,052



138,035



178,091



320,150Total assets


146,648



156,981



213,099



279,169



469,981Convertible debentures


65,367



65,588



65,809



66,030



177,368Long-term obligations (less
    current portion)


1,455



2,076



1,356



1,936



181,868Accumulated deficit


(1,062,438
)


(1,035,487
)


(988,382
)


(932,157
)


(892,245
)Total stockholders equity


20,657



44,943



90,563



142,191



181,052     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 48




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##### Table of Contents



(2)
    
    See Note 6, Accrued Severance Pay, and
    Note 7, Restructuring Charges and Asset
    Write-offs, to Consolidated Financial Statements for an
    explanation for restructuring charges, executive severance and
    asset write-offs.(3)
    
    See Note 8, Convertible Subordinated Notes, to
    Consolidated Financial Statements for an explanation of the
    repurchase of subordinated convertible notes and
    reclassification of related gains.(4)
    
    See Note 2, Summary of Significant Accounting
    Policies, to Consolidated Financial Statements for an
    explanation of the method employed to determine the number of
    shares used to compute per share data.(5)
    
    We made three adjustments to the financial statements for the
    year ended December 31, 2001 which resulted in a decrease
    in accumulated net loss of $6.7 million. The largest
    adjustment of $7.9 million gain related to the redemption
    of a portion of the embedded derivative (Issuer Call Option)
    contained in our $500.0 million of 5% convertible
    subordinated Notes due August 2007 (Notes) and the remaining
    $1.9 million and $0.6 million related to our analysis
    of the allowance for doubtful accounts and an adjustment for a
    previously recorded tax accrual, respectively. During 2001, we
    repurchased $325.9 million of face value of Notes,
    requiring $7.0 million of the bond premium to be redeemed.
    An additional $1.0 million was recorded to reflect the
    amortization of the bond premium. As part of our review of the
    allowance for doubtful accounts, we determined that an
    adjustment to increase bad debt expense and the corresponding
    allowance for doubtful accounts by $1.9 million was
    necessary for the year ended December 31, 2001. In 2001, we
    recorded a foreign income tax contingent expense to accrue for
    potential tax liabilities related to post-acquisition activities
    of foreign subsidiaries. During the restatement process, it was
    determined that this original accrual was not substantiated and
    accordingly, should not have been recorded, and we adjusted the
    balance accordingly as of December 31, 2001. 49




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##### Table of Contents



Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Form 10-K Form 10-Q.
  Restatement
    of Consolidated Financial Statements and Related
    Proceedings
    97-2, (SOP 97-2), SOP 81-1, (SOP 81-1), 00-21, 00-21), SOP 81-1, SOP 81-1.
  SOP 97-2, 00-21 Bulletin 90-1, SOP 97-2
 50




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##### Table of Contents



The
    Restatement and Other Related Matters
  .
  Revenue Recognition.
  Video Product and Post Contract Support. SOP 97-2 SOP 97-2,
 51




---



##### Table of Contents



Thomson Contract. SOP 97-2 SOP 81-1, SOP 81-1,
  Inventory Consignment.
  Other Revenue Adjustments.
  Allowance for Doubtful Accounts.
 52




---



##### Table of Contents



Deferred Revenues and Deferred Cost of Goods
    Sold.
  Use of Estimates.
  Access Network Electronics. ,
 53




---



##### Table of Contents



Israel Restructuring Reserve.
  License Fee. produced sold.
  Goods Received Not Invoiced.
  Other.
  Convertible Subordinated Notes.
 54




---



##### Table of Contents



7-year
   55




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56




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  December 31, 2003Cumulative EffectAs Previously


of Prior Year


Current YearReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
30,188


$



$



$
30,188Short-term investments


108,452











108,452Accounts receivable, net of
    allowance for doubtful accounts


29,799



2,723



(7,587
)


24,935


(a),(b)Other current receivables


3,662











3,662Inventory, net


16,364







913



17,277


(c)Other current assets


2,883











3,205Short-term Deferred cost of goods
    sold










322






(d)Total current assets


191,348



2,723



(6,352
)


187,719Property and equipment, net


11,871











12,059Fixed asset






548



(360
)





(e)Restricted cash


9,212











9,212Other assets, net


2,809











4,109Long-term Deferred cost of goods
    sold










350






(f)License fee






188



762






(g)Total assets

$
215,240


$
3,459


$
(5,600
)

$
213,099LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
26,049


$



$



$
25,286Israel restructuring






1,177










(h)Received not invoiced






(1,940
)









(i)Common area maintenance






313



(313
)





(j)Accrued payroll and related expenses


6,537











6,537Deferred revenues


3,423











1,990Thomson direct development costs










(205
)





(k)Short-term deferred revenue










(1,228
)





(l)Accrued warranty expenses


5,509











5,229Warranty reserve






(280
)









(m)Accrued restructuring and executive
    severance


2,647



1,834







1,586


(n)Israel restructuring






(1,178
)









(h)Restructuring reclass between
    short-term and long-term










(1,717
)





(o)Accrued vendor cancellation charges


2,869











2,869Accrued other liabilities


5,284



(229
)






4,706


(n)Reclass short-term portion of
    deferred rent










249






(p)Tax accrual






(631
)


33






(q)Interest payable


1,358



(1
)


(1
)


1,356Current portion of capital lease
    obligations


124



1



1



126Total current liabilities


53,800



(934
)


(3,181
)


49,685Long-term obligations


3,118



(1,514
)


(248
)


1,356


(n),(p)Long-term deferred revenue










2,207



2,207


(r)Accrued restructuring and executive
    severance


1,853



(90
)


1,716



3,479


(n),(o)Convertible subordinated notes


65,081



949



(221
)


65,809


(s)Total liabilities


123,852



(1,589
)


273



122,536Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


75











75Additional paid-in capital


1,082,036



(1
)


(1
)


1,082,034Accumulated deficit


(987,560
)


5,048



(5,870
)


(988,382
)

(t)Deferred compensation


(22
)


1



(2
)


(23
)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,368
)










(2,368
)Total stockholders equity


91,388



5,048



(5,873
)


90,563Total liabilities and
    stockholders equity

$
215,240


$
3,459


$
(5,600
)

$
213,099     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 57




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##### Table of Contents



Explanation
    of Current Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect other adjustments and reclassifications.(c)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(i)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(j)
    
    To adjust for an unrecorded liability for common area
    maintenance in prior period.(k)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(m)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(n)
    
    To reflect a reclassification adjustment made after the filing
    of the original financial statements.(o)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(p)
    
    To reflect the short-term portion of deferred rent.(q)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(r)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(s)
    
    To record amortization of bond premium to interest income.(t)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 58




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##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  March 31, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
76,060


$



$



$
76,060Short-term investments


47,151











47,151Accounts receivable, net of
    allowance for doubtful accounts


29,041



(4,864
)


1,108



25,285


(a),(n)Inventory, net


19,267



913



(336
)


20,307


(b)Inventory consignment










463






(c)Other current assets


4,623



322







5,465Short-term deferred cost of goods
    sold










520






(d)Total current assets


176,142



(3,629
)


1,755



174,268Property and equipment, net


10,821



188



(94
)


10,915Intangibles and other assets, net


11,609



1,300







13,198Long-term deferred cost of goods
    sold










210






(e)License fee










79






(f)Total Assets

$
198,572


$
(2,141
)

$
1,950


$
198,381LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
21,362


$
(763
)

$



$
20,791Received not invoiced










192






(g)Accrued payroll and related expenses


5,072











5,072Deferred revenues


4,451



(1,433
)






3,449Inventory consignment










(398
)





(c)Short-term deferred revenue










1,168






(h)Thomson direct development costs










(339
)





(i)Accrued warranty expenses


4,605



(280
)






4,524Access Network Electronics










199






(j)Accrued restructuring and executive
    severance


6,598



(2,895
)






2,797


(k)Restructuring reclass between
    short-term and long-term










(906
)





(l)Accrued vendor cancellation charges


1,399











1,399Accrued other liabilities


4,137



(349
)






3,799


(k)Reclass short-term portion of
    deferred rent










(248
)





(m)Rebate obligation










215






(n)Tax accrual










44






(o)Other current obligations


570











570Interest payable






(2
)Current portion of capital lease
    obligations






2Total current liabilities


48,194



(5,720
)


(73
)


42,401Long-term obligations


3,472



1,468



1,156



6,096


(k),(l),(m)Long-term deferred revenue






2,207



1,168



3,375


(p)Convertible subordinated notes


65,081



728



(55
)


65,754


(q)Total liabilities


116,747



(1,317
)


2,196



117,626Stockholders equity:Common stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,082,770



(1
)


1



1,082,770Accumulated deficit


(997,807
)


(822
)


(248
)


(998,877
)

(r)Treasury stock, at cost


(773
)


(1
)


1



(773
)Accumulated other comprehensive loss


(2,441
)










(2,441
)Total stockholders equity


81,825



(824
)


(246
)


80,755Total liabilities and
    stockholders equity

$
198,572


$
(2,141
)

$
1,950


$
198,381     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 59




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##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse invoicing of consigned inventory sale and related
    deferral of net revenue and COGS.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(f)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(g)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(h)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(k)
    
    The cumulative amount was adjusted from the prior period to
    reflect the reclassification adjustment made after the filing of
    the original financial statements.(l)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(m)
    
    To reflect the short-term portion of deferred rent.(n)
    
    To reclassify to accrued other liabilities rebate obligations
    with a single customer previously recorded as contra-accounts
    receivable during the quarter.(o)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(p)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(q)
    
    To record amortization of bond premium to interest income.(r)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 60




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
 EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  June 30, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
47,783


$



$



$
47,783Short-term investments


68,489











68,489Accounts receivable, net of
    allowance for doubtful accounts


27,884



(3,756
)


4,641



28,769


(a),(l)Inventory, net


21,403



1,040



(177
)


21,803


(b)Inventory consignment










(463
)





(c)Other current assets


4,321



842







5,432Short-term deferred cost of goods
    sold










269






(d)Total current assets


169,880



(1,874
)


4,270



172,276Property and equipment, net


10,045



94







10,139Other assets, net


11,432



1,589







13,271Long-term deferred cost of goods
    sold










447






(e)License fee










(197
)





(f)Total Assets

$
191,357


$
(191
)

$
4,520


$
195,686LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
16,480


$
(571
)

$



$
16,102Received not invoiced










193






(g)Accrued payroll and related expenses


4,919











4,919Deferred revenues


5,091



(1,002
)






3,813Inventory consignment










(463
)





(c)Short-term deferred revenue










567






(h)Thomson direct development costs










(380
)





(i)Accrued warranty expenses


4,191



(81
)






4,311Access Network Electronics










201






(j)Accrued restructuring and executive
    severance


9,070



(3,801
)






5,343Restructuring reclass between
    short-term and long-term










74






(k)Accrued vendor cancellation charges


713











713Accrued other liabilities


4,382



(338
)






4,413Rebate obligation










520






(l)Tax accrual










(151
)





(m)Other current obligations


1,362











1,362Total current liabilities


46,208



(5,793
)


561



40,976Long-term obligations


3,156



2,624



(73
)


5,707


(k)Long-term deferred revenue






3,375



2,901



6,276


(n)Convertible subordinated notes


65,081



673



(56
)


65,698


(o)Total liabilities


114,445



879



3,333



118,657Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,082,811







(2
)


1,082,809Accumulated deficit


(1,002,668
)


(1,070
)


1,189



(1,002,549
)

(p)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,534
)










(2,534
)Total stockholders equity


76,912



(1,070
)


1,187



77,029Total liabilities and
    stockholders equity

$
191,357


$
(191
)

$
4,520


$
195,686     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 61




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse invoicing of consigned inventory sale and related
    deferral of net revenue and COGS.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(f)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(g)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(h)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(k)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(l)
    
    To reclassify to accrued other liabilities rebate obligations
    with a single customer previously recorded as contra-accounts
    receivable during the quarter.(m)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(n)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(o)
    
    To record amortization of bond premium to interest income.(p)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 62




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  September 30, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
64,150


$



$



$
64,150Short-term investments


47,757







1



47,758Accounts receivable, net of
    allowance for doubtful accounts


20,475



885



(2,054
)


19,306


(a),(k)Inventory, net


15,529



400



(278
)


15,651


(b)Other current assets


3,586



1,111







4,599Short-term deferred cost of goods
    sold










(98
)





(c)Total current assets


151,497



2,396



(2,429
)


151,464Property and equipment, net


9,134



94







9,228Other assets, net


10,865



1,839







12,866Long-term deferred cost of goods
    sold










385






(d)License fee










(223
)





(e)Total Assets

$
171,496


$
4,329


$
(2,267
)

$
173,558LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
11,128


$
(378
)

$



$
10,942Received not invoiced










192






(f)Accrued payroll and related expenses


4,368











4,368Deferred revenues


4,345



(1,278
)






3,541Short-term deferred revenue










867






(g)Thomson direct development costs










(393
)





(h)Accrued warranty expenses


4,043



120







4,363Access Network Electronics










200






(i)Accrued restructuring and executive
    severance


7,914



(3,727
)






4,604Restructuring reclass between
    short-term and long-term










417






(j)Accrued vendor cancellation charges


2,133











2,133Accrued other liabilities


4,459



31







3,813Rebate obligation










(736
)





(k)Tax accrual










59






(l)Interest payable and current
    portion of capital lease obligations


542











542Total current liabilities


38,932



(5,232
)


606



34,306Long-term obligations


3,417



2,551



(418
)


5,550


(j)Long-term deferred revenue






6,276



2,643



8,919


(m)Convertible subordinated notes


65,081



617



(55
)


65,643


(n)Total liabilities


107,430



4,212



2,776



114,418Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,083,420



(2
)


2



1,083,420Accumulated deficit


(1,016,188
)


119



(5,044
)


(1,021,113
)

(o)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,469
)






(1
)


(2,470
)Total stockholders equity


64,066



117



(5,043
)


59,140Total liabilities and
    stockholders equity

$
171,496


$
4,329


$
(2,267
)

$
173,558     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 63




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21 and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped free-on-board destination or
    with acceptance provisions.(d)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(f)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(g)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(h)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(j)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(k)
    
    To reverse the reclassification to accrued other liabilities of
    rebate obligations with a single customer previously recorded as
    contra-receivables originally recorded in the quarter ended
    September 30, 2004. The correcting reclassification was
    performed for the quarter ended March 31, 2004 and
    June 30, 2004 as part of the restatement.(l)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(m)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(n)
    
    To record amortization of bond premium to interest income.(o)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 64




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  December 31, 2004CumulativeAs


Effect of


CurrentPreviously


Prior Period


Quarter


AsReported


Adjustments


Adjustments


Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
43,218


$



$



$
43,218Short-term investments


54,517



1



(1
)


54,517Accounts receivable, net of
    allowance for doubtful accounts


19,660



(1,169
)


68



18,559


(a)Other current receivables


1,044











1,044Inventory, net


17,144



122



(49
)


17,666


(b)E&O vendor cancellation










449






(c)Other current assets


2,042



1,013







3,516Short-term deferred cost of goods
    sold










461






(d)Total current assets


137,625



(33
)


928



138,520Property and equipment, net


5,760



94







5,854Restricted cash


8,827











1,241Non-current deposits reclass










(7,586
)





(e)Other assets, net


1,522



2,001







11,366Long-term deferred cost of goods
    sold










415






(f)License fee










(159
)





(g)Non-current deposits reclass










7,587






(e)Total Assets

$
153,734


$
2,062


$
1,185


$
156,981LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
7,845


$
(186
)

$



$
7,846Received not invoiced










187






(h)Accrued payroll and related expenses


4,181











4,493Tax accrual reclass










(245
)





(e)Bonus accrual










557






(i)Deferred revenues


2,579



(804
)






4,965Short-term deferred revenue










3,395






(j)Thomson direct development costs










(205
)





(k)Accrued warranty expenses


3,870



320







4,670Access Network Electronics










200






(l)Warranty reserve










280






(m)Accrued restructuring and executive
    severance


3,902



(3,310
)






3,744Israel restructuring










1,177






(n)Restructuring reclass between
    short-term and long-term










1,975






(o)Accrued vendor cancellation charges


521











521Accrued other liabilities


4,317



(646
)






3,873Legal accrual










(448
)





(p)Property tax










(240
)





(q)Tax accrual










645






(r)Tax accrual reclass










245






(e)Interest payable and current
    portion of capital lease obligations


1,356











1,356Total current liabilities


28,571



(4,626
)


7,523



31,468Long-term obligations


2,077







(1
)


2,076Long-term deferred revenue






8,919



2,165



11,084


(s)Accrued restructuring and executive
    severance


1,664



2,133



(1,975
)


1,822


(o)Convertible subordinated notes


65,081



562



(55
)


65,588


(t)Total liabilities


97,393



6,988



7,657



112,038Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,083,711







(2
)


1,083,709Accumulated deficit


(1,024,091
)


(4,925
)


(6,471
)


(1,035,487
)

(u)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,582
)


(1
)


1



(2,582
)Total stockholders equity


56,341



(4,926
)


(6,472
)


44,943Total liabilities and
    stockholders equity

$
153,734


$
2,062


$
1,185


$
156,981     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 65




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(i)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(j)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(k)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(m)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(n)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(o)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(p)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect a liability at
    March 31, 2005.(q)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(r)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(s)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(t)
    
    To record amortization of bond premium to interest income.(u)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 66




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  March 31, 2005Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
30,637


$



$



$
30,637Short-term investments


69,180











69,180Accounts receivable, net of
    allowance for doubtful accounts


19,736



(1,101
)


(782
)


17,853


(a)Other current receivables


1,242











1,242Inventory, net


18,611



522



437



19,342


(b)E&O vendor cancellation










(228
)





(c)Other current assets


1,634



1,474







5,126Short-term deferred cost of goods
    sold










2,018






(d)Total current assets


141,040



895



1,445



143,380Property and equipment, net


4,840



94



1



4,935Restricted cash


8,817



(7,586
)






1,241Restricted cash - long-term reclass










10






(e)Other assets, net


710



9,844







9,638Long-term deferred cost of goods
    sold










(777
)





(f)License fee










(129
)





(g)Restricted cash - long-term reclass










(10
)





(e)Total Assets

$
155,407


$
3,247


$
540


$
159,194LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
8,278


$
1


$
(1
)

$
8,278Accrued payroll and related expenses


3,601



557







3,601


(h)Bonus accrual










(557
)





(i)Deferred revenues


9,072



2,386







25,283Thomson direct development costs










(154
)





(j)Short-term deferred revenue










13,979






(k)Accrued warranty expenses


3,141



800







3,140Access Network Electronics










(801
)





(l)Accrued restructuring and executive
    severance


3,092



(158
)






3,093


(m)Restructuring reclass between
    short-term and long-term










159Accrued vendor cancellation charges


373











373Accrued other liabilities


4,031



(689
)






3,791


(h)Legal accrual










449






(n)Interest payable and current
    portion of capital lease obligations


542











542Total current liabilities


32,130



2,897



13,074



48,101Long-term obligations


1,725



(1
)






1,724Long-term deferred revenue






11,084



(5,693
)


5,391


(o)Accrued restructuring and executive
    severance


1,772



158



(158
)


1,772


(m)Convertible subordinated notes


65,081



507



(56
)


65,532


(p)Total liabilities


100,708



14,645



7,167



122,520Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


77











77Additional paid-in capital


1,085,008



(2
)


2



1,085,008Accumulated deficit


(1,026,695
)


(11,396
)


(6,629
)


(1,044,720
)

(q)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,918
)










(2,918
)Total stockholders equity


54,699



(11,398
)


(6,627
)


36,674Total liabilities and
    stockholders equity

$
155,407


$
3,247


$
540


$
159,194     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 67




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
 (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    The cumulative amount was adjusted from the prior period to
    reflect the reclassification adjustment made after the filing of
    the original financial statements.(i)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(j)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(k)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(l)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(m)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(n)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability at
    March 31, 2005.(o)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(p)
    
    To record amortization of bond premium to interest income.(q)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 68




---



##### Table of Contents



CONSOLIDATED
    BALANCE SHEET
 EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  June 30, 2005Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated(1)


NotesASSETSCurrent assets:Cash and cash equivalents

$
38,605


$



$



$
38,605Short-term investments


66,383











66,383Accounts receivable, net of
    allowance for doubtful accounts


19,957



(1,883
)


(1,620
)


16,454


(a)Other current receivables


1,758











1,758Inventory, net


12,759



731



672



13,942


(b)E&O vendor cancellation










(220
)





(c)Other current assets


2,100



3,492







8,546Short-term deferred cost of goods
    sold










2,954






(d)Total current assets


141,562



2,340



1,786



145,688Property and equipment, net


4,538



95



(1
)


4,632Restricted cash


8,763



(7,576
)






1,241Restricted cash - long-term reclass










54






(e)Other assets, net


633



8,928







11,949Long-term deferred cost of goods
    sold










2,545






(f)License fee










(103
)





(g)Restricted cash - long-term reclass










(54
)





(e)Total assets

$
155,496


$
3,787


$
4,227


$
163,510LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
4,572


$



$



$
4,572Accrued payroll and related expenses


3,147











3,147Deferred revenues


14,005



16,211







34,431Thomson direct development costs










(173
)





(h)Short-term deferred revenue










4,388






(i)Accrued warranty expenses


2,722



(1
)


1



2,722Accrued restructuring and executive
    severance


1,991



1



(1
)


1,991Accrued vendor cancellation charges


374











374Accrued other liabilities


3,609



(240
)






3,369Interest payable and current
    portion of capital lease obligations


1,356











1,356Total current liabilities


31,776



15,971



4,215



51,962Long-term obligationsLong-term deferred revenue






5,390



6,049



11,439


(j)Accrued restructuring and executive
    severance


3,441











3,441Convertible subordinated notes


65,081



451



(55
)


65,477


(k)Total liabilities


100,298



21,812



10,209



132,319Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


77











77Additional paid-in capital


1,085,820







(2
)


1,085,818Accumulated deficit


(1,027,203
)


(18,025
)


(5,980
)


(1,051,208
)

(l)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,723
)










(2,723
)Total stockholders equity


55,198



(18,025
)


(5,982
)


31,191Total liabilities and
    stockholders equity

$
155,496


$
3,787


$
4,227


$
163,510     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 69




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination and to adjust the allowance for doubtful accounts
    based on the Companys reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(j)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue to the change in revenue
    recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(k)
    
    To record amortization of bond premium to interest income.(l)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 70




---



##### Table of Contents



CONSOLIDATED STATEMENT OF OPERATIONS
 EFFECTS OF THE RESTATEMENT
 (in thousands, except per share data)
  Year Ended December 31,2004


2003As








AsPreviously





As


Previously





AsReported


Adjustments


Restated(1)


Reported


Adjustments


Restated(1)Revenues

$
150,538


$
(14,054
)

$
136,484


$
133,485


$
(3,298
)

$
130,187Cost of goods sold


106,920



(5,033
)


101,887



101,034



2,801



103,835Gross profit


43,618



(9,021
)


34,597



32,451



(6,099
)


26,352Operating expenses:Research and development


33,959



(760
)


33,199



42,839



(205
)


42,634Sales and marketing


24,145







24,145



26,781







26,781General and administrative


11,216



823



12,039



12,127



(193
)


11,934Restructuring charges, executive
    severance and asset write-offs


11,159



1,177



12,336



2,803







2,803Total operating expenses


80,479



1,240



81,719



84,550



(398
)


84,152Loss from operations


(36,861
)


(10,261
)


(47,122
)


(52,099
)


(5,701
)


(57,800
)Interest expense, net


(1,312
)


222



(1,090
)


(362
)


221



(141
)Other income, net


1,566



(535
)


1,031



2,424



(392
)


2,032Loss before tax benefit (expense)


(36,607
)


(10,574
)


(47,181
)


(50,037
)


(5,872
)


(55,909
)Income tax benefit (expense)


76







76



(316
)






(316
)Net loss

$
(36,531
)

$
(10,574
)

$
(47,105
)

$
(50,353
)

$
(5,872
)

$
(56,225
)Basic and diluted net loss per
    share

$
(0.48
)





$
(0.62
)

$
(0.68
)





$
(0.76
)Shares used in computing basic and
    diluted net loss per share


75,861







75,751



74,212







74,074     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 71




---



##### Table of Contents



CONSOLIDATED
    STATEMENT OF OPERATIONS
 EFFECTS OF THE RESTATEMENT
 (in thousands)
  Year Ended December 31,2004


2003


Notes(as restated)(1)


(as restated)(1)Net loss, as previously
    reported

$
(36,531
)

$
(50,353
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(12,858
)


(3,226
)

(a),(b)HAS


(291
)


659


(b)CMTS


(905
)


(741
)

(b),(c)Other






10


(d)Cost of goods soldRevenue analysis (cost of goods
    sold)


6,166



(3,564
)

(e)Access Network Electronics


(800
)





(f)Warranty reserve


(281
)





(g)License fee


(500
)


763


(h)E&O vendor cancellation


448






(i)Research and developmentBonus accrual


(556
)





(j)Thomson (cost of goods sold)


273



34


(k)Thomson direct development costs


1,043



171


(l)General and administrativeLegal accrual


448






(m)Bad debt expense


(590
)


(120
)

(n)Common area maintenance






313


(o)Property tax


156






(p)Tax accrual


(73
)





(q)Received not invoiced


(764
)





(r)Restructuring charges, executive
    severance and asset write-offsIsrael restructuring reserve


(1,177
)





(s)Interest income (expense), netConvertible subordinated notes


222



221


(t)Other income (expense), netTax accrual


(441
)


(33
)

(q)Fixed asset


(94
)


(359
)

(u)Net loss, as restated

$
(47,105
)

$
(56,225
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 72




---



##### Table of Contents



Explanation
    of Adjustments:
  (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect a $1.6 million reduction in revenue that was
    identified during the Companys reassessment of the
    allowance for doubtful accounts and bad debt expense account in
    the quarter ended September 30, 2004.(d)
    
    To reflect other adjustments and reclassifications.(e)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(f)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(g)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(h)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(i)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(j)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(k)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract . The
    costs were previously recognized in the period incurred.(l)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(m)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to properly reflect liability at
    March 31, 2005.(n)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(o)
    
    To adjust for an unrecorded liability for common area
    maintenance to reflect expense in the prior period.(p)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(q)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(r)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(s)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(t)
    
    To record amortization of bond premium to interest income.(u)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets. 73




---



##### Table of Contents



CONSOLIDATED
    STATEMENT OF OPERATIONS
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (as restated)(1)
  Three Months EndedMarch 31,


June 30,


September 30,


December 31,2004


2004


2004


2004


Notes(unaudited)


(unaudited)


(unaudited)


(unaudited)Net loss, as previously
    reported

$
(10,247
)

$
(4,861
)

$
(13,520
)

$
(7,903
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(1,453
)


(751
)


(5,634
)


(5,020
)

(a),(b)HAS


309



(744
)


104



40


(b)CMTS


44



69



(1,112
)


94


(b),(c)Cost of goods soldRevenue analysis (cost of goods
    sold)-2004


1,405



3,016



962



783


(e)Access Network Electronics


(200
)


(200
)


(200
)


(200
)

(f)Warranty reserve














(281
)

(g)License fee


79



(197
)


(223
)


(159
)

(h)E&O vendor cancellation














448


(i)Research and DevelopmentBonus accrual














(556
)

(j)Thomson (other)


51



46



139



37


(k)Thomson direct development costs


288



334



254



167


(l)General and administrativeLegal accrual














448


(m)Bad debt expense


(496
)


(396
)


861



(559
)

(n)Property tax














156


(o)Tax accrual










(60
)


(13
)

(p)Received not invoiced


(192
)


(192
)


(193
)


(187
)

(q)Restructuring charges, executive
    severance and asset write-offsIsrael restructuring reserve














(1,177
)

(r)Interest income (expense), net
    Convertible subordinated notes


55



55



56



56


(s)Other income (expense), netTax accrual


(44
)


151







(548
)

(p)Fixed asset


(94
)













(t)Net loss, as restated

$
(10,495
)

$
(3,670
)

$
(18,566
)

$
(14,374
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 74




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
   (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect a $1.6 million reduction in revenue that was
    identified during the Companys reassessment of the
    allowance for doubtful accounts and bad debt expense account in
    the quarter ended September 30, 2004.(d)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(e)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(f)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(g)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(h)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(i)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(j)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(k)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(m)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability for the
    quarter ended March 31, 2005.(n)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(o)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(p)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(q)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(r)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(s)
    
    To record amortization of bond premium to interest income.(t)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets. 75




---



##### Table of Contents



CONSOLIDATED
    STATEMENT OF OPERATIONS
    EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  Three Months EndedMarch 31,


June 30,2005


2005


Notes(as restated)(1)


(as restated)(1)Net loss, as previously
    reported

$
(2,604
)

$
(508
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(8,513
)


(10,563
)

(a)HAS


36



(58
)

(b)CMTS


(73
)


13


(b)Cost of goods soldRevenue analysis (cost of goods
    sold)


1,337



5,446


(c)Access Network Electronics


800






(d)License fee


(129
)


(103
)

(e)E&O vendor cancellation


(228
)


(220
)

(f)Research and developmentBonus accrual


556






(g)Thomson (other)


20



23


(h)Thomson direct development costs


134



150


(i)Sales and marketingGeneral and administrativeLegal accrual


(448
)





(k)Bad debt expense


(176
)


(723
)

(l)Restructuring charges, executive
    severance and asset write-offsInterest income (expense), net
    Convertible subordinated notes


55



56


(m)Net loss, as restated

$
(9,233
)

$
(6,487
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 76




---



##### Table of Contents



Explanation
    of Current Quarterly Adjustments:
   (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(d)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(e)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(f)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast available in March 2005.(g)
    
    To reverse expenses for retention and other miscellaneous
    bonuses earned by employees in 2004.(h)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reflect other adjustments and reclassifications.(k)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability for the
    quarter ended March 31, 2005.(l)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(m)
    
    To record amortization of bond premium to interest income. 77




---



##### Table of Contents



CONSOLIDATED
    STATEMENT OF CASH FLOWS
 EFFECTS OF THE RESTATEMENT
 TERAYON COMMUNICATION SYSTEMS, INC.
 (in thousands)
  Year Ended December 31,2004


2003As








AsPreviously





As


Previously





AsReported


Adjustments


Restated(1)


Reported


Adjustments


Restated(1)Operating activities:Net loss

$
(36,531
)

$
(10,574
)

$
(47,105
)

$
(50,353
)

$
(5,872
)

$
(56,225
)Adjustments to reconcile net loss
    to net cash (provided by) used in operating activities:Depreciation and amortization


6,416



(556
)


5,860



9,369



(147
)


9,222Amortization of deferred
    compensation


17







17



53







53Amortization of subordinated
    convertible note premium






(221
)


(221
)






(221
)


(221
)Accretion of discounts on
    short-term investments






(107
)


(107
)






(440
)


(440
)Realized gains on sales of
    short-term investments






(2
)


(2
)






(127
)


(127
)Inventory provision


11,980



(430
)


11,550



4,086



(61
)


4,025Provision for doubtful accounts






590



590







120



120Restructuring provision






6,513



6,513







2,184



2,184Write-off of fixed assets


2,393



652



3,045



497



322



819Warranty provision






3,075



3,075







2,353



2,353Vendor cancellation provision






387



387







1,362



1,362Compensation expense for issuance
    of common stock














70







70Value of common and preferred stock
    warrants issued














45







45Net changes in operating assets and
    liabilities:


















Accounts receivable, net


10,139



(1,735
)


8,404



(12,602
)


6,402



(6,200
)Inventory


(12,760
)


821



(11,939
)


(12,193
)


(852
)


(13,045
)Other assets


5,131



(4,728
)


403



7,281



(370
)


6,911Accounts payable


(18,204
)


764



(17,440
)


2,129







2,129Accrued payroll and related expenses


(2,356
)


372



(1,984
)


310







310Deferred revenues


(844
)


12,696



11,852



2,926



774



3,700Accrued warranty expenses


(1,639
)


(1,995
)


(3,634
)


(3,098
)


(2,353
)


(5,451
)Accrued restructuring charges


1,066



(5,421
)


(4,355
)


(2,254
)


(2,004
)


(4,258
)Accrued vendor cancellation charges


(2,348
)


(387
)


(2,735
)


(12,335
)


887



(11,448
)Accrued other liabilities


(2,008
)


178



(1,830
)


(2,331
)


(1,073
)


(3,404
)Interest payable


(2
)


2







3



(3
)


Net cash provided by (used in)
    operating activities


(39,550
)


(106
)


(39,656
)


(68,397
)


881



(67,516
)Investing activities:Purchases of short-term investments


(54,517
)


(35,440
)


(89,957
)


(243,652
)


(9,381
)


(253,033
)Proceeds from sales and maturities
    of short-term investments


107,931



35,549



143,480



224,154



9,947



234,101Purchases of property and equipment


(2,698
)


(2
)


(2,700
)


(3,831
)


185



(3,646
)Net cash provided by (used in)
    investing activities


50,716



107



50,823



(23,329
)


751



(22,578
)Financing activities:Principal payments on capital leases


(124
)


(2
)


(126
)


(66
)


(1,631
)


(1,697
)Proceeds from issuance of common
    stock


1,681



1



1,682



3,729



(1
)


3,728Net cash provided by financing
    activities


1,557



(1
)


1,556



3,663



(1,632
)


2,031Effect of foreign currency exchange
    rate changes


307







307



1,172







1,172Net (decrease) increase in cash and
    cash equivalents


13,030







13,030



(86,891
)






(86,891
)Cash and cash equivalents at
    beginning of year


30,188







30,188



117,079







117,079Cash and cash equivalents at end of
    year

$
43,218


$



$
43,218


$
30,188


$



$
30,188Supplemental disclosures of cash
    flow information:Cash paid for income taxes

$
138


$
37


$
175


$
194







194Cash paid for interest

$
3,268


$



$
3,268


$
3,262







3,262Supplemental non-cash investing and
    financing activities:Deferred compensation relating to
    common stock issued to non-employees

$
17


$



$
17


$
53


$



$
53     (1)
    
    See Note 3, Restatement
    of Consolidated Financial Statements to Consolidated
    Financial Statements. 78




---



##### Table of Contents



Adjustments
    for Years Ended December 31, 2000, 2001 and
    2002.
  Form 10-K.
  Year Ended December 31, 2000.
    7-year
  Year Ended December 31, 2001.
  Year Ended December 31, 2002.
 79




---



##### Table of Contents



01-09,
  Reliance on Prior Consolidated Financial
    Statements. Form 10-K Form 10-Q Form 10-K. Form 10-K Form 10-K Form 10-Q
  Executive
    Overview
  ® digital-to-analog line-ups,
  data-over-satellite
     80




---



##### Table of Contents



re-audit
  Form 10-K.
  Restated
    Results of Operations
  Comparison
    of Years Ended December 31, 2005 and 2004 (as
    restated)
  Revenues
   81




---



##### Table of Contents



Revenues
    by Groups of Similar Products
    Year EndedDecember 31,


Variance in


Variance in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)Revenues by product:DVS

$
41,806


$
24,102


$
17,704



73.5
%HAS


41,061



82,068



(41,007
)


(50.0
)%CMTS


7,797



30,210



(22,413
)


(74.2
)%Other






104



(104
)


(100.0
)%Total

$
90,664


$
136,484


$
(45,820
)


(33.6
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 82




---



##### Table of Contents



end-to-end
        Year Ended


Variance


VarianceDecember 31,


in


in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)DVS product revenue invoiced and
    recognized in current period:Total invoiced in current period

$
53.9


$
36.8


$
17.1



46.5
%Less: Invoiced in current period
    and recognized in future periods


27.4



15.0



12.4



82.7
%Total invoiced and recognized in
    current period


26.5



21.8



4.7



21.6
%DVS product revenue invoiced in
    prior fiscal years and recognized in current period


15.3



2.3



13.0



565.2
%Total DVS product revenue
    recognized in current period

$
41.8


$
24.1


$
17.7



73.4
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   83




---



##### Table of Contents



Revenues
    by Geographic Region
    Year EndedDecember 31,


Variance in


Variance in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)Revenues by geographic region:United States

$
52,838


$
72,838


$
(20,000
)


(27.5
)%Americas, excluding United States


1,871



4,930



(3,059
)


(62.0
)%Europe, Middle East and Africa
    (EMEA), excluding Israel


15,314



17,640



(2,326
)


(13.2
)%Israel


7,645



16,645



(9,000
)


(54.1
)%Asia, excluding Japan


11,544



15,259



(3,715
)


(24.3
)%Japan


1,452



9,172



(7,720
)


(84.2
)%Total

$
90,664


$
136,484


$
(45,820
)


(33.6
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.     84




---



##### Table of Contents



Significant
    Customers
      Cost of
    Goods Sold and Gross Profit
     85




---



##### Table of Contents



Year Ended


Variance


VarianceDecember 31,


in


in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)DVS product cost of goods sold
    invoiced and recognized in current period:Total invoiced in current period

$
13.4


$
7.8


$
5.6



71.8
%Less: Invoiced in current period
    and recognized in future periods


7.4



2.7



4.7



174.1
%Total invoiced and recognized in
    current period


6.0



5.1



0.9



17.6
%DVS product cost of goods sold
    invoiced in prior fiscal years and recognized in current period


2.7



0.5



2.2



440.0
%Total DVS product cost of goods
    sold recognized in current period

$
8.7


$
5.6


$
3.1



55.4
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.         86




---



##### Table of Contents



Operating
    Expenses
    Year EndedDecember 31,


Variance in


Variance in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)Research and development

$
17,650


$
33,199


$
(15,549
)


(46.8
)%Sales and marketing


22,534



24,145



(1,611
)


(6.7
)%General and administrative


20,356



12,039



8,317



69.1
%Restructuring charges, executive
    severance and asset write-offs


2,257



12,336



(10,079
)


(81.7
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Research
    and Development
      Sales
    and Marketing
      General
    and Administrative
   87




---



##### Table of Contents



Restructuring
    Charges, Executive Severance and Asset Write-offs
    Year EndedDecember 31,


Variance in


Variance in2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)Restructuring charges

$
1,003


$
6,784


$
(5,781
)


(85.2
)%Executive severance


15



3,451



(3,436
)


(99.6
)%Long-lived assets written-off


85



2,401



(2,316
)


(96.5
)%Subtotal


1,103



12,636



(11,533
)


(91.3
)%Restructuring (recovery/change in
    estimate in prior year plans)


1,154



(300
)


1,454



(484.7
)%Restructuring charges, executive
    severance and asset write-offs

$
2,257


$
12,336


$
(10,079
)


(81.7
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Restructuring
             88




---



##### Table of Contents



sub-sublease
  Executive
    Severance
    Asset
    Write-offs
  write-down
  Non-operating
    Expenses
    Year EndedDecember 31,

Variance in

Variance in2005

2004

Dollars

Percent(as restated)(1)

(as restated)(1)

(as restated)(1)Interest expense, net

$
(189
)

$
(1,090
)

$
901



(82.7
)%Other income, net


1,155



1,031



124



12.0
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.      Income
    Tax (Expense) Benefit
    Comparison
    of the Years Ended December 31, 2004 and 2003 (as
    restated)
  Revenues
    01-09,
 89




---



##### Table of Contents



Revenues
    by Groups of Similar Products
    Year EndedDecember 31,


Variance in


Variance in2004


2003


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)


(as restated)(1)Revenues by product:DVS

$
24,102


$
14,484


$
9,618



66.4
%HAS


82,068



65,532



16,536



25.2
%CMTS


30,210



46,709



(16,499
)


(35.3
)%Other


104



3,462



(3,358
)


(97.0
)%Total

$
136,484


$
130,187


$
6,297



4.8
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  ® ®
       90




---



##### Table of Contents



Revenues
    by Geographic Regions
    Year EndedDecember 31,


Variance in


Variance in2004


2003


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)


(as restated)(1)Revenues by geographic areas:United States

$
72,838


$
71,945


$
893



1.2
%Americas, excluding United States


4,930



3,081



1,849



60.0
%Europe, Middle East and Africa
    (EMEA), excluding Israel


17,640



9,450



8,190



86.7
%Israel


16,645



15,274



1,371



9.0
%Asia, excluding Japan


15,259



9,094



6,165



67.8
%Japan


9,172



21,343



(12,171
)


(57.0
)%Total

$
136,484


$
130,187


$
6,297



4.8
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    Significant
    Customers
    Cost of
    Goods Sold and Gross Profit
     91




---



##### Table of Contents



Operating
    Expenses
    Year EndedDecember 31,


Variance in


Variance in2004


2003


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)


(as restated)(1)Research and development

$
33,199


$
42,634


$
(9,435
)


(22.1
)%Sales and marketing


24,145



26,781



(2,636
)


(9.8
)%General and administrative


12,039



11,934



105



0.9
%Restructuring charges, executive
    severance and asset write-offs


12,336



2,803



9,533



340.1
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Research
    and Development
    Sales
    and Marketing
    General
    and Administrative
   92




---



##### Table of Contents



Restructuring
    Charges, Executive Severance and Asset Write-offs
    Year EndedDecember 31,


Variance in


Variance in2004


2003


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)


(as restated)(1)Restructuring charges

$
6,784


$
2,658


$
4,126



155.2
%Executive severance


3,451







3,451



Long-lived assets written-off


2,401



417



1,984



475.8
%Subtotal


12,636



3,075



9,561



310.9
%Restructuring (recovery/change in
    estimate in prior year plans)


(300
)


(272
)


(28
)


10.3
%Restructuring charges, executive
    severance and asset write-offs

$
12,336


$
2,803


$
9,533



340.1
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Restructuring
           93




---



##### Table of Contents



Executive
    Severance
      Asset
    Write-offs
    Non-operating
    Expenses
    Year EndedDecember 31,

Variance in

Variance in2004

2003

Dollars

Percent(as restated)(1)

(as restated)(1)

(as restated)(1)

(as restated)(1)Interest expense, net

$
(1,090
)

$
(141
)

$
(949
)


673.0
%Other income, net


1,031



2,032



(1,001
)


(49.3
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.      Income
    Tax Benefit (Expense)
   94




---



##### Table of Contents



Quarterly
    Review
    Revenue
    SOP 97-2 SOP 97-2
    SOP 97-2 SOP 81-1. SOP 97-2 SOP 81-1,
 95




---



##### Table of Contents



SOP 81-1,
  00-21.
  Gross
    Profit
       96




---



##### Table of Contents



per-unit- produced per-unit- sold
  Form 10-K
  Operating
    Expenses
         97




---



##### Table of Contents



Additional
    Adjustments to Quarterly Financial Statements Resulting from the
    Restatement
  01-09. contra-receivables
     98




---



##### Table of Contents



sub-ledger,
    Off-Balance
    Sheet Financings and Liabilities
   99




---



##### Table of Contents



Liquidity
    and Capital Resources
          Form 10-Q Form 10-Q
   100




---



##### Table of Contents



Contractual
    Obligations
    Payments Due by PeriodLess Than


1 - 3


4 - 5


After 5Total


1 Year


Years


Years


YearsUnconditional purchase obligations

$
12.1


$
12.1


$



$



$
Long-term debt


65.1







65.1







Operating lease obligations


12.2



3.4



6.3



2.5



Aircraft lease obligation


1.6



1.5



0.1







Total

$
91.0


$
82.1


$
6.4


$
2.5


$
       Amount of Commitment Expiration per PeriodLess Than


1 - 3


4 - 5


AfterTotal


1 Year


Years


Years


5 YearsDeposits

$
8.2


$
0.7


$
7.5


$



$
Standby letters of credit


0.5



0.2







0.3



Total

$
8.7


$
0.9


$
7.5


$
0.3


$
     Critical
    Accounting Policies
   101




---



##### Table of Contents



Revenue
    Recognition
  free-on-board
  97-2, (SOP 97-2) SOP 81-1, (SOP 81-1).
    SOP 97-2,
    SOP 97-2
  97-2.
 102




---



##### Table of Contents



Deferred
    Revenue, Deferred Cost of Goods Sold
    Allowance
    for Doubtful Accounts
    Inventory
    Valuation
         103




---



##### Table of Contents



Warranty
    Reserves
    Restructuring
    and Other Related Charges
    Contingencies
    Income
    Taxes
   104




---



##### Table of Contents



Recently
    Issued Accounting Standards
           105




---



##### Table of Contents



Item 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk  Interest Rate Risk.
 106




---



##### Table of Contents



available-for-sale
  Foreign Currency Risk.
 107




---



##### Table of Contents



Item 8.
    Financial
    Statements and Supplementary Data  TERAYON
    COMMUNICATION SYSTEMS, INC.
  INDEX TO
    CONSOLIDATED FINANCIAL STATEMENTS
  PageReport of
    Stonefield Josephson, Inc., Independent Registered Public
    Accounting Firm


109Consolidated
    Balance Sheets


110Consolidated
    Statements of Operations


111Consolidated
    Statements of Stockholders Equity


112Consolidated
    Statements of Cash Flows


113Notes to
    Consolidated Financial Statements


114  108




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   
              
 109




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.CONSOLIDATED BALANCE SHEETS 
    (in thousands)
 December 31,2005


2004(as restated)(1)ASSETSCurrent assets:Cash and cash equivalents

$
28,867


$
43,218Short-term investments


72,434



54,517Accounts receivable, net of
    allowance for doubtful accounts


9,879



18,559Other current receivables


1,606



1,044Inventory, net


10,915



17,666Other current assets


6,778



3,516Total current assets


130,479



138,520Property and equipment, net


3,915



5,854Restricted cash


332



1,241Other assets, net


11,922



11,366Total assets

$
146,648


$
156,981LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
5,036


$
7,846Accrued payroll and related
    expenses


2,105



4,493Deferred revenues


13,952



4,965Deferred gain on asset sale


8,631



Accrued warranty expenses


2,887



4,670Accrued restructuring and
    executive severance


1,305



3,744Accrued vendor cancellation charges


1,508



521Accrued other liabilities


6,287



3,873Interest payable


1,356



1,356Current portion of subordinated
    convertible notes


65,367



Total current liabilities


108,434



31,468Long-term obligations


1,455



2,076Accrued restructuring and
    executive severance


1,381



1,822Long-term deferred revenue


14,721



11,084Convertible subordinated notes






65,588Total liabilities


125,991



112,038Commitments and contingencies
    (Notes 9 and 17)Stockholders equity:Preferred stock, $0.001 par
    value: 5,000,000 shares authorized; no shares issued and
    outstanding






Common stock: $0.001 par
    value, 200,000,000 shares authorizedIssued  77,794,186 in
    2005 and 76,453,074 in 2004Outstanding  77,638,177
    in 2005 and 76,297,065 in 2004


78



76Additional paid-in capital


1,086,817



1,083,709Accumulated deficit


(1,062,438
)


(1,035,487
)Treasury stock, at cost;
    156,009 shares


(773
)


(773
)Accumulated other comprehensive
    loss


(3,027
)


(2,582
)Total stockholders equity


20,657



44,943Total liabilities and
    stockholders equity

$
146,648


$
156,981     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   110




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF OPERATIONS
  (in thousands, except per share data)
  Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Revenues

$
90,664


$
136,484


$
130,187Cost of goods sold


55,635



101,887



103,835Gross profit


35,029



34,597



26,352Operating expenses:Research and development


17,650



33,199



42,634Sales and marketing


22,534



24,145



26,781General and administrative


20,356



12,039



11,934Restructuring charges, executive
    severance and asset write-offs


2,257



12,336



2,803Total operating expenses


62,797



81,719



84,152Loss from operations


(27,768
)


(47,122
)


(57,800
)Interest expense, net


(189
)


(1,090
)


(141
)Other income, net


1,155



1,031



2,032Loss before income tax benefit
    (expense)


(26,802
)


(47,181
)


(55,909
)Income tax benefit (expense)


(149
)


76



(316
)Net loss

$
(26,951
)

$
(47,105
)

$
(56,225
)Basic and diluted net loss per
    share

$
(0.35
)

$
(0.62
)

$
(0.76
)Shares used in computing basic and
    diluted net loss per share


77,154



75,751



74,074     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   111




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  CONSOLIDATED
    STATEMENTS OF STOCKHOLDERS EQUITY
 (in
    thousands)
  AccumulatedAdditional








Other








TotalCommon Stock


Paid-in


Accumulated


Deferred


Comprehensive


Treasury Stock


StockholdersShares


Amount


Capital


Deficit


Compensation


Loss


Shares


Amount


EquityBalance at December 31,
    2002 (as restated)(1)


73,069,519


$
73


$
1,078,143


$
(932,157
)

$
(25
)

$
(3,071
)


156,009


$
(773
)

$
142,190Exercise of option for cash to
    purchase common stock


592,672



1



2,530























2,531Revaluation of options to
    non-employees










50







(50
)Amortization of deferred
    compensation


















53















53Issuance of restricted common stock
    from stock option plan for services


9,600







70























70Issuance of common stock for
    employee stock purchase plan


1,202,210



1



1,196























1,197Issuance of warrant to purchase
    common stock










45























45Comprehensive loss:Increase to unrealized gain on
    short-term investments






















(470
)










(470
)Cumulative translation adjustment






















1,172











1,172Net loss














(56,225
)


















(56,225
)Comprehensive loss


































(55,523
)Balance at December 31,
    2003 (as restated)(1)


74,874,001



75



1,082,034



(988,382
)


(22
)


(2,368
)


156,009



(773
)


90,563Exercise of option for cash to
    purchase common stock


225,645







494























494Revaluation of options to
    non-employees










(5
)






5Amortization of deferred
    compensation


















17















17Issuance of common stock for
    employee stock purchase plan


1,197,419



1



1,186























1,187Comprehensive loss:Increase to unrealized gain on
    short-term investments






















(520
)










(520
)Cumulative translation adjustment






















307











307Net loss














(47,105
)


















(47,105
)Comprehensive loss


































(47,319
)Balance at December 31,
    2004 (as restated)(1)


76,297,065



76



1,083,709



(1,035,487
)






(2,582
)


156,009



(773
)


44,943Exercise of option for cash to
    purchase common stock


1,341,112



2



3,056























3,058Accelerated vesting of stock options










52























52Comprehensive loss:Increase to unrealized gain on
    short-term investments






















16











16Cumulative translation adjustment






















(461
)










(461
)Net loss














(26,951
)


















(26,951
)Comprehensive loss


































(27,396
)Balance at December 31,
    2005


77,638,177


$
78


$
1,086,817


$
(1,062,438
)

$



$
(3,027
)


156,009


$
(773
)


20,657     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   112




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS 
    (in thousands)
  Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Cash flows from operating
    activities:Net loss

$
(26,951
)

$
(47,105
)

$
(56,225
)Adjustments to reconcile net loss
    to net cash provided by (used in) operating activities:Depreciation and amortization


3,148



5,860



9,222Amortization of subordinated
    convertible notes premium


(221
)


(221
)


(221
)Amortization of deferred
    compensation






17



53Accretion of discounts on
    short-term investments


(114
)


(107
)


(440
)Realized gains on sales of
    short-term investments






(2
)


(127
)Inventory provision


2,732



11,550



4,025Provision for doubtful accounts


132



590



120Restructuring provision


2,068



6,513



2,184Write-off of fixed assets


602



3,045



819Warranty provision


(165
)


3,075



2,353Vendor cancellation provision


1,143



387



1,362Compensation expense for issuance
    of common stock










70Value of common and preferred stock
    warrants issued










45Changes in operating assets and
    liabilities:Accounts receivable, net


7,986



8,404



(6,200
)Inventory


4,019



(11,939
)


(13,045
)Other assets


5,722



403



6,911Accounts payable


(2,810
)


(17,440
)


2,129Accrued payroll and related expenses


(2,829
)


(1,984
)


310Deferred revenues


12,624



11,852



3,700Accrued warranty expense


(1,618
)


(3,634
)


(5,451
)Accrued restructuring charges


(4,507
)


(4,355
)


(4,258
)Accrued vendor cancellation charges


(156
)


(2,735
)


(11,448
)Accrued other liabilities


1,793



(1,830
)


(3,404
)Net cash provided by (used in)
    operating activities


2,598



(39,656
)


(67,516
)Cash flows from investing
    activities:Purchases of short-term investments


(44,707
)


(89,957
)


(253,033
)Proceeds from sales and maturities
    of short-term investments


26,919



143,480



234,101Purchases of property and equipment


(1,811
)


(2,700
)


(3,646
)Net cash provided by (used in)
    investing activities


(19,599
)


50,823



(22,578
)Cash flows from financing
    activities:Principal payments on capital leases






(126
)


(1,697
)Debt extinguishment of convertible
    debt










Proceeds from issuance of common
    stock


3,110



1,682



3,728Net cash provided by financing
    activities


3,110



1,556



2,031Effect of foreign currency exchange
    rate changes


(460
)


307



1,172Net decrease in cash and cash
    equivalents


(14,351
)


13,030



(86,891
)Cash and cash equivalents at
    beginning of year


43,218



30,188



117,079Cash and cash equivalents at end of
    year

$
28,867


$
43,218


$
30,188Supplemental disclosures of cash
    flow information:Cash paid for income taxes

$
168


$
175


$
194Cash paid for interest

$
3,254


$
3,268


$
3,262Deferred compensation relating to
    common stock issued to non-employees

$



$
17


$
53     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 113




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  Note 1.
    Organization  Description
    of Business
        Note 2.
    Summary
    of Significant Accounting Policies  Basis
    of Consolidation
    Use of
    Estimates
    Foreign
    Currency Translation
  end-of-period
  Treasury
    Stock
    Concentrations
    of Credit Risk, Customers, Suppliers and Products
   114




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          Revenue
    Recognition
  free-on-board
  97-2, (SOP 97-2) SOP 81-1, (SOP 81-1).
   115




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  SOP 97-2,
      SOP 97-2.
  Deferred
    Revenue, Deferred Cost of Goods Sold
    Accounts
    Receivable, Net of Allowance for Doubtful Accounts
   116




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Research
    and Development Expenses
  SOP 97-2, SOP 81-1.
  Shipping
    and Handling Costs
    Advertising
    Expenses
    Net
    Loss Per Share
    Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Net loss

$
(26,951
)

$
(47,105
)

$
(56,225
)Basic and diluted net loss per
    share

$
(0.35
)

$
(0.62
)

$
(0.76
)Shares used in computing basic and
    diluted net loss per share


77,154



75,751



74,074     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    Cash,
    Cash Equivalents and Short-Term Investments
  available-for-sale
   117




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  other-than-temporarily 03-01 other-than-temporarily
  available-for-sale other-than-temporary available-for-sale
  Other
    Current Receivables
    Inventory
  (first-in,
  Year Ended December 31,2005


2004(as restated)(1)Raw materials

$
58


$
1,113Work-in-process






1,500Finished goods


10,857



15,053Total

$
10,915


$
17,666     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   118




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Other
    Current Assets
    Property
    and Equipment
      Year EndedDecember 31,2005


2004(as restated)(1)Software and computers

$
11,117


$
21,415Furniture and fixtures


357



995Office and equipment


175



171Leasehold improvements


2,455



5,021Machinery and equipment


14,231



20,472Property and equipment


28,335



48,074Accumulated depreciation and
    amortization


(24,420
)


(42,220
)Property and equipment, net

$
3,915


$
5,854     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    Restricted
    Cash
   119




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Other
    Assets, Net
    Warranty
    Obligations
    Stock-Based
    Compensation
      Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Net loss

$
(26,951
)

$
(47,105
)

$
(56,225
)Add: stock-based compensation
    under APB 25


52



17



123Less: Stock-based compensation
    expense determined under the fair value-based method


4,144



13,741



22,224Less: Employee stock purchase plan
    compensation expense determined under the fair value-based method






206



1,026Pro forma net loss

$
(31,043
)

$
(61,035
)

$
(79,352
)Pro forma basic and diluted net
    loss per share

$
(0.40
)

$
(0.81
)

$
(1.07
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  EITF 96-18,
 120




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Accumulated
    Other Comprehensive Loss
      Year Ended December 31,2005


2004(as restated)(1)Cumulative translation
    adjustments, net

$
(2,554
)

$
(2,093
)Unrealized gain (loss) on
    available-for-sale
    investments, net


(473
)


(489
)Total accumulated other
    comprehensive loss

$
(3,027
)

$
(2,582
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Reclassification
    Recently
    Issued Accounting Standards
       121




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
             122




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Note 3.
    Restatement
    of Consolidated Financial Statements    .
  Revenue Recognition.
  Video Product and Post Contract Support. SOP 97-2 SOP 97-2,
  Thomson Contract. SOP 97-2 SOP 81-1,
 123




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  SOP 81-1,
  Inventory Consignment.
  Other Revenue Adjustments.
  Allowance for Doubtful Accounts.
   124




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Deferred Revenues and Deferred Cost of Goods
    Sold.
  Use of Estimates.
  Access Network Electronics. ,
 125




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Israel Restructuring Reserve.
  License Fee. produced sold.
  Goods Received Not Invoiced.
  Other.
  Convertible Subordinated Notes.
 126




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        7-year
   127




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Reliance on Prior Consolidated Financial
    Statements. Form 10-K Form 10-Q Form 10-K. Form 10-K Form 10-K Form 10-Q
 128




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  December 31, 2003Cumulative EffectAs Previously


of Prior Year


Current YearReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
30,188


$



$



$
30,188Short-term investments


108,452











108,452Accounts receivable, net of
    allowance for doubtful accounts


29,799



2,723



(7,587
)


24,935


(a), (b)Other current receivables


3,662











3,662Inventory, net


16,364







913



17,277


(c)Other current assets


2,883











3,205Short-term deferred cost of goods
    sold










322






(d)Total current assets


191,348



2,723



(6,352
)


187,719Property and equipment, net


11,871











12,059Fixed asset






548



(360
)





(e)Restricted cash


9,212











9,212Other assets, net


2,809











4,109Long-term deferred cost of goods
    sold










350






(f)License fee






188



762






(g)Total assets

$
215,240


$
3,459


$
(5,600
)

$
213,099LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
26,049


$



$



$
25,286Israel restructuring






1,177










(h)Received not invoiced






(1,940
)









(i)Common area maintenance






313



(313
)





(j)Accrued payroll and related expenses


6,537











6,537Deferred revenues


3,423











1,990Thomson direct development costs










(205
)





(k)Short-term deferred revenue










(1,228
)





(l)Accrued warranty expenses


5,509











5,229Warranty reserve






(280
)









(m)Accrued restructuring and executive
    severance


2,647



1,834







1,586


(n)Israel restructuring






(1,178
)









(h)Restructuring reclass between
    short-term and long-term










(1,717
)





(o)Accrued vendor cancellation charges


2,869











2,869Accrued other liabilities


5,284



(229
)






4,706


(n)Reclass short-term portion of
    deferred rent










249






(p)Tax accrual






(631
)


33






(q)Interest payable


1,358



(1
)


(1
)


1,356Current portion of capital lease
    obligations


124



1



1



126Total current liabilities


53,800



(934
)


(3,181
)


49,685Long-term obligations


3,118



(1,514
)


(248
)


1,356


(n), (p)Long-term deferred revenue










2,207



2,207


(r)Accrued restructuring and executive
    severance


1,853



(90
)


1,716



3,479


(n), (o)Convertible subordinated notes


65,081



949



(221
)


65,809


(s)Total liabilities


123,852



(1,589
)


273



122,536Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


75











75Additional paid-in capital


1,082,036



(1
)


(1
)


1,082,034Accumulated deficit


(987,560
)


5,048



(5,870
)


(988,382
)

(t)Deferred compensation


(22
)


1



(2
)


(23
)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,368
)










(2,368
)Total stockholders equity


91,388



5,048



(5,873
)


90,563Total liabilities and
    stockholders equity

$
215,240


$
3,459


$
(5,600
)

$
213,099  129




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Year Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect other adjustments and reclassifications.(c)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(i)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(j)
    
    To adjust for an unrecorded liability for common area
    maintenance in prior period.(k)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(m)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(n)
    
    To reflect a reclassification adjustment made after the filing
    of the original financial statements.(o)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(p)
    
    To reflect the short-term portion of deferred rent.(q)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(r)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(s)
    
    To record amortization of bond premium to interest income.(t)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 130




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  March 31, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
76,060


$



$



$
76,060Short-term investments


47,151











47,151Accounts receivable, net of
    allowance for doubtful accounts


29,041



(4,864
)


1,108



25,285


(a)(n)Inventory, net


19,267



913



(336
)


20,307


(b)Inventory consignment










463






(c)Other current assets


4,623



322







5,465Short-term deferred cost of goods
    sold










520






(d)Total current assets


176,142



(3,629
)


1,755



174,268Property and equipment, net


10,821



188



(94
)


10,915Intangibles and other assets, net


11,609



1,300







13,198Long-term deferred cost of goods
    sold










210






(e)License fee










79






(f)Total Assets

$
198,572


$
(2,141
)

$
1,950


$
198,381LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
21,362


$
(763
)

$



$
20,791Received not invoiced










192






(g)Accrued payroll and related expenses


5,072











5,072Deferred revenues


4,451



(1,433
)






3,449Inventory consignment










(398
)





(c)Short-term deferred revenue










1,168






(h)Thomson direct development costs










(339
)





(i)Accrued warranty expenses


4,605



(280
)






4,524Access Network Electronics










199






(j)Accrued restructuring and executive
    severance


6,598



(2,895
)






2,797


(k)Restructuring reclass between
    short-term and long-term










(906
)





(l)Accrued vendor cancellation charges


1,399











1,399Accrued other liabilities


4,137



(349
)






3,799


(k)Reclass short-term portion of
    deferred rent










(248
)





(m)Rebate obligation










215






(n)Tax accrual










44






(o)Other current obligations


570











570Interest payable






(2
)Current portion of capital lease
    obligations






2Total current liabilities


48,194



(5,720
)


(73
)


42,401Long-term obligations


3,472



1,468



1,156



6,096


(k),(l),(m)Long-term deferred revenue






2,207



1,168



3,375


(p)Convertible subordinated notes


65,081



728



(55
)


65,754


(q)Total liabilities


116,747



(1,317
)


2,196



117,626Stockholders equity:Preferred stock, $0.001 par value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,082,770



(1
)


1



1,082,770Accumulated deficit


(997,807
)


(822
)


(248
)


(998,877
)

(r)Treasury stock, at cost


(773
)


(1
)


1



(773
)Accumulated other comprehensive loss


(2,441
)










(2,441
)Total stockholders equity


81,825



(824
)


(246
)


80,755Total liabilities and
    stockholders equity

$
198,572


$
(2,141
)

$
1,950


$
198,381  131




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse invoicing of consigned inventory sale and related
    deferral of net revenue and COGS.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(f)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(g)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(h)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(k)
    
    The cumulative amount was adjusted from the prior period to
    reflect the reclassification adjustment made after the filing of
    the original financial statements.(l)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(m)
    
    To reflect the short-term portion of deferred rent.(n)
    
    To reclassify to accrued other liabilities rebate obligations
    with a single customer previously recorded as contra-accounts
    receivable during the quarter.(o)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(p)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(q)
    
    To record amortization of bond premium to interest income.(r)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 132




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
 EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  June 30, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
47,783


$



$



$
47,783Short-term investments


68,489











68,489Accounts receivable, net of
    allowance for doubtful accounts


27,884



(3,756
)


4,641



28,769


(a)(l)Inventory, net


21,403



1,040



(177
)


21,803


(b)Inventory consignment










(463
)





(c)Other current assets


4,321



842







5,432Short-term deferred cost of goods
    sold










269






(d)Total current assets


169,880



(1,874
)


4,270



172,276Property and equipment, net


10,045



94







10,139Other assets, net


11,432



1,589







13,271Long-term deferred cost of goods
    sold










447






(e)License fee










(197
)





(f)Total Assets

$
191,357


$
(191
)

$
4,520


$
195,686LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
16,480


$
(571
)

$



$
16,102Received not invoiced










193






(g)Accrued payroll and related expenses


4,919











4,919Deferred revenues


5,091



(1,002
)






3,813Inventory consignment










(463
)





(c)Short-term deferred revenue










567






(h)Thomson direct development costs










(380
)





(i)Accrued warranty expenses


4,191



(81
)






4,311Access Network Electronics










201






(j)Accrued restructuring and executive
    severance


9,070



(3,801
)






5,343Restructuring reclass between
    short-term and long-term










74






(k)Accrued vendor cancellation charges


713











713Accrued other liabilities


4,382



(338
)






4,413Rebate obligation










520






(l)Tax accrual










(151
)





(m)Other current obligations


1,362











1,362Total current liabilities


46,208



(5,793
)


561



40,976Long-term obligations


3,156



2,624



(73
)


5,707


(k)Long-term deferred revenue






3,375



2,901



6,276


(n)Convertible subordinated notes


65,081



673



(56
)


65,698


(o)Total liabilities


114,445



879



3,333



118,657Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,082,811







(2
)


1,082,809Accumulated deficit


(1,002,668
)


(1,070
)


1,189



(1,002,549
)

(p)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,534
)










(2,534
)Total stockholders equity


76,912



(1,070
)


1,187



77,029Total liabilities and
    stockholders equity

$
191,357


$
(191
)

$
4,520


$
195,686  133




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse invoicing of consigned inventory sale and related
    deferral of net revenue and COGS.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(f)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(g)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(h)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(k)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(l)
    
    To reclassify to accrued other liabilities rebate obligations
    with a single customer previously recorded as contra-accounts
    receivable during the quarter.(m)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(n)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(o)
    
    To record amortization of bond premium to interest income.(p)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 134




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  September 30, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
64,150


$



$



$
64,150Short-term investments


47,757







1



47,758Accounts receivable, net of
    allowance for doubtful accounts


20,475



885



(2,054
)


19,306


(a)(k)Inventory, net


15,529



400



(278
)


15,651


(b)Other current assets


3,586



1,111







4,599Short-term deferred cost of goods
    sold










(98
)





(c)Total current assets


151,497



2,396



(2,429
)


151,464Property and equipment, net


9,134



94







9,228Other assets, net


10,865



1,839







12,866Long-term deferred cost of goods
    sold










385






(d)License fee










(223
)





(e)Total Assets

$
171,496


$
4,329


$
(2,267
)

$
173,558LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
11,128


$
(378
)

$



$
10,942Received not invoiced










192






(f)Accrued payroll and related expenses


4,368











4,368Deferred revenues


4,345



(1,278
)






3,541Short-term deferred revenue










867






(g)Thomson direct development costs










(393
)





(h)Accrued warranty expenses


4,043



120







4,363Access Network Electronics










200






(i)Accrued restructuring and executive
    severance


7,914



(3,727
)






4,604Restructuring reclass between
    short-term and long-term










417






(j)Accrued vendor cancellation charges


2,133











2,133Accrued other liabilities


4,459



31







3,813Rebate obligation










(736
)





(k)Tax accrual










59






(l)Interest payable and current
    portion of capital lease obligations


542











542Total current liabilities


38,932



(5,232
)


606



34,306Long-term obligations


3,417



2,551



(418
)


5,550


(j)Long-term deferred revenue






6,276



2,643



8,919


(m)Convertible subordinated notes


65,081



617



(55
)


65,643


(n)Total liabilities


107,430



4,212



2,776



114,418Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,083,420



(2
)


2



1,083,420Accumulated deficit


(1,016,188
)


119



(5,044
)


(1,021,113
)

(o)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,469
)






(1
)


(2,470
)Total stockholders equity


64,066



117



(5,043
)


59,140Total liabilities and
    stockholders equity

$
171,496


$
4,329


$
(2,267
)

$
173,558  135




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21 and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped free-on-board destination or
    with acceptance provisions.(d)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(f)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(g)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(h)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(j)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(k)
    
    To reverse the reclassification to accrued other liabilities of
    rebate obligations with a single customer previously recorded as
    contra-receivables originally recorded in the quarter ended
    September 30, 2004. The correcting reclassification was
    performed for the quarter ended March 31, 2004 and
    June 30, 2004 as part of the restatement.(l)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(m)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(n)
    
    To record amortization of bond premium to interest income.(o)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 136




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  December 31, 2004Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
43,218


$



$



$
43,218Short-term investments


54,517



1



(1
)


54,517Accounts receivable, net of
    allowance for doubtful accounts


19,660



(1,169
)


68



18,559


(a)Other current receivables


1,044











1,044Inventory, net


17,144



122



(49
)


17,666


(b)E&O vendor cancellation










449






(c)Other current assets


2,042



1,013







3,516Short-term deferred cost of goods
    sold










461






(d)Total current assets


137,625



(33
)


928



138,520Property and equipment, net


5,760



94







5,854Restricted cash


8,827











1,241Non-current deposits reclass










(7,586
)





(e)Other assets, net


1,522



2,001







11,366Long-term deferred cost of goods
    sold










415






(f)License fee










(159
)





(g)Non-current deposits reclass










7,587






(e)Total Assets

$
153,734


$
2,062


$
1,185


$
156,981LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
7,845


$
(186
)

$



$
7,846Received not invoiced










187






(h)Accrued payroll and related expenses


4,181











4,493Tax accrual reclass










(245
)





(e)Bonus accrual










557






(i)Deferred revenues


2,579



(804
)






4,965Short-term deferred revenue










3,395






(j)Thomson direct development costs










(205
)





(k)Accrued warranty expenses


3,870



320







4,670Access Network Electronics










200






(l)Warranty reserve










280






(m)Accrued restructuring and executive
    severance


3,902



(3,310
)






3,744Israel restructuring










1,177






(n)Restructuring reclass between
    short-term and long-term










1,975






(o)Accrued vendor cancellation charges


521











521Accrued other liabilities


4,317



(646
)






3,873Legal accrual










(448
)





(p)Property tax










(240
)





(q)Tax accrual










645






(r)Tax accrual reclass










245






(e)Interest payable and current
    portion of capital lease obligations


1,356











1,356Total current liabilities


28,571



(4,626
)


7,523



31,468Long-term obligations


2,077







(1
)


2,076Accrued restructuring and executive
    severance


1,664



2,133



(1,975
)


1,822


(o)Long-term deferred revenue






8,919



2,165



11,084


(s)Convertible subordinated notes


65,081



562



(55
)


65,588


(t)Total liabilities


97,393



6,988



7,657



112,038Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


76











76Additional paid-in capital


1,083,711







(2
)


1,083,709Accumulated deficit


(1,024,091
)


(4,925
)


(6,471
)


(1,035,487
)

(u)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,582
)


(1
)


1



(2,582
)Total stockholders equity


56,341



(4,926
)


(6,472
)


44,943Total liabilities and
    stockholders equity

$
153,734


$
2,062


$
1,185


$
156,981  137




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(i)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(j)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(k)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(m)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(n)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(o)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(p)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect a liability at
    March 31, 2005.(q)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(r)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(s)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable, when collectibility was not
    reasonably assured, or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(t)
    
    To record amortization of bond premium to interest income.(u)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 138




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
    EFFECTS OF THE RESTATEMENT
    (in thousands)
    (unaudited)
  March 31, 2005Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
30,637


$



$



$
30,637Short-term investments


69,180











69,180Accounts receivable, net of
    allowance for doubtful accounts


19,736



(1,101
)


(782
)


17,853


(a)Other current receivables


1,242











1,242Inventory, net


18,611



522



437



19,342


(b)E&O vendor cancellation










(228
)





(c)Other current assets


1,634



1,474







5,126Short-term deferred cost of goods
    sold










2,018






(d)Total current assets


141,040



895



1,445



143,380Property and equipment, net


4,840



94



1



4,935Restricted cash


8,817



(7,586
)






1,241Restricted
    cash  long-term reclass










10






(e)Other assets, net


710



9,844







9,638Long-term deferred cost of goods
    sold










(777
)





(f)License fee










(129
)





(g)Restricted
    cash  long-term reclass










(10
)





(e)Total Assets

$
155,407


$
3,247


$
540


$
159,194LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
8,278


$
1


$
(1
)

$
8,278Accrued payroll and related expenses


3,601



557







3,601


(h)Bonus accrual










(557
)





(i)Deferred revenues


9,072



2,386







25,283Thomson direct development costs










(154
)





(j)Short-term deferred revenue










13,979






(k)Accrued warranty expenses


3,141



800







3,140Access Network Electronics










(801
)





(l)Accrued restructuring and executive
    severance


3,092



(158
)






3,093


(m)Restructuring reclass between
    short-term and long-term










159Accrued vendor cancellation charges


373











373Accrued other liabilities


4,031



(689
)






3,791


(h)Legal accrual










449






(n)Interest payable and current
    portion of capital lease obligations


542











542Total current liabilities


32,130



2,897



13,074



48,101Long-term obligations


1,725



(1
)






1,724Long-term deferred revenue






11,084



(5,693
)


5,391


(o)Accrued restructuring and executive
    severance


1,772



158



(158
)


1,772


(m)Convertible subordinated notes


65,081



507



(56
)


65,532


(p)Total liabilities


100,708



14,645



7,167



122,520Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


77











77Additional paid-in capital


1,085,008



(2
)


2



1,085,008Accumulated deficit


(1,026,695
)


(11,396
)


(6,629
)


(1,044,720
)

(q)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,918
)










(2,918
)Total stockholders equity


54,699



(11,398
)


(6,627
)


36,674Total liabilities and
    stockholders equity

$
155,407


$
3,247


$
540


$
159,194  139




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions and to adjust the
    allowance for doubtful accounts based on the Companys
    reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination or with acceptance provisions.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    The cumulative amount was adjusted from the prior period to
    reflect the reclassification adjustment made after the filing of
    the original financial statements.(i)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(j)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(k)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(l)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(m)
    
    To reflect short-term and long-term portion of restructuring
    liabilities.(n)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability at
    March 31, 2005.(o)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination or with acceptance provisions.(p)
    
    To record amortization of bond premium to interest income.(q)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 140




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    BALANCE SHEET
 EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  June 30, 2005Cumulative EffectAs Previously


of Prior Period


Current QuarterReported


Adjustments


Adjustments


As Restated


NotesASSETSCurrent assets:Cash and cash equivalents

$
38,605


$



$



$
38,605Short-term investments


66,383











66,383Accounts receivable, net of
    allowance for doubtful accounts


19,957



(1,883
)


(1,620
)


16,454


(a)Other current receivables


1,758











1,758Inventory, net


12,759



731



672



13,942


(b)E&O vendor cancellation










(220
)





(c)Other current assets


2,100



3,492







8,546Short-term deferred cost of goods
    sold










2,954






(d)Total current assets


141,562



2,340



1,786



145,688Property and equipment, net


4,538



95



(1
)


4,632Restricted cash


8,763



(7,576
)






1,241Restricted
    cash  long-term reclass










54






(e)Other assets, net


633



8,928







11,949Long-term deferred cost of goods
    sold










2,545






(f)License fee










(103
)





(g)Restricted
    cash  long-term reclass










(54
)





(e)Total assets

$
155,496


$
3,787


$
4,227


$
163,510LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
4,572


$



$



$
4,572Accrued payroll and related expenses


3,147











3,147Deferred revenues


14,005



16,211







34,431Thomson direct development costs










(173
)





(h)Short-term deferred revenue










4,388






(i)Accrued warranty expenses


2,722



(1
)


1



2,722Accrued restructuring and executive
    severance


1,991



1



(1
)


1,991Accrued vendor cancellation charges


374











374Accrued other liabilities


3,609



(240
)






3,369Interest payable and current
    portion of capital lease obligations


1,356











1,356Total current liabilities


31,776



15,971



4,215



51,962Long-term obligationsLong-term deferred revenue






5,390



6,049



11,439


(j)Accrued restructuring and executive
    severance


3,441











3,441Convertible subordinated notes


65,081



451



(55
)


65,477


(k)Total liabilities


100,298



21,812



10,209



132,319Stockholders equity:Preferred stock, $0.001 par
    value:Authorized sharesCommon stock, $0.001 par value:Authorized shares


77











77Additional paid-in capital


1,085,820







(2
)


1,085,818Accumulated deficit


(1,027,203
)


(18,025
)


(5,980
)


(1,051,208
)

(l)Treasury stock, at cost


(773
)










(773
)Accumulated other comprehensive loss


(2,723
)










(2,723
)Total stockholders equity


55,198



(18,025
)


(5,982
)


31,191Total liabilities and
    stockholders equity

$
155,496


$
3,787


$
4,227


$
163,510  141




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
  (a)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination and to adjust the allowance for doubtful accounts
    based on the Companys reassessment of the account.(b)
    
    To reflect the cumulative effects of adjustments for
    transactions shipped
    free-on-board
    destination.(c)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(d)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(e)
    
    To reflect other adjustments and reclassifications.(f)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(g)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(h)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To reflect the cumulative effects of adjustments for the
    short-term portion of deferred revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(j)
    
    To reflect the cumulative effects of adjustments for the
    long-term portion of deferred revenue to the change in revenue
    recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments when collectibility was not
    reasonably assured or when revenue and related costs were
    deferred for transactions shipped
    free-on-board
    destination.(k)
    
    To record amortization of bond premium to interest income.(l)
    
    To reflect cumulative effects of restatement adjustments on
    accumulated deficit. 142




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED STATEMENT OF OPERATIONS
 (in thousands, except per share data)
  Year Ended December 31,2004


2003As








AsPreviously





As


Previously





AsReported


Adjustments


Restated


Reported


Adjustments


RestatedRevenues

$
150,538


$
(14,054
)

$
136,484


$
133,485


$
(3,298
)

$
130,187Cost of goods sold


106,920



(5,033
)


101,887



101,034



2,801



103,835Gross profit


43,618



(9,021
)


34,597



32,451



(6,099
)


26,352Operating expenses:Research and development


33,959



(760
)


33,199



42,839



(205
)


42,634Sales and marketing


24,145







24,145



26,781







26,781General and administrative


11,216



823



12,039



12,127



(193
)


11,934Restructuring charges, executive
    severance and asset write-offs


11,159



1,177



12,336



2,803







2,803Total operating expenses


80,479



1,240



81,719



84,550



(398
)


84,152Loss from operations


(36,861
)


(10,261
)


(47,122
)


(52,099
)


(5,701
)


(57,800
)Interest expense, net


(1,312
)


222



(1,090
)


(362
)


221



(141
)Other income, net


1,566



(535
)


1,031



2,424



(392
)


2,032Loss before tax benefit (expense)


(36,607
)


(10,574
)


(47,181
)


(50,037
)


(5,872
)


(55,909
)Income tax benefit (expense)


76







76



(316
)






(316
)Net loss

$
(36,531
)

$
(10,574
)

$
(47,105
)

$
(50,353
)

$
(5,872
)

$
(56,225
)Basic and diluted net loss per
    share

$
(0.48
)





$
(0.62
)

$
(0.68
)





$
(0.76
)Shares used in computing basic and
    diluted net loss per share


75,861







75,751



74,212







74,074  143




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    STATEMENT OF OPERATIONS
 EFFECTS OF THE RESTATEMENT
 (in thousands)
  Year Ended December 31,2004


2003


NotesNet loss, as previously
    reported

$
(36,531
)

$
(50,353
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(12,858
)


(3,226
)

(a),(b)HAS


(291
)


659


(b)CMTS


(905
)


(741
)

(b),(c)Other






10


(d)Cost of goods soldRevenue analysis (cost of goods
    sold)


6,166



(3,564
)

(e)Access Network Electronics


(800
)





(f)Warranty reserve


(281
)





(g)License fee


(500
)


763


(h)E&O vendor cancellation


448






(i)Research and developmentBonus accrual


(556
)





(j)Thomson (cost of goods sold)


273



34


(k)Thomson direct development costs


1,043



171


(l)General and administrativeLegal accrual


448






(m)Bad debt expense


(590
)


(120
)

(n)Common area maintenance






313


(o)Property tax


156






(p)Tax accrual


(73
)





(q)Received not invoiced


(764
)





(r)Restructuring charges, executive
    severance and asset write-offsIsrael restructuring reserve


(1,177
)





(s)Interest income (expense), netConvertible subordinated notes


222



221


(t)Other income (expense), netTax accrual


(441
)


(33
)

(q)Fixed asset


(94
)


(359
)

(u)Net loss, as restated

$
(47,105
)

$
(56,225
)  144




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Adjustments:
  (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect a $1.6 million reduction in revenue that was
    identified during the Companys reassessment of the
    allowance for doubtful accounts and bad debt expense account in
    the quarter ended September 30, 2004.(d)
    
    To reflect other adjustments and reclassifications.(e)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(f)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(g)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(h)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(i)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(j)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(k)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract . The
    costs were previously recognized in the period incurred.(l)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(m)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to properly reflect liability at
    March 31, 2005.(n)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(o)
    
    To adjust for an unrecorded liability for common area
    maintenance to reflect expense in the prior period.(p)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(q)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(r)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(s)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(t)
    
    To record amortization of bond premium to interest income.(u)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets. 145




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    CONSOLIDATED
    STATEMENT OF OPERATIONS
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  Three Months EndedMarch 31,


June 30,


September 30,


December 31,2004


2004


2004


2004


Notes(unaudited)


(unaudited)


(unaudited)


(unaudited)Net loss, as previously
    reported

$
(10,247
)

$
(4,861
)

$
(13,520
)

$
(7,903
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(1,453
)


(751
)


(5,634
)


(5,020
)

(a),(b)HAS


309



(744
)


104



40


(b)CMTS


44



69



(1,112
)


94


(b),(c)Cost of goods soldRevenue analysis (cost of goods
    sold)-2004


1,405



3,016



962



783


(e)Access Network Electronics


(200
)


(200
)


(200
)


(200
)

(f)Warranty reserve














(281
)

(g)License fee


79



(197
)


(223
)


(159
)

(h)E&O vendor cancellation














448


(i)Research and DevelopmentBonus accrual














(556
)

(j)Thomson (other)


51



46



139



37


(k)Thomson direct development costs


288



334



254



167


(l)General and administrativeLegal accrual














448


(m)Bad debt expense


(496
)


(396
)


861



(559
)

(n)Property tax














156


(o)Tax accrual










(60
)


(13
)

(p)Received not invoiced


(192
)


(192
)


(193
)


(187
)

(q)Restructuring charges, executive
    severance and asset write-offsIsrael restructuring reserve














(1,177
)

(r)Interest income (expense), net
    Convertible subordinated notes


55



55



56



56


(s)Other income (expense), netTax accrual


(44
)


151







(548
)

(p)Fixed asset


(94
)













(t)Net loss, as restated

$
(10,495
)

$
(3,670
)

$
(18,566
)

$
(14,374
)  146




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Quarterly Adjustments:
  (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect a $1.6 million reduction in revenue that was
    identified during the Companys reassessment of the
    allowance for doubtful accounts and bad debt expense account in
    the quarter ended September 30, 2004.(d)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(e)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(f)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(g)
    
    To adjust the accrual to reflect an updated extended warranty
    model.(h)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(i)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(j)
    
    To accrue for retention and other miscellaneous bonuses earned
    by employees in 2004.(k)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(l)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(m)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability for the
    quarter ended March 31, 2005.(n)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(o)
    
    To reverse an accrual of property taxes related to the
    Santa Clara facility.(p)
    
    To reverse an accrual of income taxes payable recorded in prior
    periods.(q)
    
    To correct an adjustment originally recorded during each quarter
    of 2004 to the received not invoiced (RNI) account. During the
    restatement, management concluded that the adjustment should
    have occurred in 2002.(r)
    
    To correct an adjustment originally recorded during the quarter
    ended December 31, 2004 that wrote-off excess Israel
    restructuring liabilities. During the restatement, management
    concluded the adjustment should have occurred during 2002.(s)
    
    To record amortization of bond premium to interest income.(t)
    
    To adjust for the reversal of a fixed asset write off reserve
    and to recognize a loss on the disposal of assets. 147




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    STATEMENT OF OPERATIONS
    EFFECTS OF THE RESTATEMENT
 (in thousands)
 (unaudited)
  Three Months EndedMarch 31,


June 30,2005


2005


Notes(as restated)


(as restated)Net loss, as previously
    reported

$
(2,604
)

$
(508
)Adjustments to net loss (increase)
    decrease:RevenuesDVS


(8,513
)


(10,563
)

(a)HAS


36



(58
)

(b)CMTS


(73
)


13


(b)Cost of goods soldRevenue analysis (cost of goods
    sold)


1,337



5,446


(c)Access Network Electronics


800






(d)License fee


(129
)


(103
)

(e)E&O vendor cancellation


(228
)


(220
)

(f)Research and developmentBonus accrual


556






(g)Thomson (other)


20



23


(h)Thomson direct development costs


134



150


(i)Sales and marketingGeneral and administrativeLegal accrual


(448
)





(k)Bad debt expense


(176
)


(723
)

(l)Restructuring charges, executive
    severance and asset write-offsInterest income (expense), net
    Convertible subordinated notes


55



56


(m)Net loss, as restated

$
(9,233
)

$
(6,487
)  148




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Explanation
    of Current Quarterly Adjustments:
   (a)
    
    To reflect adjustments to revenue related to the change in
    revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1.(b)
    
    To reflect adjustments for timing difference identified between
    deferred revenue and revenue for product sales when the fee was
    not fixed or determinable or when collectibility was not
    reasonably assured and to reflect other adjustments to the
    account.(c)
    
    To reflect adjustments to cost of goods sold related to the
    change in revenue recognition policy to
    SOP 97-2,
    EITF 00-21
    and
    SOP 81-1,
    and to reflect other adjustments for product sales when the fee
    was not fixed or determinable or when collectibility was not
    reasonably assured.(d)
    
    To reverse 2004 amortization of ANE warranty reserve and to
    recognize in the quarter ended March 31, 2005.(e)
    
    To correct pre-paid amortization on license fee based on a new
    royalty rate.(f)
    
    To reverse E&O reserves related to CMTS product based on
    revised demand forecast.(g)
    
    To reverse expenses for retention and other miscellaneous
    bonuses earned by employees in 2004.(h)
    
    To defer cost of goods sold costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(i)
    
    To defer direct development costs based on
    SOP 81-1
    until recognition of revenue at completion of contract. The
    costs were previously recognized in the period incurred.(j)
    
    To reflect other adjustments and reclassifications.(k)
    
    To correct legal accrual adjustment recorded as of
    December 31, 2004 and to reflect the liability for the
    quarter ended March 31, 2005.(l)
    
    To reflect adjustments to the allowance for doubtful accounts
    and bad debt expense based on the Companys reassessment of
    the accounts.(m)
    
    To record amortization of bond premium to interest income. 149




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONSOLIDATED
    STATEMENT OF CASH FLOWS
    EFFECTS OF THE RESTATEMENT
    (in thousands)
  Year Ended December 31,2004


2003As








AsPreviously





As


Previously





AsReported


Adjustments


Restated(1)


Reported


Adjustments


Restated(1)Operating activities:Net loss

$
(36,531
)

$
(10,574
)

$
(47,105
)

$
(50,353
)

$
(5,872
)

$
(56,225
)Adjustments to reconcile net loss
    to net cash (provided by) used in operating activities:Depreciation and amortization


6,416



(556
)


5,860



9,369



(147
)


9,222Amortization of deferred
    compensation


17







17



53







53Amortization of subordinated
    convertible note premium






(221
)


(221
)






(221
)


(221
)Accretion of discounts on
    short-term investments






(107
)


(107
)






(440
)


(440
)Realized gains on sales of
    short-term investments






(2
)


(2
)






(127
)


(127
)Inventory provision


11,980



(430
)


11,550



4,086



(61
)


4,025Provision for doubtful accounts






590



590







120



120Restructuring provision






6,513



6,513







2,184



2,184Write-off of fixed assets


2,393



652



3,045



497



322



819Warranty provision






3,075



3,075







2,353



2,353Vendor cancellation provision






387



387







1,362



1,362Compensation expense for issuance
    of common stock














70







70Value of common and preferred stock
    warrants issued














45







45Net changes in operating assets and
    liabilities:


















Accounts receivable, net


10,139



(1,735
)


8,404



(12,602
)


6,402



(6,200
)Inventory


(12,760
)


821



(11,939
)


(12,193
)


(852
)


(13,045
)Other assets


5,131



(4,728
)


403



7,281



(370
)


6,911Accounts payable


(18,204
)


764



(17,440
)


2,129







2,129Accrued payroll and related expenses


(2,356
)


372



(1,984
)


310







310Deferred revenues


(844
)


12,696



11,852



2,926



774



3,700Accrued warranty expenses


(1,639
)


(1,995
)


(3,634
)


(3,098
)


(2,353
)


(5,451
)Accrued restructuring charges


1,066



(5,421
)


(4,355
)


(2,254
)


(2,004
)


(4,258
)Accrued restructuring and executive
    severance


(2,348
)


(387
)


(2,735
)


(12,335
)


887



(11,448
)Accrued other liabilities


(2,008
)


178



(1,830
)


(2,331
)


(1,073
)


(3,404
)Interest payable


(2
)


2







3



(3
)


Net cash provided by (used in)
    operating activities


(39,550
)


(106
)


(39,656
)


(68,397
)


881



(67,516
)Investing activities:Purchases of short-term investments


(54,517
)


(35,440
)


(89,957
)


(243,652
)


(9,381
)


(253,033
)Proceeds from sales and maturities
    of short-term investments


107,931



35,549



143,480



224,154



9,947



234,101Purchases of property and equipment


(2,698
)


(2
)


(2,700
)


(3,831
)


185



(3,646
)Net cash provided by (used in)
    investing activities


50,716



107



50,823



(23,329
)


751



(22,578
)Financing activities:Principal payments on capital leases


(124
)


(2
)


(126
)


(66
)


(1,631
)


(1,697
)Proceeds from issuance of common
    stock


1,681



1



1,682



3,729



(1
)


3,728Net cash provided by financing
    activities


1,557



(1
)


1,556



3,663



(1,632
)


2,031Effect of foreign currency exchange
    rate changes


307







307



1,172







1,172Net (decrease) increase in cash and
    cash equivalents


13,030







13,030



(86,891
)






(86,891
)Cash and cash equivalents at
    beginning of year


30,188







30,188



117,079







117,079Cash and cash equivalents at end of
    year

$
43,218


$



$
43,218


$
30,188


$



$
30,188Supplemental disclosures of cash
    flow information:Cash paid for income taxes

$
138


$
37


$
175


$
194


$




194Cash paid for interest

$
3,268


$



$
3,268


$
3,262


$




3,262Deferred compensation relating to
    common stock issued to non-employees

$
17


$



$
17


$
53


$



$
53     (1)
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 150




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Note 4.
    Fair
    Value of Financial Instruments        Gross


GrossUnrealized


UnrealizedDecember 31, 2005

Amortized Cost


Gains


Losses


Fair Value(in thousands)Investments maturing in less than
    1 year:Commercial paper

$
7,950


$



$
(3
)

$
7,947Government agency obligations


47,000







(325
)


46,675Subtotal


54,950







(328
)


54,622Investments maturing in
    1-2 years:Fixed income corporate securities


3,959







(9
)


3,950Government agency obligations


13,998







(136
)


13,862Subtotal


17,957







(145
)


17,812Total

$
72,907


$



$
(473
)

$
72,434   Gross


GrossUnrealized


UnrealizedDecember 31, 2004

Amortized Cost


Gains


Losses


Fair Value(in thousands)Investments maturing in less than
    1 year:Government agency obligations

$
8,000


$



$
(72
)

$
7,928Investments maturing in
    1-2 years:Government agency obligations


47,006







(417
)


46,589Total

$
55,006


$



$
(489
)

$
54,517     Note 5.
    Commitments  Leases
  sub-sublease sub-sublease
 151




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  month-to-month
  28-month
    OperatingLeases2006

$
4,8982007


3,2212008


3,1052009


2,5782010


Thereafter


Total minimum payments

$
13,802     Purchase
    Obligations and Special Charges
    Letters
    of Credit
   152




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Royalties
  per-unit
    Note 6.
    Accrued
    Severance Pay        December 31,2005Balance at December 31, 2004

$
431Charges


14Cash payments


(444
)Balance at December 31, 2005

$
1      153




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  88-1,
  Note 7.
    Restructuring
    Charges and Asset Write-offs    2004
    Restructurings
         154




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Involuntary


Excess Leased


Aircraft LeaseTerminations


Facilities


Termination


TotalCharges

$
2,298


$
2,523


$
933


$
5,754Cash payments


(1,467
)


(850
)


(1,194
)


(3,511
)Changes in estimates


(239
)


324



954



1,039Balance at December 31, 2004


592



1,997



693



3,282Charges


1,037











1,037Cash payments


(1,534
)


(1,190
)


(344
)


(3,068
)Changes in estimates


(95
)


1,246



149



1,300Balance at December 31, 2005

$



$
2,053


$
498


$
2,551   2003
    Restructuring
    2002
    Restructuring
   155




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Excess LeasedFacilities andInvoluntary


CancelledTerminations


Contracts


TotalBalance at December 31, 2002

$
88


$
1,423


$
1,511Cash payments


(88
)


(220
)


(308
)Changes in estimates






(1,103
)


(1,103
)Balance at December 31, 2003






100



100Charges






20



20Cash payments






(5
)


(5
)Changes in estimates






(100
)


(100
)Balance at December 31, 2004






15



15Changes in estimates






(15
)


(15
)Balance at December 31, 2005

$



$



$
   2001
    Restructurings
   156




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    ExcessLeased Facilitiesand CancelledContractsBalance at December 31, 2002

$
4,066Charges


Cash payments


(1,676
)Changes in estimates


813Balance at December 31, 2003


3,203Charges


Cash payments


(1,165
)Changes in estimates


(200
)Balance at December 31, 2004


1,838Charges


Cash payments


(1,450
)Changes in estimates


(253
)Balance at December 31, 2005

$
135   Asset
    Write-offs
      Note 8.
    Convertible
    Subordinated Notes      157




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      7-year
     158




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 9.
    Contingencies  Litigation
  In re Terayon
    Communication Systems, Inc. Securities Litigation.
  Bertram v. Terayon Communication Systems, Inc.
  Campbell v. Rakib In re Terayon Communication
    Systems, Inc. Derivative Litigation
   159




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
           160




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
           161




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    and/or
           162




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 10.
    Stockholders
    Equity  Common
    Stock Warrants
        Stockholder
    Rights Plan
   163




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Common
    Stock Reserved
    December 31,2005Common stock options


18,392,821Employee stock purchase plan


600,371Total


18,993,192   Stock
    Option and Stock Purchase Plans
           164




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Options

Options OutstandingAvailable

Number of

Weighted Averagefor Grant

Shares

Exercise PriceBalance at December 31, 2002


28,991,401



14,619,825


$
8.02Options authorized


(17,000,000
)






Options granted


(7,153,320
)


7,153,320



3.05Options exercised






(602,272
)


4.20Options canceled


3,706,914



(3,706,914
)


7.61Balance at December 31, 2003


8,544,995



17,463,959


$
6.20Options authorized


3,000,000







Options granted


(4,738,944
)


4,738,944



1.96Options exercised






(225,645
)


2.19Options canceled


5,174,420



(5,174,420
)


5.19Balance at December 31, 2004


11,980,471



16,802,838


$
5.37Options authorized


(8,500,000
)






Options granted


(2,911,675
)


2,911,675



3.01Options exercised






(1,341,112
)


2.28Options canceled


5,341,415



(5,341,415
)


6.31Shares expired


(379,286
)






Balance at December 31, 2005


5,530,925



13,031,986


$
4.78     Options Outstanding

Options ExercisableWeighted AverageRange of Exercise

Shares

Remaining

Weighted Average

Exercisable

Weighted AveragePrices

Outstanding

Contractual Life

Exercise Price

Options

Exercise Price$0.00 - $1.99


2,692,641



8.59


$
1.76



1,078,710


$
1.74$2.01 - $2.95


2,606,963



7.62



2.52



2,154,490



2.47$2.97 - $3.49


2,612,493



5.50



3.04



437,250



3.04$3.50 - $6.52


1,250,704



6.13



5.53



973,743



5.58$6.81 - $66.37


3,869,185



5.00



9.33



3,858,293



9.33Total


13,031,986



6.48


$
4.78



8,502,486


$
5.88     Employee
    Stock Purchase Plan
   165




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Risk-freeInterest


Expected


Expected


DividendRates


Volatility


Life


Yield(in years)2003Stock option plans


2.67%



0.87



5.0



0.0%Employee stock purchase plan


1.27%



1.54



0.5



0.0%2004Stock option plans


3.47%



0.78



5.0



0.0%Employee stock purchase plan


1.16%



0.80



0.5



0.0%2005Stock option plans


3.93%



0.58



2.1



0.0%      166




---



##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 11.
    Income
    Taxes    Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Current:Federal

$



$



$
State






(40
)


Foreign


(149
)


116



(316
)Total current


(149
)


76



(316
)Deferred:Federal










State










Foreign










Total deferred










$
(149
)

$
76


$
(316
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Tax benefit at U.S. statutory
    rate

$
9,418


$
16,513


$
19,568Loss for which no tax benefit is
    currently recognizable


(9,418
)


(16,513
)


(19,568
)Other, net


(149
)


76



(316
)$
(149
)

$
76


$
(316
)     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   167




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended December 31,2005


2004(as restated)(1)Deferred tax assets:Net operating loss carryforwards

$
156,229


$
156,608Tax credit carryforwards


13,607



13,336Reserves and accruals


9,469



10,533Capitalized research and
    development


2,270



2,959Intangible asset amortization


24,929



27,482Deferred revenue


14,239



4,738Other, net


9,078



10,904Gross deferred tax assets


229,821



226,560Valuation allowance


(229,821
)


(226,560
)Net deferred tax assets

$



$
     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.        Note 12.
    Defined
    Contribution Plan    Note 13.
    Segment
    Information   168




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Year Ended December 31,2005


2004


2003(as restated)(1)


(as restated)(1)Geographic areas:Revenues:United States

$
52,838


$
72,838


$
71,945Americas, excluding United States


1,871



4,930



3,081Europe, Middle East and Africa
    (EMEA), excluding Israel


15,314



17,640



9,450Israel


7,645



16,645



15,274Asia excluding Japan


11,544



15,259



9,094Japan


1,452



9,172



21,343Total

$
90,664


$
136,484


$
130,187     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  169




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Year Ended December 31,2005


2004(as restated)(1)Long-lived assets:United States

$
3,701


$
4,517Americas, excluding United States


5



402Europe, Middle East and Africa
    (EMEA), excluding Israel


65



132Israel


16



687Asia


128



116Total

$
3,915


$
5,854     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    Note 14.
    Related
    Party Transactions    Note 15.
    Product
    Warranty    Year Ended December 31,2005


2004(as restated)(1)Balance at beginning of period

$
4,670


$
5,229Additions (reductions) charged to
    costs and expenses


(166
)


3,075Settlements


(1,617
)


(3,634
)Balance at end of period

$
2,887


$
4,670     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 170




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Guarantees,
    Including Indirect Guarantees of Indebtedness of
    Others
    Note 16.
    Sale of
    Certain Assets           171




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Note 17.
    Subsequent
    Events  Events
    Related to the Company Accounting Review and the
    Restatement
       172




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Repayment
    in full of 5% Convertible Subordinated Notes due
    2007
  Form 10-Q Form 10-Q
  De-listing
    by The NASDAQ Stock Market
  Form 10-Q
 173




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  over-the-counter
  Settlement
    of Securities Class Action Lawsuit
  In re Terayon Communication
    Systems, Inc. Securities Litigation No. C-00-1967-MHP,
      Settlement
    of Derivative Lawsuit
  In re Terayon
    Communication Systems, Inc. Derivative Litigation
  Costs
    of Restatement and Legal Activities
   174




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Asset
    Sales
    Reliance
    Settlement
    Discontinued
    Products
    Commitments
    and Obligations
  sub-sublease
  Changes
    in Membership and Reduction in Size of the Board of
    Directors
   175




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Note 18.
    2005 and
    2004 Unaudited Condensed Consolidated Quarterly
    Information      (unaudited)First


Second


Third


FourthYear Ended December 31,
    2005

Quarter


Quarter


Quarter


Quarter(as restated)(1)


(as restated)(1)Revenues

$
17,813


$
18,925


$
23,440


$
30,486Cost of goods sold


11,263



11,578



16,999



15,795Gross profit


6,550



7,347



6,441



14,691Operating expenses:Research and development


5,234



4,254



3,555



4,607Sales and marketing


5,674



5,610



6,326



4,924General and administrative


3,419



3,601



5,570



7,766Restructuring charges, executive
    severance and asset write-offs


1,282



282



235



458Total operating expenses


15,609



13,747



15,686



17,755Loss from operations


(9,059
)


(6,400
)


(9,245
)


(3,064
)Interest income (expense), net


(190
)


(86
)


21



66Other income (expense), net


66



(51
)


1,180



(40
)Loss before income tax benefit
    (expense)


(9,183
)


(6,537
)


(8,044
)


(3,038
)Income tax benefit (expense)


(50
)


50



(76
)


(73
)Net loss


(9,233
)


(6,487
)


(8,120
)


(3,111
)Basic and diluted net loss per
    share

$
(0.12
)

$
(0.08
)

$
(0.11
)

$
(0.04
)Shares used in computing basic and
    diluted net loss per share


76,645



76,444



76,445



76,381     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   176




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  (unaudited)First


Second


Third


FourthYear Ended December 31,
    2004

Quarter


Quarter


Quarter


Quarter(as restated)(1)


(as restated)(1)


(as restated)(1)


(as restated)(1)Revenues

$
40,069


$
41,355


$
30,560


$
24,500Cost of goods sold


27,487



25,039



30,393



18,968Gross profit


12,582



16,316



167



5,532Operating expenses:Research and development


9,129



8,136



8,304



7,630Sales and marketing


7,221



5,411



6,222



5,291General and administrative


3,124



3,542



2,384



2,989Restructuring charges, executive
    severance and asset write-offs


3,367



3,579



1,463



3,927Total operating expenses


22,841



20,668



18,373



19,837Loss from operations


(10,259
)


(4,352
)


(18,206
)


(14,305
)Interest expense, net


(310
)


(310
)


(232
)


(238
)Other income (expense), net


141



1,071



(45
)


(136
)Loss before income tax benefit
    (expense)


(10,428
)


(3,591
)


(18,483
)


(14,679
)Income tax benefit (expense)


(67
)


(79
)


(83
)


305Net loss


(10,495
)


(3,670
)


(18,566
)


(14,374
)Basic and diluted net loss per
    share

$
(0.14
)

$
(0.05
)

$
(0.24
)

$
(0.19
)Shares used in computing basic and
    diluted net loss per share


75,305



74,884



75,275



74,897     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.   177




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    CONDENSED
    CONSOLIDATED BALANCE SHEETS
    (in thousands)
  September 30,


December 31,2005


2004(unaudited)


(as restated)(1)ASSETSCurrent assets:Cash and cash equivalents

$
37,547


$
43,218Short-term investments


72,322



54,517Accounts receivable, net allowance
    for doubtful accounts


11,610



18,559Other current receivables


1,438



1,044Inventory


9,751



17,666Other current assets


8,225



3,516Total current assets


140,893



138,520Property and equipment, net


4,093



5,854Restricted cash


317



1,241Other assets, net


11,901



11,366Total assets

$
157,204


$
156,981LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
5,989


$
7,846Accrued payroll and related
    expenses


1,819



4,493Deferred revenues


23,992



4,965Deferred gain on asset sale


8,631



Accrued warranty expenses


2,655



4,670Accrued restructuring and
    executive severance


1,212



3,744Accrued vendor cancellation charges


248



521Accrued other liabilities


6,340



3,873Interest payable


542



1,356Current portion of convertible
    subordinated notes


65,422



Total current liabilities


116,850



31,468Long-term obligations


1,583



2,076Accrued restructuring and
    executive severance


1,554



1,822Long-term Deferred revenues


13,783



11,084Convertible subordinated notes






65,588Total liabilities


133,770



112,038Stockholders equity:Preferred stock






Common stock


78



76Additional paid-in capital


1,086,623



1,083,709Accumulated deficit


(1,059,327
)


(1,035,487
)Treasury stock, at cost


(773
)


(773
)Accumulated other comprehensive
    loss


(3,167
)


(2,582
)Total stockholders equity


23,434



44,943Total liabilities and
    stockholders equity

$
157,204


$
156,981     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 178




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  CONDENSED
    CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share data)
 (unaudited)
  Three Months Ended


Nine Months EndedSeptember 30,


September 30,2005


2004


2005


2004(as restated)(1)





(as restated)(1)Revenues

$
23,440


$
30,560


$
60,178


$
111,984Cost of goods sold


16,999



30,393



39,840



82,919Gross profit


6,441



167



20,338



29,065Operating expenses:Research and development


3,555



8,304



13,043



25,569Sales and marketing


6,326



6,222



17,611



18,854General and administrative


5,570



2,384



12,589



9,050Restructuring charges, executive
    severance and asset write-offs


235



1,463



1,799



8,408Total operating expenses


15,686



18,373



45,042



61,881Loss from operations


(9,245
)


(18,206
)


(24,704
)


(32,816
)Interest income (expense), net


21



(232
)


(255
)


(853
)Other income (expense), net


1,180



(45
)


1,195



1,167Loss before income tax expense


(8,044
)


(18,483
)


(23,764
)


(32,502
)Income tax expense


(76
)


(83
)


(76
)


(229
)Net loss

$
(8,120
)

$
(18,566
)

$
(23,840
)

$
(32,731
)Net loss per share, basic and
    diluted

$
(0.11
)

$
(0.25
)

$
(0.31
)

$
(0.43
)Shares used in computing, basic
    and diluted net loss per share


76,445



75,275



76,998



75,604     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements. 179




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Management
    Discussion and Analysis of Financial Condition and Results of
    Operations for the three months and nine months ended
    September 30, 2005 and 2004, respectively.
  Revenues
    Three Months Ended


Nine Months EndedSept. 30,


Sept. 30,


Variance in


Variance in


Sept. 30,


Sept. 30,


Variance in


Variance in2005


2004


Dollars


Percent


2005


2004


Dollars


Percent(as restated)(1)











(as restated)(1)Revenues by product:DVS

$
10,293


$
5,168


$
5,125



99.2
%

$
21,601


$
16,544



5,057



30.6
%HAS


10,116



19,915



(9,799
)


(49.2
)%


32,448



68,231



(35,783
)


(52.4
)%CMTS


3,031



5,477



(2,446
)


(44.7
)%


6,129



27,105



(20,976
)


(77.4
)%Other






















104



(104
)


(100.0
)%Total

$
23,440


$
30,560


$
(7,120
)


(23.3
)%

$
60,178


$
111,984


$
(51,806
)


(46.3
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.    SOP 97-2
   180




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Three Months Ended


Nine Months EndedSept. 30,


Sept. 30,


Variance in


Variance in


Sept. 30,


Sept. 30,


Variance in


Variance in2005


2004


Dollars


Percent


2005


2004


Dollars


Percent(as restated)(1)











(as restated)(1)Revenues:United States

$
14,173


$
19,050


$
(4,877
)


(25.6
)%

$
32,146


$
58,446


$
(26,300
)


(45.0
)%Americas, excluding
    United States


418



603



(185
)


(30.7
)%


1,235



4,209



(2,974
)


(70.7
)%Europe, Middle East and Africa
    (EMEA), excluding Israel


3,481



2,678



803



30.0
%


10,393



13,348



(2,955
)


(22.1
)%Israel


1,441



1,807



(366
)


(20.3
)%


5,525



14,858



(9,333
)


(62.8
)%Asia, excluding Japan


3,546



3,055



491



16.1
%


9,814



12,069



(2,255
)


(18.7
)%Japan


381



3,367



(2,986
)


(88.7
)%


1,065



9,054



(7,989
)


(88.2
)%Total

$
23,440


$
30,560


$
(7,120
)


(23.3
)%

$
60,178


$
111,984


$
(51,806
)


(46.3
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.        Cost of
    Goods Sold and Gross Profit
   181




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Operating
    Expenses
     Three Months Ended


Nine Months EndedSept. 30,


Sept. 30,


Variance in


Variance in


Sept. 30,


Sept. 30,


Variance in


Variance in2005


2004


Dollars


Percent


2005


2004


Dollars


Percent(as restated)(1)











(as restated)(1)Research and development

$
3,555


$
8,304


$
(4,749
)


(57.2
)%

$
13,043


$
25,569


$
(12,526
)


(49.0
)%Sales and marketing


6,326



6,222



104



1.7
%


17,611



18,854



(1,243
)


(6.6
)%General and administrative


5,570



2,384



3,186



133.6
%


12,589



9,050



3,539



39.1
%Restructuring charges, executive
    severance and asset write-offs


235



1,463



(1,228
)


(83.9
)%


1,799



8,408



(6,609
)


(78.6
)%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Research
    and Development
     182




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Sales
    and Marketing
    General
    and Administrative
    Restructuring
    Costs
           183




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  sub-sublease
  Executive
    Severance
    Asset
    Write-offs
    Non-operating
    Expenses
    Three Months Ended


Nine Months EndedSept. 30,


Sept. 30,


Variance in


Variance in


Sept. 30,


Sept. 30,


Variance in


Variance in2005


2004


Dollars


Percent


2005


2004


Dollars


Percent(as restated)(1)


(as restated)(1)


(as restated)(1)





(as restated)(1)


(as restated)(1)


(as restated)(1)Interest income (expense), net

$
21


$
(232
)

$
253



(109.1
)%

$
(255
)

$
(853
)

$
598



(70.1
)%Other income (expense), net


1,180



(45
)


1,225



(2,722.2
)%


1,195



1,167



28



2.4
%     (1)
    
    See Note 3, Restatement of Consolidated Financial
    Statements, to Consolidated Financial Statements.  Interest Income.
  Interest Expense.
  Other Income.
 184




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##### Table of Contents



TERAYON
    COMMUNICATION SYSTEMS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Contractual
    Obligations
    Payments Due by PeriodLess Than


1 - 3


4 - 5


After 5Total


1 Year


Years


Years


YearsUnconditional purchase obligations

$
15.4


$
15.3


$
0.1


$



$
Long-term debt


65.1







65.1







Operating lease obligations


12.9



3.4



6.2



3.3



Aircraft lease obligation


1.9



1.5



0.4







Total

$
95.3


$
20.2


$
71.8


$
3.3


$
       Amount of Commitment Expiration per PeriodLess Than


1 - 3


4 - 5


AfterTotal


1 Year


Years


Years


5 YearsDeposits

$
8.2


$
0.7


$
7.5


$



$
Standby letters of credit


0.5



0.2







0.3



Total

$
8.7


$
0.9


$
7.5


$
0.3


$
    185




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##### Table of Contents



Item 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure  Forms 8-K 8-K/A
  Item 9A.
    Controls
    and Procedures  Evaluation
    of Disclosure Controls and Procedures
    Form 10-K Form 10-K, Form 10-K.
  Managements
    Report on Internal Control over Financial Reporting
  Rules 13a-15(e) 15d-15(e))
     186




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##### Table of Contents



Form 10-K,
  
    established procedures to document the review of press releases
    to account for transactions in a complete and timely manner;
    engaged the former Assistant Controller, who had significant SEC
    reporting experience, to serve as the Companys Controller
    and to supervise the Companys financial reporting to
    ensure compliance with SEC requirements. During the quarter
    ended June 30, 2006, the Controller left the Company, and
    the Company then engaged experienced accounting consultants to
    act as the VP Finance, Corporate Controller and Revenue
    Recognition Accountant; and
    improved the internal process of drafting and reviewing periodic
    reports by implementing additional management and external legal
    counsel review prior to their submission to the Companys
    independent registered public accounting firm.    
    insufficient controls related to the identification, capture and
    timely communication of financially significant information
    between certain parts of the organization and the accounting and
    finance department to enable these departments to account for
    transactions in a complete and timely manner;
    lack of sufficient personnel with technical accounting expertise
    in the accounting and finance department and inadequate review
    and approval procedures to prepare external financial statements
    in accordance with GAAP;
    failure in identifying the proper recognition of revenue in
    accordance with GAAP, including revenue recognized in accordance
    with Statement of Position (SOP)
    97-2,
    Software Revenue Recognition
    (SOP 97-2),
    Staff Accounting Bulletin (SAB) No. 101, Revenue
    Recognition (SAB 101), as amended by
    SAB No. 104 (SAB 104),
    SOP 81-1,
    Accounting for Performance of Construction-Type and
    Certain Production-Type Contracts
    (SOP 81-1),
    Financial Accounting Standards Board, Emerging Issues Task Force
    (EITF)
    00-21,
    Accounting for Revenue Arrangements with Multiple
    Deliverables (EITF
    00-21);
    the use of estimates, including monitoring and adjusting
    balances related to certain accruals and reserves, including
    allowance for doubtful accounts, legal charges, license fees,
    restructuring charges, taxes, warranty obligations and fixed
    assets;
    lack of sufficient analysis and documentation of the application
    of GAAP; and
    ineffective controls over the documentation, authorization and
    review of manual journal entries and ineffective controls to
    ensure the accuracy and completeness of certain general ledger
    account reconciliations conducted in connection with period end
    financial reporting.   187




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##### Table of Contents



Changes
    in Internal Control over Financial Reporting
  Form 10-Q
      
    insufficient controls related to the identification, capture and
    timely communication of financially significant information
    between certain parts of the organization and the accounting and
    finance department to enable these departments to account for
    transactions in a complete and timely manner; and
    lack of sufficient personnel with technical accounting expertise
    in the accounting and finance department and inadequate review
    and approval procedures to prepare external financial statements
    in accordance with GAAP.  Detailed
    Discussion of Material Weaknesses
   188




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##### Table of Contents



Revenue Recognition. SOP 97-2, 00-21. SOP 81-1
  
    The Company acquired its video products as part of acquisitions
    completed by the Company in 1999 and 2000, and at that time
    determined that the products would be accounted for under
    SAB 101, as amended by SAB 104. The Company did not
    sufficiently evaluate its video products and continued to
    account for its video products in accordance with SAB 104 when
    revenue on the video products should have been accounted for in
    accordance with the software revenue recognition principles
    under
    SOP 97-2.
    Additionally, the Company sold maintenance support contracts
    that included software upgrades with its video products and did
    not establish vendor specific objective evidence (VSOE) of fair
    value on the pricing of such maintenance contracts in accordance
    with
    SOP 97-2,
    SAB 104 and EITF
    00-21.
    Because the Company continued to account for the video products
    and maintenance sold with the video products under SAB 104,
    the Company did not take the steps necessary to establish VSOE
    of fair value on the pricing of its maintenance products and
    revenue was recognized during incorrect periods.
    The Company did not properly account for a significant
    transaction whereby it developed a broadcast platform based on
    its DM 6400 product to sell to its customer Thomson
    Broadcast (Thomson) in accordance with project accounting under
    SOP 81-1,
    SAB 104 and EITF
    00-21. The
    Company entered into an agreement with Thomson in December 2003
    where it agreed to develop a statistical remultiplexing product
    that would include certain features and functionality
    (BP 5100) agreed upon by the parties, as well as
    maintenance of the products purchased by Thomson for a period of
    one year. In September 2004, Thomson accepted the BP 5100
    and the Company recognized revenue on the products sold through
    September 2004 and the maintenance provided through September
    2004. In December 2004, the Company recognized revenue on the
    BP 5100s sold to Thomson and the maintenance provided to
    Thomson in the quarter ended December 31, 2004. In December
    2004, the Company extended its agreement with Thomson by
    agreeing to develop an additional software release containing
    additional features and functionality that were not developed
    under the original agreement and providing product maintenance
    for an additional period of one year. The Company should have
    accounted for the transaction as a multiple element arrangement
    under
    SOP 97-2
    and adopted the completed contract recognition criteria under
    SOP 81-1,
    which would have required the Company to delay recognizing
    revenue under its agreement with Thomson until December 2005
    when the Company completed its deliverables under the agreement.
    The Company incorrectly recorded deferred revenue and cost of
    goods sold on the balance sheet for certain transactions. As a
    result of the Companys focus on revenue recognition more
    generally as described above, the Company identified specific
    invoices for which deferred revenue for these sales had been
    recognized but the criteria for revenue recognition had not been
    met, including the criteria that delivery or performance had
    occurred, the fees were fixed or determinable or that
    collectibility was reasonably assured. Accordingly, the Company
    corrected these errors in deferred revenue, deferred cost of
    goods sold, inventory and accounts receivable accounts and
    recognized revenue when title transferred or customer payments
    were reasonably assured and all criteria for revenue recognition
    were met.  The Use of Estimates.
  
    The Company did not effectively monitor and adjust reserves
    related to its restructuring charges. In 2001, the Company
    restructured a portion of its leased facilities in Israel. The
    Company did not sufficiently review its restructuring charges to
    account for its rental of the restructured facilities such that
    at one point, the restructuring reserve exceeded the amount of
    rent due under the lease.
    The Company over accrued reserves related to the payment of
    legal fees, taxes and other liabilities owed to third party
    vendors. The Company did not have controls in place to
    accurately estimate the accruals. 189




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##### Table of Contents




    The Company used the wrong methodology to account for a prepaid
    license fee associated with the research and development of one
    of its product lines. The Company prepaid a license fee of
    $2.0 million to license technology to incorporate into the
    semiconductor chip used in its cable modem and eMTA products.
    Additionally, as part of the license agreement, the Company was
    required to pay a royalty of $1.00 per semiconductor chip
    sold to a third party. When the Company selected the method of
    amortization to be applied to the $2.0 million license fee,
    the Company opted to amortize $1.00 per chip for each chip
    utilized in the modem and eMTA products based on the third party
    rate established in the license agreement. However, the Company
    amortized the $2.0 million over the production of the
    semiconductor chips and not the sale of the modem and eMTA
    products containing the semiconductor chips. In hindsight, the
    Company should have used the useful life method, which resulted
    in quarterly adjustments as the royalty of $1.00 was overstated.
    The Company did not properly account for warranty obligations
    related to the sale of certain assets. In July 2003, the Company
    sold certain assets related to one of its products to a third
    party. Under the terms of the sale, the Company agreed to assume
    up to $1.0 million warranty obligation on the product
    related to the complaint of one customer. The Company recorded
    the $1.0 million as an accrued warranty liability. The
    Company amortized $0.8 million of the $1.0 million
    obligation during 2004. However, during the course of the
    restatement, the Company determined that the obligation should
    not have been relieved unless either there was other actual
    expenses incurred in connection with the obligation or upon the
    actual expiration of the warranty. Since the Company did not
    incur any expenses in connection with this obligation, the
    Company corrected this error by increasing the accrual $0.2
    million in each quarter of 2004. Accordingly, the warranty
    obligation of $1.0 million was relieved at March 31,
    2005 at the expiration of the warranty term.  Qualified Accounting Personnel.
  Inadequate
    Controls over Documentation and Record Keeping.
  
    The Company did not have sufficient controls to address the
    amendment of sales orders with its customers. Sales orders could
    be amended through the amendment of the sales orders, purchase
    orders and agreements. When sales were amended through sales or
    purchase orders, the person processing the amendments would
    exercise discretion in inputting the revised terms and
    conditions and there was no consistent policy requiring the
    accounting and finance department to approve such amendments or
    even informing the accounting and finance department of such
    amendments.
    The Company did not retain certain corporate records in
    conjunction with the sale of certain subsidiaries to third
    parties.
    The Company did not have sufficient controls in place to ensure
    the proper authorization and review of manual journal entries
    and the associated support documentation. Additionally, the
    Company did not keep adequate documentation related to the
    reconciliation of certain general ledger accounts.  Remediation
    Steps to Address Material Weaknesses
  Form 10-K,
  Communication
    of Financial Information.
  
    During the quarter ended June 30, 2005, the Company established
    procedures to document the review of press releases to account
    for transactions in a complete and timely manner. 190




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##### Table of Contents




    During the quarter ended June 30, 2005, the Company also
    improved the internal process of drafting and reviewing periodic
    reports by implementing additional management and external legal
    counsel review prior to their submission to the Companys
    independent registered public accounting firm.
    Continue to monitor the communication channels between our
    senior management and our accounting and finance department and
    take prompt action, as necessary, to further strengthen these
    communication channels;
    Increase staffing in the accounting and finance department;
    Re-allocate duties to persons within the accounting and finance
    organization to maximize their skills and experience;
    Implement training procedures for new employees and/or
    consultants in the accounting and finance department on our
    disclosure procedures and controls, our Company and our actions
    in previous reporting periods; and
    Take steps to ensure that our senior management has timely
    access to all material financial and non-financial information
    concerning our business.  Revenue
    Recognition.
  
    During the first three quarters of 2006, the Companys
    accounting and finance department, with the assistance of
    outside consultants, implemented procedures to recognize sales
    of its video products under the software accounting rules under
    SOP 97-2
    in accordance with GAAP.
    In 2006, the Company established pricing guidelines and internal
    procedures to ensure consistent pricing to allow for the
    establishment of VSOE of fair value for sales made with multiple
    element arrangements.
    During the second and third quarters of 2005, the accounting and
    finance department established procedures surrounding the
    month-end close process to ensure that the information and
    estimates necessary for recognizing revenue in accordance with
    SOP 97-2
    were available.
    The Company will provide its accounting staff with training on
    revenue recognition, including software accounting and project
    accounting, and GAAP, including attending seminars and
    conferences. Additional training will be provided on a regular
    and periodic basis and updated as considered necessary.
    During the quarter ended March 31, 2006, the Company hired
    an experienced revenue accountant to review all revenue
    transactions and to ensure that revenues, cost of goods sold,
    deferred revenue and deferred cost of goods sold are properly
    accounted for in accordance with GAAP and the Companys
    policies. This accountant will leave the Company following the
    completion of the restatement, and the Company intends to hire a
    replacement.  Use of
    Estimates.
  
    The Company has engaged the services of experienced accounting
    consultants to review the Companys books and close
    procedures on a monthly basis to assist management in ensuring
    that the Companys financial statements are being recorded
    in accordance with GAAP.
    The Company continues to engage the services of an outside tax
    accounting firm to assist with the calculation of the
    Companys tax liabilities.
    During the quarter ended September 30, 2006, the Company
    established a process where all significant accruals must be
    reviewed and approved by the Corporate Controller.
    During the quarter ended June 30, 2006, the Company
    implemented a process to obtain and assess accruals for legal
    costs and expenses owed to third party vendors whereby the
    Companys legal department obtains monthly estimates from
    the third party vendors and reviews the amount reported by third
    party vendors for accuracy. 191




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##### Table of Contents



Accounting
    Personnel.
  
    During the quarter ended June 30, 2006, the Company engaged
    experienced accounting consultants to act as the
    VP Finance, Corporate Controller and Revenue Recognition
    Accountant.
    During the second, third and fourth quarters of 2006, the
    Company engaged expert accounting consultants to assist the
    Companys accounting and finance department with the
    management and implementation of controls surrounding revenue
    recognition, the administration of existing controls and
    procedures, the preparation of the Companys periodic
    reports and the documentation of complex accounting transactions.
    The Company continues to take steps to recruit additional
    qualified senior accounting personnel, including certified
    public accountants personnel with recent public accounting firm
    experience.  Record
    Keeping and Documentation.
  
    During the quarter ended March 31, 2007, the Companys
    employees involved in order entry will receive training
    regarding the controls and procedures surrounding the amendment
    of sales orders. Additional training will be provided on a
    regular and periodic basis and updated as necessary to reflect
    any changes in the Companys or its customers
    business practices or activities.
    During the quarter ended June 30, 2006, the Company entered
    into agreements with third parties that purchased assets from
    the Company in Israel. These agreements provide the Company with
    access to the corporate records and require the third parties to
    retain documents in accordance with Israeli law.
    The Company has adopted a policy requiring it to retain a copy
    of all corporate records in connection with dispositions of
    assets to third parties.
    The Company has established policies and procedures for the
    review and approvals of all manual journal entries.
    Improving the review process that occurs prior to providing the
    initial draft of the periodic report to our independent auditors
    for review.
    The Company has developed monthly close schedules which include
    the timeline for completion and approval of reconciliations by
    the Corporate Controller.  Subsequent
    Changes in Internal Control over Financial Reporting
    Report of
    Independent Registered Public Accounting Firm
  REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
    INTERNAL CONTROL OVER FINANCIAL REPORTING
  The Board
    of Directors and
 Shareholders of Terayon Communication Systems, Inc.
   192




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193




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##### Table of Contents



Item 9B.  Other
    Information   PART III  Item 10.
    Directors
    and Executive Officers of the Registrant    Name

Age

PositionJerry D. Chase


47


Chief Executive Officer and
    DirectorMark A. Richman


46


Chief Financial Officer and Senior
    Vice President, Finance and AdministrationMatthew J. Aden


50


Senior Vice President, Global
    Sales and Customer SupportZaki Rakib


48


Chairman of the Board and DirectorMatthew Miller(2)


59


DirectorShlomo Rakib


49


DirectorLewis Solomon(1)(2)(3)


73


DirectorHoward W. Speaks, Jr.(1)(2)


58


DirectorDavid Woodrow(1)(3)


60


Director     (1)
    
    Member of Audit Committee(2)
    
    Member of Compensation Committee(3)
    
    Member of Nominating and Governance Committee 194




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##### Table of Contents



Jerry D. Chase
  Mark A. Richman
  Mathew J. Aden
  Dr. Zaki Rakib
  Dr. Matthew Miller
  Shlomo Rakib
 195




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##### Table of Contents



Lewis Solomon
  Howard W. Speaks, Jr.
  David Woodrow
  Board
    Committees and Meetings
  Audit
    Committee
  Form 10-K
 196




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##### Table of Contents



Audit
    Committee Financial Expert
    Compensation
    Committee
        Nominating
    and Governance Committee
       197




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##### Table of Contents



Legal
    Committee
    Section 16(a)
    Beneficial Ownership Reporting Compliance
      Code of
    Ethics
    Item 11.
    Executive
    Compensation  Summary
    Compensation Table
   198




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##### Table of Contents



Long-TermCompensationSecuritiesAnnual Compensation

Underlying

All OtherName and Principal



Salary

Bonus

Options/

CompensationPosition in Fiscal 2005

Year

($)

($)

SARs (#)

($)Jerry D. Chase(1)


2004



125,897







800,000



52,656
(4)Chief Executive Officer


2005



400,000











450
(5)Mark A. Richman(2)


2004



26,154







500,000



38
(5)Chief Financial Officer and Senior


2005



300,000











450
(5)Vice President, Finance and
    AdministrationMatthew J. Aden(3)


2005



139,167



42,066



500,000



206
(5)Senior Vice President, Global
    Sales and
    Customer Support     (1)
    
    Mr. Chase was appointed the Chief Executive Officer the
    Company effective September 2004.(2)
    
    Mr. Richman was appointed the Chief Financial Officer and
    Senior Vice President, Finance and Administration of the Company
    effective November 2004.(3)
    
    Mr. Aden was appointed Senior Vice President, Global Sales
    and Customer Support of the Company effective July 2005.(4)
    
    Represents $52,544 moving expenses paid to Mr. Chase in
    connection with the commencement of his employment and $112 in
    taxable insurance premiums.(5)
    
    Represents taxable insurance premiums.    Option
    Grants in Last Fiscal Year
  Individual Grants





Potential RealizableNumber of

Percentage of





Value at Assumed AnnualSecurities

Total Options

Exercise



Rates of Stock PriceUnderlying

Granted to

or Base



AppreciationOptions

Employees in

Price

Expiration

for Option TermName

Granted (#)

Fiscal Year

($/Sh)

Date

5% ($)

10% ($)Jerry D. Chase






















Mark A. Richman






















Matthew J. Aden


500,000



17.2
%


3.17



7/31/2015



996,798



2,526,082   twenty-five
 199




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##### Table of Contents



Aggregated
    Option Exercises in Last Fiscal Year and Fiscal Year-End Option
    Values
    Number of Securities

Value of UnexercisedUnderlying Unexercised

In-the-MoneyOptions at

Options atFiscal Year-End (#)

Fiscal Year-End ($)Name

Exercisable/Unexercisable

Exercisable/Unexercisable(1)Jerry D. Chase

250,000/550,000

160,000/352,000Mark A. Richman

135,416/364,584

43,333/116,667Matthew J. Aden

0/500,000

/     (1)
    
    Calculated on the basis of the closing price of the
    Companys common stock as reported on The NASDAQ Stock
    Market on December 30, 2005, $2.31, minus the exercise
    price.  Compensation
    of Directors
    Cash
    Compensation
    
    a monthly retainer of $2,000;
    a per meeting attendance fee of $1,000 for each Board of
    Directors or committee meeting attended; and
    for the chairs of the Audit Committee, the Compensation
    Committee and the Nominating and Governance Committee, an
    additional $500 for each committee meeting attended.    Equity
    Compensation
      
    for each outside director, an option to purchase
    60,000 shares of common stock on the date of such
    directors initial election or appointment;
    an annual grant of options to purchase 25,000 shares of
    common stock on the date of each annual meeting of stockholders,
    prorated for the
    12-month
    period prior to the annual meeting of stockholders if the
    director has not continuously served as director during such
    period; and
    for each outside director who is then serving as a member of a
    committee of the Companys Board of Directors, an option to
    purchase 6,000 shares of common stock for service on each
    such committee on the date of each annual meeting of
    stockholders, prorated for the
    12-month
    period prior to the annual meeting of stockholders if the
    director has not continuously served as a committee member
    during such
    12-month
    period. 200




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##### Table of Contents



Employment
    and Severance Agreements with Named Executive Officers
  Jerry D.
    Chase and Mark A. Richman
      
    a lump sum cash payment equal to 12 months of the
    executives then base salary;
    a lump sum cash payment equal to the greater of (1) the
    executives annual performance bonus for the most recent
    completed calendar year or (2) the executives target
    performance bonus in effect for the year of the
    termination; and
    payment for the cost of COBRA continuation premiums for the
    medical, dental and vision care benefits for the executive
    officer and his dependents for a period of up to 12 months.    
    a lump sum cash payment equal to, in the case of Mr. Chase,
    2.5 times, and in the case or Mr. Richman, 2 times,
    the sum of (1) the executive officers then base
    salary and (2) an amount that is equal to the greater of
    (a) the executives annual performance bonus for the
    most recent completed calendar year or (b) the
    executives target performance bonus in effect for the year
    of the termination;
    payment for the cost of COBRA continuation premiums for the
    medical, dental and vision care benefits for the executive
    officer and his dependents for a period of up to 30 months
    in the case of Mr. Chase, and 24 months in the case of
    Mr. Richman; and
    full vesting of all of the executive officers unvested
    stock options. 201




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##### Table of Contents



gross-up gross-up
    Matthew
    J. Aden
    
    a lump sum cash payment equal to 12 months of his then base
    salary and
    payment for the cost of COBRA continuation premiums for the
    medical, dental and vision care benefits for Mr. Aden and
    his dependents for a period of up to 12 months.    
    a lump sum cash payment equal to 2 times his then base salary;
    a lump sum cash payment equal to 2 times the greater of
    (1) Mr. Adens sales commission payments for the
    most recent completed calendar year or
    (2) Mr. Adens target sales commission payment in
    effect for the year of the termination;
    payment for the cost of COBRA continuation premiums for the
    medical, dental and vision care benefits for Mr. Aden and
    his dependents for a period of up to 24 months; and
    full vesting of all of his unvested stock options.    Compensation
    Committee Interlocks and Insider Participation
   202




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##### Table of Contents



Item 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters    Beneficial OwnershipNumber of


PercentageBeneficial Owner

Shares


OwnershipKern Capital Management, LLC(1)


11,080,800



14.3
%114 West 47th Street,
    Suite 1926New York, New York 10036Zaki Rakib(2)


4,302,040



5.5
%Shlomo Rakib(3)


4,302,040



5.5
%Jerry D. Chase(4)


466,666



*Lewis Solomon(5)


352,692



*Mark A. Richman(6)


260,416



*Matthew J. Aden(7)


187,500



*David M. Woodrow(8)


128,302



*Howard W. Speaks, Jr.(9)


67,593



*Matthew Miller(10)


57,183



*All executive officers and
    directors as a group (9 persons)(11)


10,124,432



13.0
%     (1)
    
    Kern Capital Management, LLC filed an amendment to
    Schedule 13G, dated as of February 14, 2006, with the
    Commission. Kern Capital Management, LLC reported beneficial
    ownership of 11,080,800 shares.(2)
    
    Shares beneficially owned by Dr. Zaki Rakib include
    240,000 shares of common stock held by the
    Shlomo Rakib Childrens Trust of which Dr. and
    Mrs. Rakib are trustees, and 1,300,000 shares of
    common stock underlying stock options, which are exercisable
    within 60 days of November 30, 2006. Dr. Rakib
    disclaims beneficial ownership of these shares held by the Zaki
    Rakib Childrens Trust and stock and stock options held by
    Dr. Rakibs family members, totaling
    4,302,040 shares.(3)
    
    Shares beneficially owned by Shlomo Rakib include
    240,000 shares of common stock held by the Zaki Rakib
    Childrens Trust of which Mr. And Mrs. Rakib are
    trustees, and 1,300,000 shares of common stock underlying
    stock options which are exercisable within 60 days of
    November 30, 2006. Mr. Rakib disclaims beneficial
    ownership of these shares held by the Shlomo Rakib
    Childrens Trust and stock and stock options held by
    Mr. Rakibs family members, totaling
    4,302,040 shares.(4)
    
    Shares beneficially owned include 466,666 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(5)
    
    Shares beneficially owned include 292,692 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006, as well as
    60,000 shares of common stock. 203




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##### Table of Contents



(6)
    
    Shares beneficially owned include 260,416 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(7)
    
    Shares beneficially owned include 187,500 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(8)
    
    Shares beneficially owned include 128,302 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(9)
    
    Shares beneficially owned include 67,593 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(10)
    
    Shares beneficially owned include 57,183 shares of common
    stock underlying stock options that are exercisable within
    60 days of November 30, 2006.(11)
    
    Shares beneficially owned by the Companys current
    directors and executive officers as a group include
    4,060,352 shares of common stock underlying stock options
    that are exercisable within 60 days of November 30,
    2006.  Item 13.
    Certain
    Relationships and Related Transactions    Item 14.
    Principal
    Accountant Fees and Services    2005Audit fees(1)

$
637Audit-related fees(2)


Tax fees(3)


All other fees


$
637     (1)
    
    Audit fees consist of fees for professional services rendered
    for the audit of the Companys consolidated annual
    financial statements and review of the interim consolidated
    financial statements included in quarterly reports and services
    that are normally provided in connection with statutory and
    regulatory filings or engagements. In 2005, audit fees include
    fees for professional services rendered for the audits of
    (i) managements assessment of the effectiveness of
    internal control over financial reporting and (ii) the
    effectiveness of internal control over financial reporting.(2)
    
    Audit-related fees consist of fees billed for professional
    services that are reasonably related to the performance of the
    audit or review of the Companys consolidated financial
    statements but are not reported under Audit Fees.
    Such fees include, among other things, employee benefit plan
    audits and certain consultations concerning financial accounting
    and reporting standards.(3)
    
    Tax fees consist of fees for professional services rendered for
    assistance with federal, state and international tax compliance.   204




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##### Table of Contents



de minimus
 PART IV  Item 15.
    Exhibits,
    Financial Statement Schedules  Form 10-K.
  Form 10-K.
      Form 10-K
  ExhibitNumber

Exhibit Description3
.1

Amended and Restated Certificate
    of Incorporation of Terayon Communication Systems, Inc.(11)3
.2

Bylaws of Terayon Communication
    Systems, Inc.(11)3
.3

Certificate of Amendment to
    Amended and Restated Certificate of Incorporation of Terayon
    Communication Systems, Inc.(11)3
.4

Certificate of Designation of
    Series A Junior Participating Preferred Stock.(4)4
.1

Specimen Common Stock
    Certificate.(2)4
.2

Amended and Restated Information
    and Registration Rights Agreement, dated April 6, 1998.(1)4
.3

Form of Security for Terayon
    Communication Systems, Inc.s 5% Convertible
    Subordinated Notes due August 1, 2007.(3)4
.4

Registration Rights Agreement,
    dated July 26, 2000, among Terayon Communication Systems,
    Inc. and Deutsche Bank Securities, Inc. and Lehman Brothers,
    Inc.(3)4
.5

Indenture, dated July 26,
    2000, between Terayon Communication Systems, Inc. and State
    Street Bank and Trust Company of California, N.A.(3)4
.6

Rights Agreement, dated
    February 6, 2001, between Terayon Communication Systems,
    Inc. and Fleet National Bank.(4)10
.1

Form of Indemnification Agreement
    between Terayon Communication Systems, Inc. and each of its
    directors and officers.(16)10
.2

1995 Stock Option Plan, as
    amended.(1)10
.3

1997 Equity Incentive Plan, as
    amended.(6)10
.4

1998 Employee Stock Purchase Plan,
    as amended.(9)10
.5

1998 Non-Employee Directors
    Stock Option Plan, as amended.(9)10
.6

1998 Employee Stock Purchase Plan
    Offering for Foreign Employees.(5)10
.7

1999 Non-Officer Equity Incentive
    Plan, as amended.(10) 205




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##### Table of Contents



ExhibitNumber

Exhibit Description10
.8

Azrieli Center Offices Lease
    Agreement, dated January 23, 2000, between Canit HaShalom
    Investments Ltd. and Terayon Communication Systems, Inc.(6)10
.9

Azrieli Center Agreement to
    Transfer Lease Rights, dated January 23, 2000.(8)10
.10

Data Over Cable Service Interface
    Specifications License Agreement, dated December 21, 2001,
    between Terayon Communication Systems, Inc. and Cable Television
    Laboratories, Inc.(6)10
.11

Amendment to DOCSIS IPR Agreement
    to cover DOCSIS 2.0, dated December 21, 2002, between
    Terayon Communication Systems, Inc. and Cable Television
    Laboratories, Inc.(6)10
.12

Lease Agreement, dated
    September 18, 1996, between Sobrato Interests III and
    VeriFone.(7)10
.13

Triple Net Sublease, dated
    April 1, 2002, by and between Terayon Communication
    Systems, Inc. and
    Hewlett-Packard
    Company.(7)10
.14

Aircraft Lease Agreement, dated
    February 8, 2002, between Terayon Communication Systems,
    Inc. and General Electric Capital Corporation.(8)10
.15

Letter of Credit Agreement, dated
    February 8, 2002, between Terayon Communication Systems,
    Inc. and General Electric Capital Corporation.(8)10
.16

Agreement, dated January 23,
    2004, between Terayon Communication Systems, Inc. and
    YAS Corporation.(12)10
.17

First Amendment to Aircraft Lease
    Agreement, dated December 31, 2003, between
    Terayon Communication Systems, Inc. and General Electric
    Capital Corporation.(14)10
.18

Code of Business Conduct.10
.19

Notification Letter of Intent to
    Terminate or Sublease the Aircraft Lease Agreement, dated
    March 12, 2004.(14)10
.20

Employment Agreement, dated
    July 22, 2005, between Terayon Communication Systems, Inc.
    and Jerry Chase.(17)10
.21

Proprietary Information and
    Inventions Agreement, dated July 22, 2004, between
    Terayon Communication Systems, Inc. and Jerry Chase.(13)10
.22

Aircraft Sublease Agreement, dated
    August 24, 2004, between Terayon Communication Systems,
    Inc. and United Furniture Equipment Rental, Inc.(13)10
.23

Employment Agreement, dated
    July 22, 2005, between Terayon Communication Systems, Inc.
    and Mark Richman. (17)10
.24

Proprietary Information and
    Inventions Agreement, dated November 10, 2004, between
    Terayon Communication Systems, Inc. and Mark Richman.(16)10
.25

Form of Option Agreement for the
    Terayon Communication Systems, Inc. 1997 Equity Incentive
    Plan.(15)10
.26

Form of Option Agreement for the
    Terayon Communication Systems, Inc. 1998 Non-Employee Directors
    Stock Option Plan.(16)10
.27

Lease, dated August 9, 2006
    between Sobrato Development Companies #871 and
    Terayon Communication Systems, Inc.10
.28

Triple Net
    Sub-Sublease
    Agreement, effective as of August 9, 2006, as amended,
    between Terayon Communication Systems, Inc. and Citrix
    Systems, Inc.10
.29

Employment Agreement, dated
    July 27, 2005, between Terayon Communication Systems, Inc.
    and Matt Aden. (17)10
.30

Proprietary Information and
    Inventions Agreement, dated July 27, 2005, between
    Terayon Communication Systems, Inc. and Matthew J. Aden.(17)10
.31

Amendment No. 1 to the
    Terayon Communication Systems, Inc. 1997 Equity Incentive Plan.10
.32

Non-Employee Director Equity
    Compensation Policy.10
.33

Non-Employee Director Equity
    Compensation Policy Nonstatutory Stock Option Agreement.10
.34

2006 Executive Sales Commission
    Plan.10
.35

2006 Section 16 Executive
    Officer Bonus Plan. 206




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##### Table of Contents



ExhibitNumber

Exhibit Description21
.1

List of Subsidiaries.24
.1

Power of Attorney (see signatures
    of this
    Form 10-K).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 2002.99
.1

Audit Committee Charter of Terayon
    Communication Systems, Inc.99
.2

Compensation Committee Charter of
    Terayon Communication Systems, Inc.99
.3

Nominating and Governance
    Committee Charter of Terayon Communication Systems, Inc.     (1)
    
    Incorporated by reference to exhibits to our Registration
    Statement on
    Form S-1
    filed on June 16, 1998 (File
    No. 333-56911).(2)
    
    Incorporated by reference to exhibits to our Registration
    Statement on
    Form S-1/A
    filed on July 31, 1998 (File
    No. 333-56911).(3)
    
    Incorporated by reference to our Registration Statement on
    Form S-3
    filed on October 24, 2000 (File
    No. 333-48536).(4)
    
    Incorporated by reference to our Report on
    Form 8-K
    filed on February 9, 2001.(5)
    
    Incorporated by reference to our Report on
    Form 10-K
    filed on April 2, 2001.(6)
    
    Incorporated by reference to our Report on
    Form 10-K
    filed on April 1, 2002.(7)
    
    Incorporated by reference to our Report on
    Form 10-Q
    filed on May 15, 2002.(8)
    
    Incorporated by reference to our Report on
    Form 10-K
    filed on March 27, 2003.(9)
    
    Incorporated by reference to our Report on Registration
    Statement on
    Form S-8
    filed on August 30, 2002.(10)
    
    Incorporated by reference to our Report on
    Form 10-Q
    filed on August 14, 2003.(11)
    
    Incorporated by reference to our Report on
    Form 8-K
    filed on November 21, 2003.(12)
    
    Incorporated by reference to our Report on
    Form 10-Q
    filed on July 27, 2004.(13)
    
    Incorporated by reference to our Report on
    Form 10-Q
    filed on November 9, 2004.(14)
    
    Incorporated by reference to our Report on
    Form 10-K
    filed on March 15, 2004.(15)
    
    Incorporated by reference to our Report on
    Form 8-K
    filed on September 14, 2004.(16)
    
    Incorporated by reference to our Report on
    Form 10-K
    filed on March 15, 2005.(17)
    
    Incorporated by reference to our Report on
    Form 10-Q
    filed on August 9, 2005. 207




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##### Table of Contents



(4)(d)
    Financial Statement Schedules
      Balance atBeginning of








Balance atPeriod


Charges


Deductions


End of PeriodDecember 31, 2005:Allowance for doubtful
    accounts  U.S.

$
2,254


$
5,036


$
(4,481
)

$
2,809Allowance for doubtful
    accounts  International














Total Allowance for doubtful
    accounts


2,254



5,036


$
(4,481
)


2,809Reserve for inventory valuation


12,267



2,732



(7,146
)


7,853Valuation allowance on deferred
    tax assets


226,560



3,261







229,821December 31, 2004 (as
    restated):Allowance for doubtful
    accounts  U.S.

$
6,037


$
4,014


$
(7,797
)

$
2,254Allowance for doubtful
    accounts  International


473







(473
)


Total Allowance for doubtful
    accounts


6,510



4,014



(8,270
)


2,254Reserve for inventory valuation


12,291



11,550



(11,574
)


12,267Valuation allowance on deferred
    tax assets


227,978







(1,418
)


226,560December 31, 2003 (as
    restated):Allowance for doubtful
    accounts  U.S.

$
201


$
6,131


$
(295
)

$
6,037Allowance for doubtful
    accounts  International


1,576







(1,103
)


473Total Allowance for doubtful
    accounts


1,777



6,131



(1,398
)


6,510Reserve for inventory valuation


25,473



4,025



(17,207
)


12,291Valuation allowance on deferred
    tax assets


244,803







(16,825
)


227,978  208




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##### Table of Contents



SIGNATURES      
  Chief Executive Officer
  attorney-in-fact Form 10-K, attorney-in- attorney-in-fact
    Signature

Title

Date/s/  Jerry
    D. ChaseJerry
    D. Chase

Chief Executive Officer and
    Director

December 29, 2006/s/  Mark
    A. RichmanMark
    A. Richman

Chief Financial Officer
    (Principal Financial Officer,
    Principal Accounting Officer)

December 29, 2006/s/  Zaki
    RakibDr.
    Zaki Rakib

Chairman of the Board of Directors

December 29, 2006/s/  Shlomo
    RakibShlomo
    Rakib

Director

December 29, 2006/s/  Lewis
    SolomonLewis
    Solomon

Director

December 29, 2006/s/  David
    WoodrowDavid
    Woodrow

Director

December 29, 2006/s/  Matthew
    MillerDr.
    Matthew Miller

Director

December 29, 2006/s/  Howard
    W. SpeaksHoward
    W. Speaks, Jr.

Director

December 29, 2006  209