<PAGE>
================================================================================

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                              --------------------


                                   FORM 10 - Q


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


                  FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002

                         Commission File Number 0-11630

                              ---------------------


                        TERAFORCE TECHNOLOGY CORPORATION
             (Exact Name of Registrant as Specified in Its Charter)


                    DELAWARE                                   76-0471342
        (State or Other Jurisdiction of                     (I.R.S. Employer
         Incorporation or Organization)                   Identification No.)

   1240 EAST CAMPBELL ROAD, RICHARDSON, TEXAS                    75081
    (Address of Principal Executive Offices)                   (Zip Code)

                                  469-330-4960
              (Registrant's Telephone Number, Including Area Code)

                              ---------------------


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

There were 89,088,850 shares of Common Stock outstanding as of April 30, 2002.


================================================================================


<PAGE>


                TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES

                                      INDEX

<Table>
<Caption>
                                                                                                             PAGE
                                                                                                             ----
<S>                <C>                                                                                       <C>
PART I             FINANCIAL INFORMATION

ITEM 1             FINANCIAL STATEMENTS

                   Consolidated Balance Sheets of the Company
                   at March 31, 2002 (unaudited) and December 31, 2001                                          2

                   Consolidated Statements of Operations of the Company
                   (unaudited) for the three months ended March 31, 2002 and 2001                               3

                   Consolidated Statements of Cash Flows of the Company
                   (unaudited) for the three months ended March 31, 2002 and 2001                               4

                   Notes to Consolidated Financial Statements                                                   5

ITEM 2             MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                   CONDITION AND RESULTS OF OPERATIONS                                                          8

ITEM 3             QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                                   12

PART II            OTHER INFORMATION

ITEM 1             LEGAL PROCEEDINGS                                                                           12

ITEM 2             CHANGES IN SECURITIES AND USE OF PROCEEDS                                                   12

ITEM 6             EXHIBITS AND REPORTS ON FORM 8-K                                                            12

</Table>


<PAGE>


                         PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

                TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
                           Consolidated Balance Sheets
                    (Thousands of dollars, except share data)

<Table>
<Caption>
                                                                       March 31,         December 31,
                                                                         2002                2001
                                                                      -----------        ------------
                                                                      (unaudited)
<S>                                                                   <C>                <C>
                                    Assets
Current assets:
   Cash and cash equivalents                                          $     4,183        $          1
   Investments                                                                 53                  53
   Accounts receivable, net of allowances of $1,606 in 2002
     and $1,691 in 2001                                                     1,000                 869
   Receivable from affiliate                                                  799                 816
   Inventories                                                              3,027               3,262
   Prepaid services                                                           700                  --
   Net current assets of discontinued operations                               --               2,880
   Prepaid expenses                                                           196                 224
                                                                      -----------        ------------
              Total current assets                                          9,958               8,105

Property and equipment, net                                                   639                 638
Investment in affiliate                                                     1,314               1,284
Other assets                                                                  220                 169
                                                                      -----------        ------------
                                                                      $    12,131        $     10,196
                                                                      ===========        ============

                Liabilities and Stockholders' Equity (Deficit)

Current liabilities:
   Notes payable                                                      $     6,700        $      7,554
   Accounts payable                                                           964               1,864
   Accrued liabilities                                                      1,285               2,389
                                                                      -----------        ------------
              Total current liabilities                                     8,949              11,807

Stockholders' equity (deficit):
   Common Stock, $.01 par value. Authorized 200,000,000 shares;
     87,088,850 shares issued                                                 871                 871
   Additional paid-in capital                                             181,907             181,898
   Accumulated deficit                                                   (178,009)           (182,793)
                                                                      -----------        ------------
                                                                            4,769                 (24)
   Less 400,474 shares of common stock in treasury at cost                 (1,587)             (1,587)
                                                                      -----------        ------------
              Total stockholders' equity (deficit)                          3,182              (1,611)
                                                                      -----------        ------------
                                                                      $    12,131        $     10,196
                                                                      ===========        ============
</Table>


See accompanying notes to consolidated financial statements.


                                       2
<PAGE>


                TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
                      Consolidated Statements of Operations
                        (Thousands except per share data)


<Table>
<Caption>
                                                             Three Months Ended March 31,
                                                             ----------------------------
                                                                2002              2001
                                                             ----------        ----------
                                                                     (unaudited)
<S>                                                          <C>               <C>
Net revenue                                                  $    1,630        $    3,054
Cost of revenue                                                     759             3,174
                                                             ----------        ----------
                Gross profit                                        871              (120)
                                                             ----------        ----------

Expenses:
   Engineering and development                                    1,037             1,547
   Selling and administrative                                     1,237             2,849
                                                             ----------        ----------
                                                                  2,274             4,396
                                                             ----------        ----------
                Operating loss                                   (1,403)           (4,516)
                                                             ----------        ----------

Other income (expense):
   Litigation settlement                                          6,300                --
   Earnings of unconsolidated affiliate                              30                --
   Interest expense                                                (104)               (4)
   Other                                                            (39)               30
                                                             ----------        ----------
                                                                  6,187                26
                                                             ----------        ----------
Income (loss) from continuing operations                          4,784            (4,490)

Loss from discontinued operations                                    --              (415)
                                                             ----------        ----------

Net income (loss)                                            $    4,784        $   (4,905)
                                                             ==========        ==========

Basic and diluted income (loss) per share:
   Continuing operations                                     $     0.06        $    (0.05)
   Discontinued operations                                           --             (0.01)
                                                             ----------        ----------
     Net income (loss) per share                             $     0.06        $    (0.06)
                                                             ==========        ==========

Weighted average number of common shares outstanding -
   Basic and diluted                                             86,688            85,698
                                                             ==========        ==========
</Table>

See accompanying notes to consolidated financial statements.


                                       3
<PAGE>


                TERAFORCE TECHNOLOGY CORPORATION AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows
                             (Thousands of dollars)

<Table>
<Caption>
                                                                         Three Months Ended March 31,
                                                                         ----------------------------
                                                                            2002              2001
                                                                         ----------        ----------
                                                                                 (unaudited)
<S>                                                                      <C>               <C>
Cash flows from operating activities:
   Net income (loss)                                                     $    4,784        $   (4,905)
   Adjustments to reconcile net income (loss) to
     net cash used in operating activities:
        Litigation settlement                                                (6,300)               --
        Utilization of prepaid services                                         300                --
        Depreciation and amortization                                            54               310
        Earnings of unconsolidated affiliate                                    (30)               --
        Other                                                                    83               (16)
        Change in operating assets and liabilities:
             Accounts receivable                                                  9             1,214
             Inventories                                                        235            (1,714)
             Assets held for sale                                                --               995
             Accounts payable and accrued liabilities                        (1,716)             (195)
                                                                         ----------        ----------
               Net cash used in operating activities                         (2,581)           (4,311)
                                                                         ----------        ----------

Cash flows from investing activities:
   Proceeds from litigation settlement                                        6,300                --
   Capital expenditures                                                         (55)             (139)
   Net proceeds from disposal of discontinued operations                      1,372                --
   Other                                                                         --                16
                                                                         ----------        ----------
               Net cash provided by (used in) investing activities            7,617              (123)
                                                                         ----------        ----------

Cash flows from financing activities:
   Proceeds from issuance of notes payable                                      500                --
   Principal payments on notes payable                                       (1,354)               --
                                                                         ----------        ----------
               Net cash used in financing activities                           (854)               --
                                                                         ----------        ----------

Net increase (decrease) in cash and cash equivalents                          4,182            (4,434)
Cash and cash equivalents, beginning of period                                    1             5,587
                                                                         ----------        ----------
Cash and cash equivalents, end of period                                 $    4,183        $    1,153
                                                                         ==========        ==========
</Table>


See accompanying notes to consolidated financial statements.


                                       4
<PAGE>


                        TERAFORCE TECHNOLOGY CORPORATION
                   Notes to Consolidated Financial Statements
                                   (Unaudited)
                                 March 31, 2002


BASIS OF PRESENTATION

         The accompanying consolidated financial statements have been prepared
by the Company without audit in accordance with accounting principles generally
accepted in the United States of America for interim financial statements and
with instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion
of management, all adjustments (consisting only of normal recurring accruals)
considered necessary for a fair presentation have been included.

         The accompanying consolidated financial statements do not include
certain footnotes and financial presentations normally required under accounting
principles generally accepted in the United States of America and, therefore,
should be read in conjunction with the audited financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2001.

         The Company incurred an operating loss in the first quarter of 2002 and
has incurred significant operating losses in 2001, 2000 and 1999. These losses
were funded by proceeds from the issuance of equity securities and notes
payable, and as of March 31, 2002 notes payable due within one year amounted to
$6,700,000. In 2001 and through January 2002, the Company has disposed of
certain operations and assets and has reduced operating expenses. In addition,
revenues from the Company's defense electronics business increased in the first
quarter of 2002 and have increased in each of the last three years, and are
expected to continue to increase in 2002. Accordingly, management expects the
Company to generate positive cash flow from operations by the end of 2002.
However, until that point, the Company expects to generate losses and negative
cash flow from operations.

         In January, 2002 the Company received cash proceeds of $1,660,000 from
the sale of its engineering design services business and in March, 2002 received
cash proceeds of $6,300,000 from the settlement of litigation. Management
believes that these amounts will be sufficient to fund its negative cash flow
from operations during 2002; however, management does not believe these amounts
will be sufficient to repay all outstanding debt as it comes due. Therefore, the
continued existence of the Company is dependent on the refinancing or
restructuring of these obligations.

         The Company believes that it will be able to refinance or restructure
the outstanding notes payable due in 2002 through either the issuance of equity
securities, the incurrence of new debt or the modification of the terms of the
existing notes payable. There can be no assurance the Company can refinance or
restructure this outstanding debt or that it can do so under acceptable terms.
These financial statements have been prepared assuming the Company will continue
as a going concern and do not include any adjustments that might result from the
outcome of this uncertainty.


                                       5
<PAGE>


INVENTORIES

         The components of inventories are as follows:

<Table>
<Caption>
                                           March 31,     December 31,
                                             2002            2001
                                           ---------     ------------
                                                ($ Thousands)
<S>                                        <C>           <C>
         Raw materials                     $   2,336     $      2,615
         Work in process                         481              493
         Finished goods                          210              154
                                           ---------     ------------
                        Total              $   3,027     $      3,262
                                           =========     ============
</Table>

SEGMENTS OF BUSINESS

         Net revenue by business segment:


<Table>
<Caption>
                                   Three Months Ended March 31,
                                   ----------------------------
                                      2002              2001
                                   ----------        ----------
                                          ($ Thousands)
<S>                                <C>               <C>
Defense electronics                $    1,630        $    1,318
Optical networking equipment               --             1,555
Other                                      --               181
                                   ----------        ----------
                                   $    1,630        $    3,054
                                   ==========        ==========
</Table>

         Not reflected above are net revenues from engineering design services
for the three months ended March 31, 2001 in the amount of $1,511,000.

         Segment-specific margins (gross profit less total engineering and
development costs, including capitalized software for the segment):

<Table>
<Caption>
                                               Three Months Ended March 31,
                                               ----------------------------
                                                  2002              2001
                                               ----------        ----------
                                                      ($ Thousands)
<S>                                            <C>               <C>
        Defense electronics                    $       97        $      (21)
        Optical networking equipment                 (101)             (905)
        Other                                        (162)             (741)
                                               ----------        ----------
           Subtotal segment specific                 (166)           (1,667)
        All other expenses                         (1,237)           (2,849)
                                               ----------        ----------
                   Operating loss              $   (1,403)       $   (4,516)
                                               ==========        ==========
</Table>

Assets identifiable only by combined segments:

<Table>
<Caption>
                                           At March 31,       At December 31,
                                               2002                2001
                                           ------------       ---------------
                                                   ($ Thousands)
<S>                                        <C>                <C>
Defense electronics                        $      4,092       $         4,052
Optical networking equipment and other            2,553                 2,625
Not allocable to a segment                        5,486                 3,519
                                           ------------       ---------------
           Total                           $     12,131       $        10,196
                                           ============       ===============
</Table>


                                       6
<PAGE>


INCOME TAXES

         For the three months ended March 31, 2002, the Company's effective
income tax rate differed from the federal statutory rate due to current period
tax expense offset by a decrease in the valuation allowance for the same amount.
For the three months ended March 31, 2001 the Company's effective income tax
rate differed from the federal statutory rate due to taxable losses incurred for
which no benefit was provided.

EARNINGS PER SHARE

         Basic and diluted earnings per share are the same for the three months
ended March 31, 2002 and 2001 because all potential common shares were
anti-dilutive for those periods.

STOCKHOLDERS' EQUITY

         In April, 2002 the Company issued 2,000,000 shares of common stock in
exchange for the return and cancellation of warrants to purchase a total of
26,017,308 shares of common stock. The warrants had an exercise price of $0.75
per share. If the Company's common stock trades at a price of $0.75 or more for
ten consecutive trading days prior to October 14, 2002, the Company will be
required to issue an additional 3,000,000 shares of common stock.


                                       7
<PAGE>


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE PERIOD ENDED MARCH 31, 2002

Forward Looking Statement

This Quarterly Report on Form 10-Q contains certain forward looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. In this report,
as well as in oral statements made by the Company, statements that are prefaced
with the words "may," "will," "expect," "anticipate," "believe," "continue,"
"estimate," "project," "intend," "designed" and similar expressions are intended
to identify forward-looking statements regarding events, conditions and
financial trends that may affect the Company's future plans, business strategy,
results of operations, financing activities and financial position. These
statements are based on the Company's current expectations and estimates as to
prospective events and circumstances about which the Company can give no firm
assurance. Further, any forward-looking statement speaks only as of the date the
statement was made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date the
statement was made. Because it is not possible to predict every new factor that
may emerge, forward-looking statements should not be relied upon as a prediction
of actual future financial condition or results. Examples of types of forward
looking statements include statements on future levels of net revenue and cash
flow, new product development, strategic plans and financing. These forward
-looking statements involve risks and uncertainties that could cause actual
results to differ materially from those projected or anticipated. Factors that
might cause such a difference include, but are not limited to: general economic
conditions in the markets the Company operates in; the ability of the Company to
execute its plan in strategic direction; success in the development and market
acceptance of new and existing products; dependence on suppliers, third party
manufacturers and channels of distribution; customer and product concentration;
fluctuations in customer demand; the ability to obtain and maintain access to
external sources of capital; the ability to control costs; overall management of
the Company's expansion; and other risk factors detailed from time to time in
the Company's filings with the Securities and Exchange Commission. The terms
"we," "our" and "us" and similar terms refer to the Company and its consolidated
subsidiaries, not to any individual or group of individuals.

         Our engineering design services business was sold in January 2002. As
of December 31, 2001 this business is accounted for as a discontinued operation
in our financial statements. Accordingly, net revenue, cost of revenue and
expenses in the accompanying financial statements do not include any amounts
related to these operations. The net operating results of this business is
reflected as loss from discontinued operations in the accompanying statement of
operations.

--------------------------------------------------------------------------------
COMPARISON OF FIRST QUARTER 2002 TO FIRST QUARTER 2001
--------------------------------------------------------------------------------

         The following table shows the revenue and gross profit for the
Company's products:

<Table>
<Caption>
                                   Three Months Ended March 31,
                                   ----------------------------
                                      2002              2001
                                   ----------        ----------
                                          ($ Thousands)
<S>                                <C>               <C>
Net revenue:
Defense electronics                $    1,630        $    1,318
Optical networking equipment               --             1,555
Other                                      --               181
                                   ----------        ----------
                                   $    1,630        $    3,054
                                   ----------        ----------
Gross profit (loss):
Defense electronic products        $      871        $      420
Optical networking equipment               --                --
Other                                      --              (540)
                                   ----------        ----------
                                   $      871        $     (120)
                                   ----------        ----------
</Table>


                                       8
<PAGE>

NET REVENUE

         Net revenue from defense electronics increased 24% in the first quarter
of 2002 as compared to the first quarter of 2001. This increase reflects an
increasing demand for our products, including our PowerPC based products that we
began shipping to customers in the fourth quarter of 2000. First quarter 2002
amounts also reflect continued sales of our products based on Texas Instruments'
digital signal processors that we have been shipping to customers since 1997.
Although our net revenues have increased, we believe that there has been a
temporary decrease in new order activity in the defense electronics industry. We
believe this slowdown reflects reevaluations of programs within the Department
of Defense and changes in priorities.

         Net revenue from optical networking products during 2001 represent
sales related to our OmniLynx product line. In August 2001, we sold the OmniLynx
product line to Intelect Technologies, Inc.

GROSS PROFIT

         Gross profit from defense electronics increased 107% in the first
quarter of 2002 as compared to the first quarter of 2001. The 2002 gross profit
is equal to approximately 53% of net revenue from the sale of these products.
The increase in gross profit is a result of increased net revenue in 2002 as
compared to 2001, higher utilization of fixed production costs, and the sale of
products with lower material costs than in prior periods.

         As of December 31, 2000 all assets related to the OmniLynx product line
were adjusted to the lower of cost and net realizable value. Accordingly, sales
of OmniLynx products during the first quarter of 2001 produced no gross profit.

ENGINEERING AND DEVELOPMENT EXPENSE

         Engineering and development expense decreased 33% to $1,037,000 in the
first quarter of 2002 from $1,547,000 in the same period in 2001. Costs by
product line are as follows:

<Table>
<Caption>
                                  Three Months Ended March 31,
                                  ----------------------------
                                     2002              2001
                                  ----------        ----------
                                        ($ Thousands)
<S>                               <C>               <C>
Defense electronics               $      774        $      441
Optical networking products              101               397
Other                                    162               709
                                  ----------        ----------
                                  $    1,037        $    1,547
                                  ==========        ==========
</Table>

         Engineering and development expenses related to defense electronics in
the first quarter of 2002 reflect on-going enhancements of our PowerPC based
products, including "ruggedized" versions of these products. The reduced
expenses related to optical networking products reflect significantly reduced
activity on our Aegean project. Unless we are able to secure outside financing
for this project, we expect to suspend all activity related to this project.
Other engineering and development expenses in the first quarter of 2002 related
to our Centauri project. We suspended all activity related to the Centauri
project in March 2002. Included in engineering and development expenses during
the first quarter of 2002 is approximately $300,000 related to design services
provided by Flextronics International, Ltd. These services are provided under
the engineering design services agreements we entered into when we sold our
engineering design services business in January 2002. Other engineering and
development expenses in the first quarter of 2001 include approximately $500,000
of costs related to the engineering organization involved with the OmniLynx
product line.


                                       9
<PAGE>


SELLING AND ADMINISTRATIVE EXPENSE

         Selling and administrative expenses decreased $1,612,000, or 57%, in
the first quarter of 2002 as compared to the first quarter of 2001.
Approximately $1,380,000 of this decrease relates to costs associated with the
OmniLynx product line. The remainder of the decrease results primarily from
reduced administrative costs.

LITIGATION SETTLEMENT

         In March 2002 we settled our outstanding litigation against Cadence
Design Systems, Inc. We received $6,300,000, net of attorney fees, from this
settlement.

INTEREST EXPENSE

         Interest expense increased by $100,000 in the first quarter of 2002 as
compared to the first three months of 2001 because of increased borrowings.

--------------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
--------------------------------------------------------------------------------

         As of March 31, 2002, the Company has working capital of $1,009,000,
including cash and cash equivalents of $4,183,000. Notes payable amount to
$6,700,000 as of March 31, 2002. Of this amount, $100,000 is due on demand,
$6,000,000 is due May 31, 2002 and $600,000 is due October 12, 2002. The cash
and cash equivalents arose primarily from proceeds from the settlement of
litigation and from the disposal of discontinued operations.

OPERATING ACTIVITIES

         Net cash used in operating activities amounted to $2,581,000 during the
three months ended March 31, 2002. This amount arose primarily from the
operating loss of $1,403,000 and the payment of accounts payable and accrued
liabilities totaling $1,716,000. These amounts were offset by the utilization of
a prepayment for engineering design services with Flextronics International,
Ltd. of $300,000 and by a reduction in inventories of $235,000.

INVESTING ACTIVITIES

         For the three months ended March 31, 2002, investing activities
provided cash in the amount of $7,617,000. This amount consists primarily of
$6,300,000 from the settlement of litigation and $1,372,000 from the disposal of
discontinued operations, net of $288,000 of costs related to these operations.
Capital expenditures for the first quarter of 2002 were $55,000 and related
primarily to production test equipment.

FINANCING ACTIVITIES

         In the first quarter of 2002 we borrowed $500,000 for general working
capital purposes under a demand note. We repaid a total of $1,354,000 in demand
notes from the proceeds of the litigation settlement and the disposal of
discontinued operations.

LIQUIDITY OUTLOOK

         During 2001 and the first quarter of 2002 we have eliminated
significant costs from our operations. Furthermore, net revenues from our
defense electronics business increased in the first


                                       10
<PAGE>


quarter of 2002 as compared to previous quarters. We generally expect these
revenues to continue to increase in 2002. However, due to the nature of our
business and the timing of orders and shipments of products, there may be
periods during which revenues decline. If revenues from our defense electronics
business increase and costs do not increase from the levels we currently
anticipate, we expect to generate positive cash flow from operations by about
the third quarter of 2002. As a result of the proceeds received from the
disposal of discontinued operations and the settlement of litigation we have
cash and cash equivalents of $4,183,000 as of March 31, 2002. We expect this to
be sufficient to fund our operating activities until we begin to generate
positive cash flow from operations.

         However, as of March 31, 2002 we have notes payable of $6,700,000, of
which $6,000,000 is due May 31, 2002. We do not expect that our existing cash
flow from operations to be adequate to repay this debt when it matures.
Therefore, we intend to restructure this debt by either replacing it with other
debt instruments, repaying it from the proceeds of issuing new equity or debt
securities, or amending the terms of the obligations so that the debt is not due
in 2002. While we expect to accomplish this restructuring, we have not yet done
so, and there is no assurance that we will before the debt becomes due. If we
were to issue equity securities or debt that is convertible into common stock,
there could be significant dilution to existing common shareholders.

         If we do not restructure the debt due on May 31, 2002 by that date, it
is likely that we will default on those obligations. In that case, the parties
that have guaranteed that debt will be obligated to repay those borrowings and
we will have demand obligations to those parties in an amount equal to the debt
that they repay. In that event, these parties will have collateral rights in
most of our accounts receivable and inventory. In addition, they will be our
largest creditor and could demand payment at any time. They could therefore be
in a position to obtain a judgment against the Company and exert significant
influence over our actions.

         Our consolidated financial statements have been prepared on the basis
that we are a going concern and do not include any adjustments that might be
necessary if this were not the case. These adjustments include changes in the
possible future recoverability and classification of assets or the amount and
classification of liabilities.

         Our estimate of capital needs is subject to a number of risks and
uncertainties that could result in additional capital needs that have not been
anticipated. An important aspect of our estimated capital requirements is our
ability to generate positive cash flow from operations. This in turn is
dependent upon our ability to increase revenues from our defense electronics
business, to generate adequate gross profit from those sales and to control
other costs and expenses. Our capital needs could increase materially if any of
our contingent liabilities are resolved adversely to us. In addition, we could
require more working capital if the defense electronics business increases more
rapidly than we currently anticipate.

CONTINGENT LIABILITIES

         As discussed in "ITEM 3 - Legal Proceedings" in the Company's Annual
Report on Form 10-K, the Company is exposed to certain contingent liabilities
which, if resolved adversely to the Company, would adversely affect its
liquidity, its results of operations, and/or its financial position.


                                       11
<PAGE>


ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We have outstanding debt amounting to $6,000,000 that bears interest at
a variable interest rate. This interest is based on a widely used reference
interest rate known as LIBOR. An increase of 50 basis points in LIBOR would
result in an increase in our annual interest expense of $30,000.

         As of March 31, 2002 we have cash and temporary investments of
$4,183,000. The majority of this amount is invested in money market funds which
pay interest at rates that fluctuate with market conditions. A decrease of 50
basis points in the interest rate which these investments pay would result in a
decrease in our annual interest income of approximately $20,000.

                           PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

         In March 2002, we settled the litigation we had brought against Cadence
Design Systems, Inc. ("Cadence"). Under the settlement Cadence paid $9,450,000,
of which we retained $6,300,000 after payment of legal fees. (See Current Report
of Form 8-K filed March 15, 2002.)

ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS

         In April 2002 we issued a total of 2,000,000 shares of our common stock
in exchange for the return and cancellation of warrants for the purchase of
26,017,308 shares of common stock. In addition, should our common stock trade at
a price of $0.75 or more for ten consecutive trading days prior to October 14,
2002, we will issue an additional 3,000,000 shares of common stock. These shares
are deemed restricted under federal security laws. We have agreed to register
these shares for resale with the SEC.

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

         A.  Listed below are all Exhibits filed as part of this report.

<Table>
<Caption>
Exhibit  Description of Exhibit
-------  ----------------------
<S>      <C>
4.1      Exchange Agreement dated April 11, 2002 between the Company and St.
         James Capital Partners, L.P. and SJMB, L.P.

4.2      Registration Rights Agreement dated April 11, 2002 between the Company
         and St. James Capital Partners, L.P. and SJMB, L.P.

4.3      Exchange Agreement dated April 11, 2002 between the Company and The
         Coastal Corporation Second Pension Trust

4.4      Registration Rights Agreement dated April 11, 2002 between the Company
         and The Coastal Corporation Second Pension Trust
</Table>

         B. The Company has not filed any report on Form 8-K during the period
covered by this Report, except as follows:

              Current report on Form 8-K dated January 14, 2002, as amended by
              Form 8-K/A filed March 25, 2002

              Current report on Form 8-K filed March 15, 2002.


                                       12
<PAGE>


                                   SIGNATURES

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

                        TERAFORCE TECHNOLOGY CORPORATION.
                                  (Registrant)



Date:    May 10, 2002              /s/ ROBERT P. CAPPS
         -------------------       ---------------------------------------------
                                    Robert P. Capps
                                    Chief Financial Officer
                                    (Principal Financial and Accounting Officer)



Date:    May 10, 2002              /s/ HERMAN M. FRIETSCH
         -------------------       ---------------------------------------------
                                    Herman M. Frietsch
                                    Chief Executive Officer and Director
                                    (Principal Executive Officer)



                                       13
<PAGE>


                               INDEX TO EXHIBITS

<Table>
<Caption>
EXHIBIT
NUMBER   DESCRIPTION
-------  -----------
<S>      <C>
4.1      Exchange Agreement dated April 11, 2002 between the Company and St.
         James Capital Partners, L.P. and SJMB, L.P.

4.2      Registration Rights Agreement dated April 11, 2002 between the Company
         and St. James Capital Partners, L.P. and SJMB, L.P.

4.3      Exchange Agreement dated April 11, 2002 between the Company and The
         Coastal Corporation Second Pension Trust

4.4      Registration Rights Agreement dated April 11, 2002 between the Company
         and The Coastal Corporation Second Pension Trust
</Table>