Adrian Mongeli, et al. v. Terayon Communication Systems, Inc., et al. 06-CV-03936-Declaration Of

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281-SF/7512727.3 Case Number: 3-06-CV-03936 MJJ

DECLARATION OF SHEILA A. JAMBEKAR

MORGAN, LEWIS & BOCKIUS LLPJohn H. Hemann (Bar No. 165823)Michael J. Lawson (Bar No. 66547)Sheila A. Jambekar (Bar No. 239101)

One MarketSpear Street TowerSan Francisco, CA 94105Tel: (415) 442-1000Fax: (415) 442-1001

ERNST & YOUNG LLPBruce M. CormierJoel E. Bonner (Bar No. 105492)

1225 Connecticut Avenue, NWWashington, D.C. 20036Tel: (202) 327-7603Fax: (202) 327-7601

Attorneys for DefendantERNST & YOUNG LLP

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

SAN FRANCISCO DIVISION

ADRIAN MONGELI, Individually, And On Behalf Of All Others Similarly Situated,

Plaintiff,

vs.

TERAYON COMMUNICATIONS SYSTEMS, INC., ZAKI RAKIB, JERRY D. CHASE, MARK A. RICHMAN, EDWARD LOPEZ, RAY FRITZ, CAROL LUSTENADER, MATTHEW MILLER, SHLOMO RAKIB, DOUG SABELLA, CHRISTOPHER SCHAEPE, MARK SLAVEN, LEWIS SOLOMON, HOWARD W. SPEAKS, ARTHUR T. TAYLOR, DAVID WOODROW, and ERNST & YOUNG LLP,

Defendants.

Case No. 3-06-CV-03936 MJJ

CLASS ACTION

DECLARATION OF SHEILA A. JAMBEKAR IN SUPPORT OF DEFENDANT ERNST & YOUNG LLP’S MOTION TO DISMISS AND REQUEST FOR JUDICIAL NOTICE

Hearing Date: June 26, 2007Time: 9:30 a.m.Dept.: Courtroom 11Judge: Hon. Martin J. JenkinsAction Filed: June 23, 2006

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281-SF/7512727.3 1 Case Number: 3-06-CV-03936 MJJ


I, Sheila A. Jambekar, declare as follows:

1. I am an attorney at law, duly licensed to practice before this Court and the Courts

of the State of California. I am an associate with the law firm of Morgan, Lewis & Bockius LLP,

attorneys for Defendant Ernst & Young LLP (“Ernst & Young”). The facts set forth herein are

known to me personally, and if called upon to testify, I could and would testify competently to

those facts.

2. This Declaration is made in support of Defendant Ernst & Young’s Request for

Judicial Notice in Support of Its Motion to Dismiss.

3. On March 7, 2007, I searched LIVEDGAR via the website, www.gsionline.com,

for Terayon Communication Systems, Inc.’s (“Terayon’s”)10-K filings for the years ending

December 31, 2001, December 31, 2002, December 31, 2003, December 31, 2004 and December

31, 2005. LIVEDGAR is a database through which U.S. Securities and Exchange Commission

filings can be obtained.

4. Attached as Exhibit A is a true and correct copy of the cover page, table of

contents, and pages 35 through 73 of Terayon’s 10-K filing for the year ending December 31,

2001, that I obtained from searching LIVEDGAR.

5. Attached as Exhibit B is a true and correct copy of the cover page, table of

contents, and pages 54 through 103 of Terayon’s 10-K filing for the year ending December 31,

2002, that I obtained from searching LIVEDGAR.

6. Attached as Exhibit C is a true and correct copy of the cover page, index, and

pages 53 through 89 of Terayon’s 10-K filing for the year ending December 31, 2003, that I

obtained from searching LIVEDGAR.

7. Attached as Exhibit D is a true and correct copy of the cover page, index, and

pages 56 through 92 of Terayon’s 10-K filing for the year ending December 31, 2004, that I

obtained from searching LIVEDGAR.

8. Attached as Exhibit E is a true and correct copy of the cover page, index, and

pages 48 and 49 of Terayon’s 10-K filing for the year ending December 31, 2005, that I obtained

from searching LIVEDGAR.

www.gsionline.com,

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281-SF/7512727.3 2 Case Number: 3-06-CV-03936 MJJ


9. On March 20, 2007, I went to the Yahoo! Finance website at

http://finance.yahoo.com/, typed the ticker symbol for Terayon (TERN.PK) into a text box in the

upper left corner of the page, and clicked on the link entitled “Get Quotes.” On the next page that

opened, I then chose the link entitled “Historical Prices.” Then, on the next page that opened

after that, I set the date range for June 1, 2001 until March 31, 2006 and clicked the link “Get

Prices.” This opened a new page with a table containing daily stock price information for

Terayon between June 1, 2001 until March 31, 2006. I then clicked on the link “Download to

Spreadsheet,” which opened a new window containing the same stock price data in an Excel

spreadsheet. Attached as Exhibit F is a true and correct copy of the printout of that Excel

spreadsheet containing information regarding Terayon’s daily stock prices for the period of June

1, 2001 until March 31, 2006.

I declare under penalty of perjury under the laws of the United States and the State of

California that the foregoing is true and correct. Executed on this 23rd day of March 2007, in San

Francisco, California.

/S/Sheila A. Jambekar

http://finance.yahoo.com/,

Exhibit A

Table of Contents

SECURITIES AND EXCHANGE COMMISSIO N

Washington , D .C . 2054 9

Form 10-K

(Mark one)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 193 4For the fiscal year ended December 31, 2001

orTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 193 4For the transition period from to

Commission File Number: 000-24647

Terayon Communication Systems, Inc.(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction ofincorporation or organization

2952 Bunker Hill Lane

77-0328533(IRS Employ-

Identification No )

Santa Clara, California 95054(408)727-440 0

(Address, including zip code, and telephone number , including area code, of the registrant's principal executive offices)

Secu ri ties registered pursuant to Section 12(b) of the Act :

Title of Each Class :Name of each exchangeon Which Registered :

None None

Secu rities registered pursuant to Section 12(g) of the Act :

Common Stock, par value $0.001 per share(Title of Class)

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 1934during 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 filingrequirements for the past 90 days . Yes 0 No ❑

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to

the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K .

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock onMarch 28, 2002 as reported on the Nasdaq National Market, was approximately $471,647,933 . Shares of Common Stock held by each officer and directorand by each person known to the Company who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may bedeemed to be affiliates . This determination of affiliate status is not necessarily a conclusive determination for other purposes .

As of March 28, 2002, registrant had outstanding 72,701,056 shares of Common Stoc k

DOCUMENTS INCORPORATED BY REFERENC E

Portions of the definitive Proxy Statement to be filed with the Securities and Exchange Commission in May 2002, pursuant to Section 14 of theSecurities Exchange Act of 1934, in connection with the 2001 Annual Meeting of Stockholders of Terayon Communication Systems, incorporated : Part III .

TABLE OF CONTENT S

PARTIItem 1 . BusinessItem 2 . Propertie sItem ; . Leal ProceedinesItem 4 . Submission of Matters to a Vote of Security Holders

PART l IItem 5 . Market for the Re iistrant's Common Equity and Related Stockholder MattersItem 6 . Selected Financial DataItem 7 . Manaeement's Discussion and Analysis of Financial Condition and Results of OperationsItem 7a. Market Risk Disclosure Informatio nItem 8 . Financial Statements and Sunolementa1y Dat aItem 9 . Changes in and Disaereements with Accountants on Accounting and Financial Disclosures

PART II IItem 10 . Directors and Officers of the Remst rantItem 11 . Executive CompensationItem 12 . Security Ownership of Certain Beneficial Owners and ManagementItem 13 . Certain Relationship and Related Transactions

PART I VItem 14 . Exhibits. Financial Statement Schedules, and Reports on Form 8 K

SIGNATURE SEXHIBIT INDEXEXHIBIT 10 .3EXHIBIT 10 .14EXHIBIT 10 .15EXHIBIT 10 .16EXHIBIT 10 .17EXHIBIT 10 .18EXHBIIT 21 .1EXHIBIT 23 .1

Table of Content s

Item 8. Financial Statements and Supplementary Data

TERAYON COMMUNICATION SYSTEMS, INC .

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Pag e

Report of Ernst & Young LLP, Independent Auditors 36Consolidated Balance Sheets 37Consolidated Statements of Operations 38Consolidated Statements of Stockholders' Equity 39-40Consolidated Statements of Cash Flows 41Notes to Consolidated Financial Statements 42-73

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Table of Contents

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Terayon Communication Systems, In c

We have audited the accompanying consolidated balance sheets of Terayon Communication Systems, Inc . as of December 31, 2001 and 2000, and the

related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2001 . Ouraudits also included the financial statement schedule listed in the index at Item 14(a) . These financial statements and schedule are the responsibility of theCompany's management . Our responsibility is to express an opinion on these financial statements and schedule based on our audits .

We conducted our audits in accordance with auditing standards generally accepted in the United States . Those standards require that we plan and

perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement . An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financial statements . An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overall financial statement presentation . We believe that our audits provide areasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of

Terayon Communication Systems, Inc . at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the threeyears in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States . Also, in our opinion, therelated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects,the information set forth therein .

/s/ ERNST & YOUNG LL P

San Jose , Californi a

January 28, 2002

36

Table of Contents


CONSOLIDATED BALANCE SHEETS

December 31 ,

2001 2000

(In thousands,except share data)

ASSETSCurrent assets :

Cash and cash equivalents $ 100,274 $ 347,01 5Short-term investments 233,614 215,442Accounts receivable, less allowance for doubtful accounts o f

$7,207 in 2001 and $6,542 in 2000 48,386 42,772Accounts receivable from related parties 4,006 17,454Other current receivables 7,476 32,02 7Inventory 16,658 87,76 7Other current assets 13,462 7,02 1

Total current assets 423,876 749,49 8Property and equipment, net 25,279 33,53 3Intangibles and other assets, net 17,491 643,69 6

Total assets $ 466,646 $1,426,72 7

LIABILITIES AND STOCKHOLDERS'EQUIT YCurrent liabilities :

Accounts payable $ 42,821 S 123,994Accrued payroll and related expenses 9,441 13,10 5Deferred revenues 4,169 4,99 8Warranty reserves 8,368 5,92 5Accrued purchase price payable - 14,13 8Accrued restructuring charges 8,197 -Accrued vendor cancellation charges 17,291 19,00 0Other accrued liabilities 14,015 6,71 9Current portion of long-term debt 3,273 10,85 3Short-term debt - 2,69 7Current portion of capital lease obligations 126 13 1

Total current liabilities 107,701 201,56 0Long-term debt 2,467 11 9Long-term portion of capital lease obligations ° 233 35 8Other long ,term obligations 1,800 3,444Convertible subordinated notes 174,141 500,00 0Deferred tax liability - 18,56 5Commitments and contingencie sStockholders' equity :

Preferred stock, $0 .001 par value :Authorized shares - 5,000,00 0Issued and outstanding shares - none in 2001 and 2000 - -

Common stock, $0 .001 par value :Authorized shares - 200,000,000Issued - 72,201,322 in 2001 and 67,431,261 in 200 0Outstanding - 72,073,483 in 2001 and 67,396,539 in 2000 73 6 8

Additional paid in capital 1,074,203 1,037,964Accumulated deficit (892,994) (329,148 )Deferred compensation (458) (6,788 )Stockholders' notes receivable - (3 )Treasury Stock, at cost ; 127,839 shares in 2001 and 34,722

shares in 2000 (768) (73 )Accumulated other comprehensive income 248 66 1

Total stockholders' equity 180,304 702,68 1

Total liabilities and stockholders' equity $ 466,646 $1,426,727

See accompanying notes .

37

Table of Contents


CONSOLIDATED STATEMENTS OF OPERATION S

Revenues:Product revenuesRelated party product revenues

Total revenues

Cost of goods sold :Cost of product revenue sCost of related party product revenuesSpecial charge s

Total cost of goods sold

Gross profitOperating expenses :

Research and developmentCost of product development assistance agreementIn-process research and developmen tSales and marketingGeneral and administrativeGoodwill amortizationRestructuring costs and asset write-offs

Total operating expenses

Loss from operationsInterest incomeInterest expenseOther expens e

Loss before extraordinary gain and tax benefitIncome tax benefit

Loss before extraordinary gainExtraordinary gain on early retirement of debt

Net loss

Years Ended December 31,

2001 2000

(In thousands , except per share data)

$ 227,036 $ 220,22 8<7 AA< 110 Z21

279,481 339,549

196,430 205,78733,181 64,74433,506 19,000

263,117 289,53 1

16,364 50,01 8

79,927 68,27 0- 9,563- 30,53 5

55,701 45,26 131,309 24,80925,410 59,05 7

587,149 -

779,496 237,49 5

(763,132) (187,477 )18,132 19,79 4

(15,224) (11,265 )(2,864) ( 1,819 )

(763,088) (180,767 )(13,915) -

(749,173) (180,767 )12 l,)7 -

Basic and diluted net loss per share before extraordinary gainExtraordinary gain on early retirement of debt

Basic and diluted net loss per share

Shares used in computing historical basic and diluted net loss pershare applicable to common stockholders

$ (563,846)

$ (10.96)2 .71

$ (8.25 )

68,331

$(180,767)

$ (2 .95)

$ (2.95 )

61,349

1999

$ 57,34539,664

97,009

46,21525,82 9

72,044

24,965

17,57935,14714,60015,727

7,4763,52 4

94,053

(69,088 )5,101

(93 )

(64,080)

(64,080 )

$ (64,080)

$ (1 .55)

$ (1 .55 )

41,26 0


38

Table of Contents


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUIT Y

AccumulatedCommon Stock Additional Stockholders ' Other Treasury Stock Total

Paid-in Accumulated Deferred Notes Comprehensive Stockholders '

Shares Amount Capital Deficit Compensation Receivable Income Shares Amount Equity

(In thousands , except share amounts)Balance at

December 31, 1998 32,916,242 $ 16 $ 114,594 . $ (84,301) $ (2,184) $ (22) $ $ $ 28,103Issuance of commo n

stock, net issuancecosts 4,203,892 2 75,123 75,12 5

Exercise of options fo rcash to purchasecommon stock 1,927,986 1 2,486 2,48 7

Exercise of commo nstock warrant fo rcash 6,000,000 3 19,497 19,50 0

Cash proceeds fro mpayment on aStockholder notereceivable - 16 1 6

Amortization ofunearne dcompensation relate dto stock - 631 63 1

Issuance of warrant t opurchase commonstock - 35,587 35,58 7

Issuance of commo nstock for Employe eStock Purchase Plan 202,326 1,170 1,17 0

Compensation expenserelated to optionacceleration forterminatedemployees 856 85 6

Compensation expens efor common stockissued in exchang efor services 61 6 1

Compensation expensefor common stockissued in lieu ofbonus 1,192 25 25

Acquisition of ImediaCorporation 1,714,814 1 106,737 106,73 8

Acquisition of Radwi zLimited 1,992,306 1 52,718 52,719

Comprehensive income : -Increase in unrealized

gain on short-terminvestments - (283) (283 )

Net loss (64,080) (64,080 )

Comprehensiveloss (64,363)

Balance a tDecember 31, 1999 48,958,758 24 408,854 (148,381) (1,553) (6) (283) 258,65 5

Exercise of option forcash to purchasecommon stock 1,935,675 3 14,180

Repurchase of commonstock (34,722 )

Cash proceeds frompayment o nstockholders notesreceivable

Unearned compensationrelated to stockoptions 3,497

Amortization ofunearne dcompensation relate dto stoc k

Issuance of warrant topurchase commonstock 44,14 3

Issuance of commonstock for EmployeeStock Purchase Plan 277,060 2,08 8

Issuance of commonstock in relation toStock Split 22 (22 )

Cashless exercise ofwarrants 3,687,618 4 (4)

Acquisitions :Telgate 4,440,000 4 95,96 9ANE 1,404,552 2 83,475

34,722

3

(3,497)

3,465

14,183

(73) (73)

3

3,465

44,143

2,088

95,97383,477

Internet Telecom 377,380 1 46,47 3Ultracom 536 , 766 1 58,63 7Combox 1,547,770 2 98,782Mainsail 2 , 969,062 3 162,556Digitrans 762,133 1 15,320True Chat 534,487 1 2,663

Purchase priceadjustment on 1999acquisitions 1,353

Comprehensive income:Increase to unrealized

gain on short-terminvestments

Cumulativ etranslatio nadjustment

Net loss ( 180,767 )

Comprehensiveloss

46,47458,63898,784

(4,719) 157,84015,321

(484) 2,180

1,353

(153) (153)

1,097 1,097(180,767)

(179,823 )

Balance atDecember 31, 2000 67,396,539 $ 68 $1,037,964 $ (329,148) $ (6,788) $ (3) $ 661 34,722 $ (73) $ 702,681

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Table of Contents


CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - (Continued )

A ccumulate dCommon Stock Additional Stockholders ' Other Treasury Stock Tota l

Paid-in Accumulated Deferred Notes Comprehensive Stockholders 'Shares Amount Capital Deficit Compensation Receivable Income Shares Amount Equity

(In thousands, except share amounts)Exercise of option for

cash to purchasecommon stock 2,507,582 $ 4 $ 12,494 $ 12,498

Repurchase of commonstock (93,117) 93,117 (695) (695)

Issuance of options 719 (719) -Amortization of

deferredcompensation 5,815 5,81 5

Adjustments to deferredcompensation due toemploye eterminations (1,234) 1,234 -

Issuance of restrictedcommon stock fo rservices provided 275,250 1,237 1,23 7

Issuance of commonstock for Employe eStock Purchase Plan 381,428 1,966 1,96 6

Issuance of warrants topurchase commo nstock 1,187 1,18 7

Issuance of commonstock for tender offer 141,442 2,001 2,00 1

Issuance of commo nstock for retiremen tof debt 1,464,359 1 17,869 17,870

Cash proceeds fro mpayment onstockholders notesreceivable 3 3

Comprehensive income : -Increase to unrealize d

gain on short-terminvestments 208 208

Cumulativ etranslatio nadjustment (621) (621 )

Net loss (563,846) (563,846)

Comprehensiv eloss (564,259)

Balance a tDecember 31, 2001 72,073,483 $ 73 $1,074,203 $ (892,994) $ (458) $ - $ 248 127,839 $ (768) $ 180,304


40

Table of Contents


CONSOLIDATED STATEMENTS OF CASH FLOW S

Years Ended December 31 ,

2001 2000 1999

(In thousands )Operating activities :Net loss $ (563,846) $ (180,767) $ (64,080)Adjustments to reconcile net loss to net cash (used in) provide d

by operating activities :Depreciation 15,728 11,284 2,12 1Write-off and amortization of intangible assets 619,157 106,305 6,08 9In-process research and development - 30,535 14,60 0Amortization related to stock options 5,815 3,465 63 1Compensation expense relating to issuance of commo n

stock to employees 2,001 - 2 5Loss on disposal of fixed assets 1,600 - 3 3Extraordinary gain on early retirement of debt (185,327)Compensation expense for common stock issued in

exchange for consulting services 1,237 - 6 1Value of common and preferred stock warrants issued 505 9,563 35,587Option acceleration related to a terminated employee - - 856

Changes in operating assets and liabilities :Accounts receivable (5,614) (28,757) (11,925)Accounts receivable from related parties 13,448 (10,173) (5,732)Inventory 71,109 (82,776) (1,041 )Other assets 16,606 (18,876) (2,305 )Accounts payable (81,173) 110,777 4,617Accrued payroll and related expenses (3,664) 7,167 3,463Deferred revenues (829) 457 4,54 1Warranty reserves 2,443 3,240 1,62 1Accrued restructuring charges 8,197 - -Accrued vendor cancellation charges (1,709) 19,000 -Other accrued liabilities 7,296 16,189 2,93 3Deferred taxes (18,565) 7,567 -Current portion of long term debt - 10,853 -Other non-current liabilities 704 5,661 5

Net cash (used in) provided by operating activities (94,881) 20,714 (7,900 )

Investing activities :Purchases of short-term investments (402,653) (376,108) (217,323 )Proceeds from sales and maturities of short-term Investments 384,689 240,744 150,98 4Purchases of property and equipment (9,074) (38,534) (4,718)Officer note receivable - - 100Purchase of developed technology - - (1,850)Purchase ofother assets - (17,969) (508 )Cash received from acquisitions - - 2,65 9Cash paid for acquisition of businesses - (14,848) (250 )Pre-acquisition loan to Imedia - - (1,800 )

Net cash (used in) investing activities (27,038) (206,715) (72,706 )

Financing activities:Principal payments on capital leases (130) (12) (28)Principal payments on long-term debt (24,415) - -Proceeds from long-term debt - 484,429 43Increase in other non-current liabilities - - 35 5Exercise of options and warrant to purchase common stock 12,498 14,183 21,98 3Payments on repurchase of common stock (695) (73 )Principal payments on stockholder notes receivable 3 3 1 6Debt repurchase of convertible notes (113,428) - -Proceeds from issuance of common stock 1,966 2,088 76,29 3

Net cash (used in) provided by financing activities (124,201) 500,618 98,66 2Effect of exchange rate changes (621) - -

Net decrease in cash and cash equivalents (246,741) 314,617 18,056Cash and cash equivalents at beginning of year 347,015 32,398 14,342Cash and cash equivalents at end of year $ 100,274 $ 347,015 $ 32,398

Supplemental disclosures of cash flow information :Cash paid for income taxes $ 31 $ - $ -Cash paid for interest $ 20,810 $ 365 $ -Supplemental noncash investing and financing activities :Common shares issued for settlement of convertible debt $ 17,900 $ - $ -

Acquisition of businesses $ - $ 565,228 $ 161,864Deferred Compensation relating to common stock issued t o

non-employees $ 684 - $ -Reduction in deferred compensation due to termination of

employees $ 1,234 $ - $ -Issuance of warrants in connection with purchase of TrueChat $ 682 $ - $ -

See accompanying notes

41

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NOTES TO CONSOLIDATED FINANCIAL STATEMENT S

1 . Organization and Summary of Significant Accounting Policie s

Description of Business

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

Company reincorporated in the State of Delaware .

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

Basis of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned and majority owned subsidiaries . All intercompany

balances and transactions have been eliminated .

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to makeestimates and assumptions that affect the amounts reported in the financial statements and accompanying notes . Actual results could differ from thoseestimates .

Foreign Currency Translation

For operations outside the U .S . that prepare financial statements in currencies other than the U .S. dollar, results of operations and cash flows are

translated at average exchange rates during the period, and assets and liabilities are translated at end-of-period exchange rates . Translation adjustments areincluded as a separate component of accumulated other comprehensive income (loss) in stockholders' equity . For the three years ended December 31, 2001,translation gains and losses were not significant .

Concentrations of Credit Risk, Customers, Suppliers, and Products

The Company operates in two principal operating segments : Cable Broadband Access Systems (Cable) and Telecom Access Systems (Telecom) . TheCompany sells primarily to customers within the cable and telecommunications industries, including related parties (see Note 13) . The Company performsongoing credit evaluations of its customers and generally requires no collateral . A relatively small number of customers account for a significant percentageof the Company's revenues and accounts receivable . The Company expects that the sale of its products to a limited number of customers and resellers maycontinue to account for a high percentage of revenues for the foreseeable future .

Currently, the Company relies on single source suppliers of materials and labor for the significant majority of its product inventory but is activelypursuing additional supplier alternatives . As a result, should the Company's current suppliers not produce and deliver inventory for the Company to sell on atimely basis, operating results may be adversely impacted .

Substantially all of the Company's revenues have been attributable to sales of the TeraLink and the TeraPro . These products are expected to account fora significant part of the Company's revenues for the foreseeable future . As a result, a decline in demand for or failure to achieve broad market acceptance ofthe TeraLink or the TeraPro would adversely affect operating results .

In addition, market acceptance of the Company's products may be affected by the emergence and evolution of industry standards . While the Companyexpects its products to become compliant with industry standards, its inability to do so may adversely affect operating results .

42

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TERAYON COMMUNICATION SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

The Company invests its excess cash in debt instruments of governmental agencies, and corporations with credit ratings of AA/ AA- or better or A1/P1 or better, respectively. The Company has established guidelines relative to diversification and maturities that a ttempt to maintain safety and liquidity .The Company has not experienced any significant losses on its cash equivalents or short- term investments .

Revenue Recognition

The Company sells its products directly to broadband access service providers, system resellers and distributors and recognizes revenue upon shipmentto the customer when title is transferred . Revenues related to product sales are generally recognized when : (1) persuasive evidence that an arrangementexists, (2) delivery has occurred or services have been rendered, (3) the seller's price to the buyer is fixed or determinable, and (4) collectibility isreasonably assured . The Company's existing agreements with its system resellers and distributors do not contain price protection provisions and do notgrant return rights beyond those provided by the Company's standard warranty .

Research and Development Expenses

Research and development expenses are charged to expense as incurred .

Shipping and Handling Costs

Costs related to shipping and handling are included in cost of sales for all periods presented .

Advertising Expenses

The Company accounts for advertising costs as expense in the period in which they are incurred . Advertising expense for the years ended December 31,2001 and 2000 were $2 .3 million and $1 .0 million, respectively . Advertising expenses were not significant in 1999 .

The Company has entered into co-marketing arrangements with Rogers Cablesystems, Inc . ("Rogers"), a related party (see Note 13) and ShawCommunications, Inc . ("Shaw") . Such amounts, totaling $7 .5 million for Shaw and $2 .9 million for Rogers, are included in other current assets . TheCompany may be required to charge such activities against revenues in accordance with EITF 01-09, "Accounting for Consideration given by a Vendor to aCustomer or Reseller in Connection with the Purchase or Promotion of the Vendor's Products . "

Net Loss Per Share Applicable to Common Stockholders

Historical basic and diluted net loss per share was computed using the weighted average number of common shares outstanding . Options, warrants,restricted stock and preferred stock were not included in the computation of historical diluted net loss per share because the effect would be antidilutive .

Shares used in the calculation of historical basic and diluted net loss per share follows (in thousands, except per share data) :

Net loss

Shares used in computing historical basic and diluted net lossper shar e

Historical basic and diluted net loss per share


2001 2000 1999

$ (563,846) $ (180,767) $ (64,080)

68,331 61,349 41,260$ (8.25) $ (2.95) $ (1 .55 )

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ( Continued)

Options to purchase 20,007,686, 21,489,536 and 10,342,338 shares of common stock were outstanding at December 31, 2001, 2000 and 1999,respectively, and warrants to purchase 2,408,300, 2,072,318 and 4,072,318 shares of common stock were outstanding at December 31, 2001, 2000 and1999, respectively, but were not included in the computation of diluted net loss per share, since the effect is antidilutive .

Derivative Financial Instruments

As of January 1, 2001, the Company adopted Financial Accounting Standards Board Statement No . 133, "Accounting for Derivative Instruments andHedging Activities" (SFAS 133) . As a result of the adoption of SFAS 133, the Company will recognize all derivative financial instruments, such as foreignexchange contracts, in the consolidated financial statements at fair value regardless of the purpose or the intent for holding the instrument . Changes in thefair value of derivative financial instruments are either recognized periodically in income or in shareholders' equity as a component of comprehensiveincome depending on whether the derivative financial instrument qualifies for hedging accounting, and if so, whether it qualifies as a fair value hedge orcash flow hedge. Generally, changes in fair values of derivatives accounted for as fair value hedges are recorded in income along with the portions of thechanges in the fair values of the hedged items that relate to the hedged risks . Changes in fair values of derivatives accounted for as cash flow hedges, to theextent they are effective as hedges, are recorded in other comprehensive income, net of deferred taxes . Changes in fair value of derivatives used as hedges ofthe net investment in foreign operations are reported in other comprehensive income as part of the cumulative translation adjustment . Changes in fair valueof derivatives not qualifying as hedges are reported in income .

As the Company had no derivative financial instruments outstanding as of December 31, 2001 or December 31, 2000, the adoption of SFAS 133 had noimpact on the financial statements of the Company at December 31, 2001 or December 31, 2000 .

Cash Equivalents and Short- Term Investments

The Company invests its excess cash in money market accounts and debt instruments and considers all highly liquid debt instruments purchased with anoriginal maturity of three months or less to be cash equivalents . Investments with an original maturi ty at the time of purchase of over three months areclassified as sho rt-term investments regardless of maturity date as all investments are classified as available- for-sale and can be readily liquidated to meetcurrent operational needs .

The Company accounts for investments in accordance with Statement of Financial Accounting Standards No . 115, "Accounting for Certain Investmentsin Debt and Equity Securities" . Management determines the appropriate classification of debt securities at the time of purchase and reevaluates suchdesignation as of each balance sheet date . The Company's short-term investments, which consist primarily of commercial paper, U .S . government andU.S . government agency obligations and fixed income corporate securities, are classified as available-for-sale and are carried at amortized cost whichapproximates fair market value . Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities areincluded in interest income . The cost of securities sold is based on the specific identification method . The Company had no material investments in equitysecurities at either December 31, 2001 or December 31, 2000 .

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ( Continued )

Inventory

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

December 31 ,

2001 2000

Finished goods $ 6,433 $64,987Work- in process 236 1,736Raw materials 9,989 21,044

$16,658 $ 87,76 7

Other Current Receivables

As of December 31, 2001, other current receivables included approximately $5 .2 million due from contract manufacturers for raw mate ri als purchasedfrom the Company .

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation and amortization . Property and equipment are depreciated for financialreporting purposes using the straight-line method over the estimated useful lives, generally three to five years . Leasehold improvements are amortized usingthe straight-line method over the shorter of the useful lives of the assets or the terms of the leases . The recoverability of the carrying amount of property andequipment is assessed based on estimated future undiscounted cash flows, and if an impairment exists, the charge to operations is measured as the excess ofthe carrying amount over the fair value of the assets . Based upon this method of assessing recoverability, the Company recorded $1 .6 million in assetimpairment during 2001 related to assets acquired in the purchase of Access Network Electronics Division of Tyco Electronics Corporation ("ANE") . Noasset impairment occurred in 2000 or 1999 .

Property and equipment are as follows (in thousands) :

December 31 ,

2001 2000

Software and computers $` 25,328 $ 20,44 8Furniture and equipment 29,754 25,70 8Leasehold improvements 3,573 3,090Automobiles 37 5 8Construction in progress 4,805 5,11 9

63,497 54,423Accumulated depreciation and amortization (38,218) (20,890)

Property and equipment, net $ 25,279 $ 33,53 3

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Intangibles and Other Assets

Intangibles and other assets consisted of the following (in thousands) :

December 31 ,

2001 2000

Goodwill $ 3,072 $ 503,60 6Assembled workforce 20,769 28,30 0Other intangibles 202,730

23,841 734,636Accumulated amortization (20,074) (112,394)

Intangibles, net 3,767 622,242Other assets 13,724 21,45 4

Total intangibles and other assets $ 17,491 $ 643,69 6

Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for as purchases .During 2001, $0.7 million was added to goodwill relating to an increase in the purchase price of TrueChat (see Note 14) and $4 .5 million was added toassembled workforce relating to retention payments in conjunction with the acquisition of ANE (see Note 14) .

Impairment of Goodwill and Other Long-Lived Assets

Goodwill and other long-lived assets are reviewed for impairment whenever events such as product discontinuance, plant closures, product dispositionsor other changes in circumstances indicate that the carrying amount may not be recoverable . When such events occur, the Company compares the carryingamount of the assets to undiscounted expected future cash flows . If this comparison indicates that there is an impairment, the amount of the impairment istypically calculated using discounted expected future cash flows . The discount rate applied to these cash flows is based on the Company's weighted averagecost of capital, which represents the blended costs of debt and equity.

During 2001, the Company recorded impairment charges for goodwill and other intangible assets (see Note 6) .

Warranty Reserves

The Company provides a standard warranty for most of its products, generally lasting one year from the date of purchase . The Company provides forthe estimated cost of product warranties at the time revenue is recognized . The Company's warranty obligation is affected by product failure rates, materialusage and service delivery costs incurred in correcting a product failure . Reserve estimates are based on historical experience and expectation of futureconditions .

Stock-Based Compensatio n

The Company accounts for its employee stock plans in accordance with Accounting Principles Board Opinion No . 25, "Accounting for Stock Issued toEmployees" (APB Opinion No . 25), and includes the disclosure-only provisions as required under Statement of Financial Accounting Standards No . 123,"Accounting for Stock-Based Compensation" (SFAS 123) .

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Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income presented in the accompanying consolidated balance sheets and statements of stockholders' equity consistsof net unrealized gain on short-term investments and accumulated net foreign currency translation losses .

The following are the components of comprehensive income (loss) :

2001 2000 1999

Net loss $ (563,846) $ (180,767)Cumulative translation adjustments (621) (153)Change in unrealized gain (loss) on available-for-sal e

investments 208 1,097

Total comprehensive loss $(564,259) $(179,823)

Reclassification

Certain amounts reported in previous years have been reclassified to conform to the 2001 presentation .

Impact of Recently Issued Accounting Standards

$ (64,080)

(283 )

$ (64,363 )

In August 2001, the Financial Accounting Standards Board issued FAS No . 144, "Accounting for the Impairment or Disposal of Long-lived Assets" .FAS No . 144 supercedes FAS No . 121, "Accounting for the Impairment of Long-lived Assets and Assets to be Disposed of' and the accounting andreporting provisions of Accounting Principles Board Opinion No . 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transaction ." FAS No . 144 also amends Accounting ResearchBulletin No . 5 1, "Consolidated Financial Statements," to eliminate the exception to consolidation for a subsidiary for which control is likely to betemporary . The provisions of FAS No . 144 will be effective for fiscal years beginning after December 15, 2001 . The effect of adopting FAS No . 144 hasbeen evaluated by the Company, and does not have a material adverse effect on Terayon's financial position or results of operations .

In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No . 141, Business Combinations, andNo . 142, Goodwill and Other Intangible Assets . Statement 141 requires that the purchase method of accounting be used for all business combinationsinitiated after June 30, 2001 . Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assetsarising from business combinations completed after June 30, 2001 . Statement 142 prohibits the amortization of goodwill and intangible assets withindefinite useful lives . Statement 142 requires that these assets be reviewed for impairment at least annually . Intangible assets with finite lives will continueto be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity methodinvestments no longer be amortized.

The Company will apply Statement 142 beginning in the first quarter of 2002 . Application of the nonamortization provisions of Statement 142 willsignificantly reduce amortization expense that was approximately $25 .4 million in fiscal 2001 . The Company will reclassify identifiable intangible assetswith indefinite lives, as defined by Statement 142, to goodwill at the date of adoption . The Company will test goodwill for impairment using the two-stepprocess prescribed in Statement 142 . The first step is a screen for potential impairment, while the second step measures the amount of the impairment, ifany. The Company expects to perform the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 inthe first quarter of 2002 . Any impairment charge resulting from these transitional impairment tests will be reflected as the cumulative effect of a change inaccounting principle in the first

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quarter of 2002 . Based on the preliminary unaudited analysis completed to date, we do not believe that the application of these statements will have anadverse material impact on the earnings and financial position of the Company .

2 . Fair Value of Financial Instruments

The following estimated fair value amounts have been determined using available market information and appropriate valuation methodologies .However, considerable judgment is required in interpreting market data to develop the estimates of fair value . Accordingly, the estimates presented hereinare not necessarily indicative of the amounts that the Company could realize in a current market exchange .

December 31, 2001

Gross GrossAmortized Unrealized Unrealized Estimated

Short- term Investments Cost Gains Losses Fair Valu e

(In thousands )Investments maturing in less than 1 year :Commercial paper $ 77,670 $ 24 $ - $ 77,69 4Fixed income corporate securities 40,194 6 - 40,200Government agency obligations 7,954 (6) - 7,94 8

Total $125,818 $ 24 $ - $125,84 2Investments maturing in 1 - 2 years :Fixed income corporate securities 31,276 568 - 31,844Government agency obligations 75,498 430 - 75,92 8

Total $106,774 $ 998 $ - $107,772

Total $ 232,592 $1,022 $ - $ 233,61 4

December 31, 2000

Gross GrossAmortized Unrealized Unrealized Estimated

Short-term Investments Cost Gains Losses Fair Valu e

(In thousands )Investments maturing in less than 1 year :Commercial paper $ 86,638 $ - $ - $ 86,63 8Fixed income corporate securities 84,557 190 - 84,747Government agency obligations 44,000 57 - 44,05 7

Total $215,195 $ 247 $ - $ 215,442

Realized gains and losses were insignificant for each of the years in the three year period ended December 31, 2001 .

3 . Commitment s

Leases

The Company leases its facilities and certain equipment under operating leases . The operating leases for the Company's facilities expire in 2002 and2003 . Rent expense was approximately $7,249,940, $4,165,600, and $1,013,000, for the years ended December 31, 2001, 2000, and 1999, respectively . InOctober 1999, the Company subleased the facilities formerly occupied by Imedia Corporation to a third party through 2003 . Sublease rental income wasapproximately $90,914 and $243,600 for the years ended December 31, 2001 and

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2000 and $57,400 for the period from September 16, 1999 (acquisition date) to December 31, 1999 . The lease was terminated in 2001 .

The Company leases certain equipment under noncancelable lease agreements that are accounted for as capital leases . Equipment under capital leasearrangements included in property and equipment aggregated approximately $1,207,461 and $1,273,960 at December 31, 2001 and 2000, respectively .Related accumulated amortization was approximately $796,376 and $432,398 at December 31, 2001 and 2000, respectively . Amortization expense relatedto assets under capital leases is included in depreciation expense . The capital leases are secured by the related equipment and the Company is required tomaintain liability and property damage insurance .

Future minimum lease payments under noncancelable operating leases and capital leases are as follows (in thousands) :

December 31, 2001

Operating Leases Capital Leases

2002 $ 5,316 $ 15 42003 3,954 16 92004 3,160 8 02005 2,391 -

Total minimum payments $14,821 40 3

Less amount representing interest 44

359Less current portion 12 6

Long term portion $ 233

There are no future minimum sublease payments to be received under noncancelable subleases due to the termination of the lease .

Purchase Obligations

The Company has purchase obligations to certain of its suppliers that support the Company's ability to manufacture its products . The obligationsrequire the Company to purchase minimum quantities of the suppliers' products at a specified price . During fiscal year 2001, the Company recorded specialcharges of $33 .5 million relating to vendor cancellation fees . As of December 31, 2001, the Company had approximately $58 .7 million of purchaseobligations, of which $17 .3 million is included on the balance sheet as accrued vendor cancellation charges . The remaining obligations are expected tobecome payable at various times through mid-2003 .

As of December 31, 2001 the Company had $1 .6 million in unused letters of credit outstanding .

Royalties

The Company has purchased, through its acquisition of Radwiz Limited ("Radwiz"), certain technology that was developed by Radwiz and a formersister company utilizing funding provided by the Israeli Chief Scientist of the Ministry of Industry and Trade ("OCS") . The purchase of the technology wasapproved by the OCS . As a condition for this approval, the Company has committed to pay royalties to the Government of Israel on proceeds from sales ofproducts based on this technology. Royalty rates are 3% - 5% . Royalties are payable from the commencement of sales of products based on the technologyuntil the cumulative amount of the royalties paid and accrued by the Company equals 100% of the funding received from the OCS . The

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Company's total obligation for royalties, based on royalty-bearing government participations received or accrued, net of royalties paid or accrued, totaled

approximately $2 .0 million at December 31, 2001 .

4 . Debt Obligation s

In connection with the acquisition of Mainsail Networks the Company assumed $3,520,000 Senior Secured Promissory Note . The note is secured by the

general assets of Mainsail Networks and bears an interest rate equal to ten percent per annum . Interest accrued monthly. The promissory note wassubsequently paid in full on April 30, 2001 .

5 . Accrued Severance Pa y

Several of the Company's subsidiaries are subject to Israeli law and labor agreements, under which they are required to make severance payments todismissed employees and employees leaving its employment in certain other circumstances . The subsidiaries' severance pay liability to its employees,which is calculated on the basis of the salary of each employee for the last month of the reported year multiplied by the years of such employee'semployment is included in the Company's consolidated balance sheet on the accrual basis, and is partially funded by a purchase of insurance policies in thesubsidiaries' name . At December 31, 2001, approximately $1,800,000 for accrued severance pay was included in other long-term obligations .Approximately $1,115,000 relating to the amounts funded by the purchase of insurance policies was included in other assets at December 31, 2001 .

6 . Restructuring Charges and Asset Write-offs

The Company incurred restructuring charges in the amount of $12 .7 million and a write-down of impaired assets in the amount of $1 .6 million for the

year ended December 31, 2001 . The write-down of $1 .6 million related to fixed assets acquired from ANE that were determined to have no remaininguseful life. Of the total restructuring charges, $3 .2 million relates to employee termination costs covering 293 technical, production and administrativeemployees . As of December 31, 2001, approximately 240 employees have been terminated and we paid approximately $2 .0 million in termination costs .

The remaining $9 .5 million of restructuring charges relates primarily to costs for excess leased facilities . Included in the remaining $9 .5 million are$3 .4 million of charges incurred in the fourth quarter for revisions in estimates of excess facility charges . As of December 31, 2001, the Company paidapproximately $2 .5 million related to lease costs . At December 31, 2001, restructuring charges of $8 .2 million remain accrued, primarily related to excessfacility costs and employee terminations . The Company anticipates utilizing the remaining restructuring accrual, which relates to servicing operating leasepayments or negotiated buyout of operating lease commitments, through 2005 .

Restructuring costs are summarized below ( in millions) :

Excess Lease dFacilities and

Involunta ry CancelledTerminations Contracts Total

Balance at December 31, 2000 $ 0.0 $ 0.0 $ 0. 0Additions 3 .2 9.5 12 . 7Cash Payments (2.0) (2.5) (4 .5 )

Balance at December 31, 2001 $ 1 .2 $ 7 .0 $ 8 . 2

In March 2001, the Company evaluated the carrying value of certain long-lived assets and acquired intangibles, consisting primarily of goodwillrecorded on its balance sheet . Pursuant to accounting rules, the majority of the goodwill was recorded based on stock prices at the time acquisitionagreements were executed

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and announced. Goodwill and other long-lived assets are reviewed for impairment whenever events such as product discontinuance, plant closures, productdispositions or other changes in circumstances indicate that the carrying amount may not be recoverable . When such events occur, the Company comparesthe carrying amount of the assets to undiscounted expected future cash flows . If this comparison indicates that there is an impairment, the amount of theimpairment is based on the fair value of the assets, typically calculated using discounted expected future cash flows . The discount rate applied to these cashflows is based on the Company's weighted average cost of capital, which represents the blended costs of debt and equity .

Downturns in the broadband services and telecommunications markets created unique circumstances with regard to the assessment of goodwill andother intangible assets for recoverability. As a result of management's decision to suspend certain product lines and product development efforts during2001, intangible assets totaling $163 .1 million relating to certain acquisitions with no future value were written off . Further, the aforementioned downturnsin the principal markets in which the Company continues to operate, have negatively impacted the forecasted revenues and cash flows from certain otherbusinesses acquired during fiscal 1999 and 2000 . As a result of these events, in accordance with the Company's policy, the comparison of the undiscountedexpected future cash flows to the carrying amount of the related intangible assets resulted in an impairment and accordingly the Company recorded awrite-down of these assets related to both of the Company's Cable and Telecom segments of $409 .7 million during 2001 to reflect the fair value of suchassets.

During 2001, the Company recorded a deferred tax asset of approximately $4 .0 million and corresponding reduction of goodwill, for the tax benefit offoreign net operating loss carryforwards relating to a previous acquisition . Due to the impairment write-off, the deferred tax asset, and remaining netdeferred tax liability were also written-off.

7 . Convertible Subordinated Note s

In July 2000, the Company issued $500 million of 5% Convertible Subordinated Notes due in August 2007 (the "Convertible Notes") resulting in netproceeds to the Company of approximately $484.4 million . The Convertible Notes are the Company's general unsecured obligation and are subordinated inright of payment to all existing and future senior indebtedness and to all of the liabilities of the Company's subsidiaries . The Convertible Notes areconvertible into shares of the Company's common stock at a conversion price of $84 .01 per share at any time on or after October 24, 2000 through maturityunless previously redeemed or repurchased . The Company may redeem some or all of the Convertible Notes at any time on or after October 24, 2000 andbefore August 7, 2003 at a redemption price of $1,000 per $1,000 principal amount of the Convertible Notes, plus accrued and unpaid interest, if any, if theclosing price of the Company's stock exceeds 150% of the conversion price, or $126 .01 for at least 20 trading days within a period of 30 consecutivetrading days ending on the trading day prior to the date of mailing of the redemption notice . The Company will also make an additional payment of $193 .55per $1,000 principal amount of Convertible Notes, less the amount of any interest actually paid on the Convertible Notes before the date of redemption . TheCompany may redeem the Notes at any time on or after August 7, 2003 at specified prices plus accrued and unpaid interest . Interest is payablesemiannually . Debt issuance costs related to the Convertible Notes were approximately $15 .6 million and are amortized over seven years . At December 31,2001 amortization of debt issuance costs totaled $1 .1 million .

In 2001, the Company repurchased approximately $325 .9 million of the Convertible Subordinated Notes for $113 .4 million in cash and $17 .9 million instock, resulting in an extraordinary gain of approximately $185 .3 million net of related unamortized issuance costs of $9.3 million .

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8 . Contingencies

Litigatio n

In September 1999, a group of prospective investors in Imedia Corporation (Imedia), now our subsidiary, named Imedia as a defendant in an actionalleging that Imedia breached its term sheet with the plaintiffs when Imedia negotiated its acquisition by us and, as a result, did not permit plaintiffs toinvest in Imedia . The plaintiffs sought damages in excess of $12 .0 million . The terms of the Imedia Agreement and Plan of Merger and Reorganizationprovided that shares of our common stock that were to be issued to the former shareholders of Imedia were placed in escrow to indemnify us for anydamages that are directly or indirectly suffered by us as a result of plaintiffs' claims . The value of the escrowed shares was approximately $10 .0 millionbased on the market value of our common stock on or about the closing date of the acquisition .

On or about September 5, 2000 , the Company received an amended complaint ( Complaint), Evergreen Canada Israel Management , Ltd v. ImediaCorporation , pending in the Superior Court of the State of Califo rn ia . The Complaint alleg ed both (i) intentional interference with contractual relations and(ii) intentional interference with prospective economic advantage against the Company, claiming that the Company formed and operated a conspiracy todeprive plaintiffs of the opportunity to invest in Imedia. Plaintiffs argued that, prior to the Company's purchase of the Imedia shares , the Company knew ofan alleged , pre-existing financing agreement between the plaintiffs and Imedia that contained a "no shop" clause , prohibiting Imedia from seeking orobtaining financing from any other sources , including a prohibition against Imedia selling its own stock or engaging in related transactions that preceded theacquisition . The Company was subsequently served with the Complaint and filed a demurrer challenging the legal sufficiency of the two causes of action .Other defendants demurred also . The demurrer hearing was held on Janua ry 16 , 2001 . Prior to the Court issuing a final ruling at that hearing , the Plaintiffsagreed to amend their complaint . The Plaintiffs filed a second amended complaint and, in response , the Company filed demurrers challenging all the causesof action. The Company ' s demurrer was heard on May 22, 2001, and the Cou rt ruled that three contract claims and the to rtuous interference with theprospective economic advantage claims should be dismissed. The Cou rt also dismissed the two fraud claims with leave to amend .

The Plaintiffs then filed a third amended complaint, and the defendants each filed demurrers and motions to strike challenging that pleading . Thedemurrers and motions to strike were argued in November 2001 .

Prior to a ruling on the demurrers and motions to strike, the parties entered into a settlement agreement in which Plaintiffs dismissed all claims withprejudice . The parties agreed that the settlement agreement would not be construed to be an admission of any liability on the part of the Company or any ofthe other defendants . The lawsuit was dismissed with prejudice in March 2002 .

Beginning in April 2000, several plaintiffs filed lawsuits against the Company and certain of its officers and directors in federal court . The plaintiff inthe first of these lawsuits purported to represent a class whose members purchased our securities between February 2, 2000 and April 11, 2000 . Thecomplaint alleged that the defendants had violated the federal securities laws by issuing materially false and misleading statements and failing to disclosematerial information regarding our technology . The allegations in the other lawsuits were substantially the same and, on August 24, 2000, all of theselawsuits were consolidated in the United States District Court, Northern District of California . The consolidated lawsuit is named In re TerayonCommunication Systems, Inc. Securities Litigation . The court hearing the consolidated action has appointed lead plaintiffs and lead plaintiffs' counselpursuant to the Private Securities Litigation Reform Act .

On September 21, 2000, the lead plaintiffs filed a consolidated class action complaint containing factual allegations nearly identical to those in theoriginal lawsuits . The consolidated class action complaint, however, alleged claims on behalf of a class whose members purchased or otherwise acquiredour securities between November 15, 1999 and April 11, 2000 . On October 30, 2000, defendants moved to dismiss the consolidated class action complaint .On March 14, 2001, after defendants motion had been fully briefed and argued, th e

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court issued an order granting in part defendants' motion and giving plaintiffs leave to file an amended complaint . On April 13, 2001, plaintiffs filed theirfirst amended consolidated class action complaint. On June 15, 2001, defendants moved to dismiss this new complaint and oral argument on the motionoccurred on December 17, 2001 . The Company has not received an order from the court regarding the motion to dismiss argued on December 17, 2001 .

The lawsuit seeks an unspecified amount of damages, in addition to other forms of relief . The Company considers the lawsuits to be without merit andwe intend to defend vigorously against these allegations . However, the litigation could prove to be costly and time consuming to defend, and there can be noassurances about the eventual outcome.

On October 16, 2000, a lawsuit was filed against the Company and the individual defendants (Zaki Rakib, Selim Rakib, and Raymond Fritz) in thesuperior court of San Luis Obispo County, California . This lawsuit is titled Bertram v. Terayon Communications Systems, Inc (Bertram) . The Bertramcomplaint contains factual allegations similar to those alleged in the federal securities class action lawsuit . The complaint asserts causes of action forunlawful business practices, unfair and fraudulent business practices, and false and misleading advertising . Plaintiffs purport to bring the action on behalf ofthemselves and as representatives of "all persons or entities in the State of California and such other persons or entities outside California that have been andare adversely affected by defendants' activity, and as the Court shall determine is not inconsistent with the exercise of the Court's jurisdiction ." Plaintiffsseek equitable and injunctive relief . Defendants removed the Bertram case to the United States District Court, Central District of California and, onJanuary 19, 2001, filed a motion to dismiss the complaint . A hearing on defendants' motion was held March 26, 2001 and the court granted Defendants'motion to dismiss the action and denied Plaintiffs' motion requesting remand . On April 5, 2001, Defendants moved for an order requiring furtherproceedings, if any to take place in the Northern District of California . Plaintiffs did not oppose this motion and eventually entered into a stipulation to goforward in the Northern District . On July 9, 2001, a status conference was held in this case before Judge Patel . Plaintiffs did not appear for the conference,and the court requested that defendants submit an order dismissing the Bertram action with prejudice, which the defendants have submitted to the court . TheCompany believes that these allegations, as with the allegations in the federal securities case, are without merit and intends to contest the matter vigorously.

9 . Stockholders' Equity

Public Offerings

In January 1999, the Company completed a public offering of 6,500,000 shares of common stock, of which 3,500,000 shares were offered by theCompany and 3,000,000 shares were offered by existing stockholders . The public offering resulted in proceeds to the Company of approximately$62,500,000, net of underwriting discounts, commissions, and other offering costs . In February 1999, the underwriters purchased an additional 975,000shares of common stock as a result of the exercise of the over-allotment option, of which 703,892 and 271,108 shares of common stock were purchasedfrom the Company and certain existing stockholders, respectively. This additional sale of common stock resulted in additional proceeds of approximately$12,700,000 to the Company .

Stockholder Rights Pla n

In February 2001, the Company's Board of Directors approved the adoption of a Stockholder Rights Plan under which all stockholders of record as ofFebruary 20, 2001 received rights to purchase shares of a new series of Preferred Stock. The rights were distributed as a non-taxable dividend and willexpire in ten years from the record date . The rights will be exercisable only if a person or group acquires 15 percent or more of the Company's CommonStock or announces a tender offer for 15 percent or more of the Company's Common Stock . If a person or group acquires 15 percent or more of theCompany's Common Stock, all rights holders

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except the buyer will be entitled to acquire the Company's Common Stock at a discount . The Board may terminate the Rights Plan at any time or redeemthe rights prior to the time a person or group acquires more than 15 percent of the Company's Common Stock .

Common Stoc k

In February 2000, the Company's board of directors approved a two-for-one split of the Company's outstanding shares of common stock to beeffected in the form of a stock dividend, subject to stockholder approval of an increase in the Company's authorized shares of common stock. In April 2000,the Company's stockholders approved an increase in the Company's authorized shares to 200,000,000 . The Company's Board of Directors subsequentlyestablished the record date for the stock split as April 25, 2000 and the stock dividend was distributed on May 5, 2000 . The changes in the capital structureresulting from the split were given retroactive effect in the consolidated financial statements .

In June 2001, the Company issued 160,000 shares of the Company's common stock to members of their Board of Advisors and recorded $595,000 inrelated compensation expense . The compensation expense was calculated using the closing price of the Company's common stock on the date the stock wasissued of $3 .72 per share .

In November 2001, the Company's Board of Directors approved a tender offer which permitted employees and members of the Board of Directors theability to exchange all unvested options granted with an exercise price per share equal to or greater than $9 .00 for a common stock award . On December 6,2001, 9,480,629 outstanding options were exchanged for 141,442 shares of common stock . The value of the common stock issued was $2,001,000, usingthe closing price of the Company's common stock on the date of issuance of S14 .15 per share, and was recorded as compensation expense in 2001 .

During 2001, the Company issued 115,250 shares of common stock to its employees, and recorded $642,000 in related compensation expense . Thecompensation expense was calculated using the closing price of the Company's common stock on the date of issuance .

Common Stock Warrants

In conjunction with a Series F convertible preferred stock financing in April 1998, the Company issued a warrant to purchase 6,000,000 shares of theCompany's common stock at an exercise price of $3 .25 per share to Shaw Communications, Inc . (the "Shaw Warrant") . In addition, the Company issued awarrant (the "Anti-Dilution Warrant") to purchase an indeterminate number of shares of common stock. The Anti-Dilution Warrant is exercisable at theoption of Shaw Communications, Inc . ("Shaw") during the period that Shaw owns equity in the Company and in the event the Company issues new equitysecurities at below the current market price defined in the Anti-Dilution warrant . The aggregate exercise price is $0.50 . The Company issued certain equitysecurities that, as of December 31, 2001 and 1999, required the Company to issue an additional 35,982 and 33,936 warrants to purchase shares of commonstock, respectively, pursuant to the Anti-Dilution warrant . During the year ended December 31, 2000 no equity securities were issued that resulted in theincrease in the number of shares issuable pursuant to the Anti-Dilution warrant . The Company recorded expenses of approximately $226,000 and $439,000relating to the issuance of warrants pursuant to the Anti-Dilution Warrant, in 2001 and 1999, respectively, and none in 2000 . As of December 31, 2001, theAnti-Dilution Warrant was exercisable for an aggregate of 108,300 shares of the Company's common stock .

In March 1999, Shaw purchased 3,000,000 shares of the Company's common stock at $3 .25 per share and in November 1999 Shaw purchased anadditional 3,000,000 shares of the Company's common stock at $3 .25 per share, resulting in net proceeds to the Company of $19 .5 million. The shares werepurchased pursuant to the exercise of the Shaw Warrant .

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On March 18, 1999, the Company entered into a one-year Product Development Assistance Agreement ("Development Agreement") with RogersCommunications Inc ("Rogers") . Under the terms of the Development Agreement, Rogers agreed to provide the Company assistance with thecharacterization and testing of the Company's subscriber-end and head-end voice over cable equipment . In addition, Rogers agreed to provide theCompany technology to assist the Company in connection with its efforts to develop high quality, field proven technology solutions that are DOCSIS (1 .0,1 .1 and 1 .2)-compliant and packet cable-compliant . In consideration of Rogers entering into the Development Agreement, the Company issued Rogers twofully vested and non-forfeitable warrants, each to purchase 2,000,000 shares of common stock . One warrant has an exercise price of $0 .50 per share andone warrant has an exercise price of $18 .50 per share . The warrants were exercisable in full or in part through March 31, 2000 . The fair value of the twowarrants was approximately $45,000,000 and resulted in a noncash charge included in operations over the term of the Product Development AssistanceAgreement . As a result of the Development Agreement, the Company's results of operations for the years ended December 31, 2000 and 1999 includenoncash charges of $9 .6 million and $35 .1 million, respectively . In February 2000, Rogers exercised the warrants on a cashless basis, resulting in theissuance of 3,687,618 shares of the Company's common stock and no proceeds to the Company .

In October 1999, a customer of the Company entered into an agreement with Telegate Ltd . whereby the Customer committed to an investment inTelegate in connection with the acquisition of all the outstanding shares of Telegate by the Company . The Customer committed to provide this investmentin the event that the acquisition of Telegate by the Company were not to have closed . In January 2000, the Company issued the customer a warrant topurchase 2,000,000 shares of the Company's common stock at a price of $30 .75 per share ; the closing price of the Company's common stock on the date thewarrant was issued . The warrant is fully vested, non-forfeitable, and immediately exercisable and has a term of three years . The fair value of the warrant,determined as approximately $34,600,000 using the Black Scholes model, was included in the Telegate purchase price and was associated with the value ofthe customer relationship . The value of the warrant resulted in a non-cash charge to cost of goods sold to be amortized over the three- year term of thewarrant . For the year ended December 31, 2001 and 2000, the Company incurred approximately $2,900,000 and $11,500,000 in amortization expenserelated to the Warrant, respectively . The Company did not record any related amortization expense in 1999 . In the first quarter of 2001, the Companywrote-off the intangible assets relating to the purchase of Telegate (see Note 6) .

In February 2001, the Company issued a warrant to purchase 200,000 shares of the Company's common stock at a price of $5 .4375 per share, theclosing price of the Company's common stock on the date the warrant was issued, in connection with the December 2000 acquisition of TrueChat, Inc .Under terms of the warrant 100,000 shares are vested and exercisable immediately and the remaining 100,000 shares vest and become exercisable at the rateof 1/24 per month, beginning January 31, 2001 . The fair value of the warrant of approximately $682,000 was calculated using the Black-Scholes methodand was recorded as additional consideration relating to the purchase of TrueChat, Inc .

In June 2001, the Company issued a fully vested, immediately exercisable, warrant to purchase 100,000 shares of the Company's Common Stock at aprice of $5 .98 per share to Philips Semiconductors Inc . in consideration for the continuation of their strategic relationship with the Company . The fair valueof the warrant, calculated using the Black Scholes method of approximately $280,000 was recorded as cost of goods sold during 2001 .

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Common Stock Reserved

Common stock reserved for issuance is as follows :

December 31,200 1

Common stock options 40,405,352Common stock warrants 2,408,300Employee stock purchase plan 539,18 6

43,352,83 8


In March 1995, the Board of Directors approved a stock option plan (the "1995 Plan"), that authorized shares for future issuance to be granted asoptions to purchase shares of the Company's common stock . As of December 31, 2001 a total of 4,229,494 shares have been authorized for issuance relatedto the 1995 Plan .

In February 1997, the Board of Directors approved an equity incentive plan (the "1997 Plan"), that authorized 2,100,000 shares for future issuance to begranted as options to purchase shares of the Company's common stock . In June 1998, the Company's Board of Directors authorized the adoption of theamended 1997 Plan, increasing the aggregate number of shares authorized for issuance under the 1997 Plan to 6,600,000 shares (4,500,000 additionalshares) . The amendment also provided for an increase to the authorized shares each year on January 1, starting with January 1, 1999, if the number of sharesreserved for future issuance was less than five percent (5%) of the Company's outstanding common stock, then the authorized shares would be increased toa balance equal to 5% of the common stock outstanding . There were no increases to the 1997 Plan in 1998 or 1999 . On January 1, 2000, 2,384,528 shareswere added to the 1997 Plan for a total of 8,984,528 shares .

The 1997 Plan was amended on June 13, 2000 to increase the number of shares of common stock from 8,984,528 to 12,754,528 (3,770,000 additionalshares) and to provide for an increase in the number of shares of common stock ("Evergreen Provision") on January 1, 2000 through and includingJanuary 1, 2007, by the lesser of five percent (5%) of the common stock outstanding on such January 1 or 3,000,000 shares . On January 1, 2001, 3,000,000shares were added to the 1997 plan pursuant to the evergreen provision .

In June 1998, the Company's Board of Directors authorized the adoption of the 1998 Non-Employee Directors' Stock Option Plan (the "1998 Plan"),pursuant to which 400,000 shares of the Company's common stock have been reserved for future issuance to non-employee directors of the Company.

In September 1999, the Company's Board of Directors authorized the adoption of the 1999 Non-Officers Equity Incentive Plan (the "1999 Plan"),pursuant to which 6,000,000 shares of the Company's common stock have been reserved for future issuance to non-officer employees of the Company . In2000, the Company's Board of Directors amended the 1999 Plan to increase the number of authorized shares to 18,500,000 . In 2001, the Company's Boardof Directors amended the 1999 Plan to increase the number of authorized shares to 28,500,000 .

At December 31, 2001, the total authorized number of shares under the 1995, 1997, 1998 and 1999 plans was 4,229,494, 15,754,528, 400,000 and28,500,000 respectively . All Plans are administered by the Board of Directors .

The 1995 and 1997 Plans provide for incentive stock options or nonqualified stock options to be issued to employees, directors, and consultants of theCompany. Prices for incentive stock options may not be less than the fair market value of the common stock at the date of grant . Prices for nonqualifiedstock options may not be less than 85% of the fair market value of the common stock at the date of grant . Options are immediatel y

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exercisable and vest over a period not to exceed five years from the date of grant . Any unvested stock issued is subject to repurchase by the Company at theoriginal issuance price upon termination of the option holder's employment . Unexercised options expire ten years after the date of grant .

The 1998 Plan provides for non-discretionary nonqualified stock options to be issued to non-employee directors of the Company automatically as ofthe effective date of their election to the Board of Directors and annually following each Annual Stockholder meeting . Prices for nonqualified options maynot be less than 100% of the fair market value of the common stock at the date of grant . Options vest and become exercisable over a period not to exceedthree years from the date of grant . Unexercised options expire ten years after the date of grant .

The 1999 Plan provides for nonqualified stock options to be issued to non-officer employees and consultants of the Company . Prices for nonqualifiedstock options many not be less than 85% of the fair market value of the common stock at the date of the grant . Options vest and become exercisable over aperiod not to exceed five years from the date of grant. Unexercised options expire ten years after date of grant .

During the year ended December 31, 2001 and 2000, the Company recorded aggregate deferred compensation of approximately $35,000 and$3,500,000, respectively, representing the difference between the grant price and the deemed fair value of the Company's common stock options grantedduring the period. The amortization of deferred compensation is being charged to operations and is being amortized over the vesting period of the options,which is typically five years . For the years ended December 31, 2001, 2000 and 1999, the amortization expense was approximately $456,000, $631,000 and$631,000, respectively.

The following is a summary of additional information with respect to the 1995 Stock Option Plan, the 1997 Equity Incentive Plan, the 1998Non-Employee Directors' Stock Option Plan, the 1999 Non-Officer Equity Incentive Plan, outstanding options assumed by Terayon in conjunction with itsbusiness acquisitions of (see Note 14) and option grants made outside the Plans :

Options Outstandingand Exercisable

Options Number Weighted-Averag eAvailable of Exercis efor Grant Shares Price

Balance at December 31, 1998 . 4,157,483 5,382,468 $ 2.2 7Options authorized 6,000,000 - -Options granted (7,826,568) 7,826,568 $ 22 .00Options exercised - (1,927,986) $ 1 .73Options canceled 938,712 (938,712) $ 5 .83

Balance at December 31, 1999 . 3,269,627 10,342,338 $ 16.7 8Options authorized 18,654,528 - -Options granted (15,937,301) 15,937,301 $ 51 .1 4Options exercised - (1,936,867) $ 7.2 6Options canceled 2,853,236 (2,853,236) $ 1 .3 6

Balance at December 31, 2000 8,840,090 21,489,536 $ 39.2 7Options authorized 13,000,000 - -Options granted (22,925,565) 22,925,565 $ 6 .2 5Options exercised - (2,924,274) $ 4 .5 9Options canceled 21,483,141 (21,483,141) $ 35.9 9

Balance at December 31, 2001 20,397,666 20,007,686 $ 9 .75

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In addition, the following table summarizes information about stock options that were outstanding and exercisable at December 31, 2001 :

Options Outstanding and Exercisable

Weighted - AverageNumber Weighted - Average Remaining

of Exercise Contractual LifeRange of Exercise Prices Shares Price ( in Years)

$ 0 .01 - $ 6 .52 6,252,038 $ 4.65 8 .69$ 6 .54 - $ 6 .81 10,594,391 $ 6.81 9 .1 3$ 6.86- $31 .41 2,043,321 $ 20 .25 8 .29$31 .47 - $69 .75 1,067,603 $ 43 .82 8 .2 3$82 .78 - $123 .50 50,333 $ 112 .12 8 .2 1

Total 20, 007,68 6

At December 31, 2001, approximately 6,437,117 options issued and outstanding were exercisable and approximately 18,835 shares of common stockoutstanding were subject to repurchase by the Company. Common stock subject to repurchase represents any unvested shares of common stock held by anoptionholder which, upon termination of the optionholder's employment, may be repurchased by the Company. Such shares are subject to repurchase attheir original issuance price . Repurchased shares are recorded as Treasury stock .

In June 1998, the Board of Directors approved, and the Company adopted, the 1998 Employee Stock Purchase Plan (the "ESPP"), which is designed toallow eligible employees of the Company to purchase shares of common stock at semiannual intervals through periodic payroll deductions . An aggregate of1,400,000 shares of common stock has been reserved for the ESPP, and 860,814 shares have been issued through December 31, 2001 . The Purchase Plan isimplemented in a series of successive offering periods, each with a maximum duration of 24 months . Eligible employees can have up to 15% of their basesalary deducted that is to be used to purchase shares of the common stock on specific dates determined by the Board of Directors (up to a maximum of$25,000 per year based upon the fair market value of the shares at the beginning date of the offering). The price of common stock purchased under thePurchase Plan will be equal to 85% of the lower of the fair market value of the common stock on the commencement date of each offering period or thespecified purchase date .

The Company has elected to follow APB Opinion No . 25 and related interpretations in accounting for its employee stock plans because, as discussedbelow, the alternative fair value accounting provided for under FAS 123 requires the use of valuation models that were not developed for use in valuingemployee stock instruments . Under APB Opinion No. 25, when the exercise price of the Company's employee stock options equals the market price of theunderlying stock on the date of grant, no compensation expense is recognized .

Pro forma information regarding net loss is required under FAS 123 and is calculated as if the Company had accounted for its employee stock optionsgranted during the years ended December 31, 2001, 2000 and 1999 and for its ESPP shares to be issued under the fair value method of FAS 123 . The fairvalue for employee stock options granted was estimated at the date of grant based on the Black-Scholes model using the following weighted averageassumptions : risk-free interest rates of 4 .50%, 5 .98%, and 6 .70%, for 2001, 2000, and 1999, respectively ; no dividend yield ; volatility factors of 1 .50, 1 .20,and 0 .80 for 2001, 2000, and 1999, respectively and a weighted average expected life of the option of five years . The fair value for employee stock purchaseplan shares to be issued was estimated using the following weighted average assumptions : risk-free interest rate of 4 .14%, 6.35% and 6.71% for 2001, 2000and 1999, respectively, no dividend yield, volatility factors of 1 .50, 1 .20, and 0 .80 for 2001, 2000, and 1999, respectively and a weighted average expectedlife of the shares of six months .

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As discussed above, the valuation models used under FAS 123 were developed for use in estimating the fair value of traded options that have no vestingrestrictions and are fully transferable . In addition, valuation models require the input of highly subjective assumptions, including the expected life of theoption . Because the Company's employee stock options have characteristics significantly different from those of traded options and because changes in thesubjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide areliable single measure of the fair value of its employee stock instruments .

For purposes of pro forma disclosures, the estimated fair value of the options granted and ESPP shares to be issued is amortized to expense over theirrespective vesting periods . Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grantdates for awards under those plans consistent with the method of FAS 123, the Company's net loss applicable to common stockholders and net loss pershare applicable to common stockholders would have been increased to the pro forma amounts indicated below (in thousands, except per share data) :

Pro forma net los s

Pro forma basic and diluted net loss per share


2001 2000 1999

$ (692,779) $ (300,666) $ (75,321)

$ (10.14) $ (4.90) $ (1 .83 )

The pro forma impact of options granted and ESPP shares to be issued on the net loss applicable to common stockholders for the years endedDecember 31, 2001, 2000 and 1999 is not representative of the effects on net income (loss) for future years, as future years will include the effects ofoptions vesting as well as the impact of multiple years of stock option grants .

The options' weighted average grant date fair value, which is the value assigned to the options under FAS 123, was $5 .83, $43 .81, and $28 .31, foroptions granted during 2001, 2000, and 1999,respectively . The weighted average grant date fair value of ESPP shares to be issued was $3 .99, $9.30 and$8 .40 for the years ended December 31, 2001, 2000 and 1999, respectively .

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10. Income Taxes

For the year ended December 31, 2001, the Company had a benefit from Income Taxes of $13 .9 million . Due to operating losses and the inability torecognize the benefits, there is no provision for income taxes for the years ended December 31, 2000 and 1999 .

Year Ended December 31 ,

2001 2000 1999

(In thousands)

Current :Federal $ $ - $ -State $ - $ - $Foreign $ 831 $ - $

Total current $ 831 $ :- $Deferred :

Federal $ - $ - $ -State $ - $ - $Foreign $(14,746) $'- $ -

Total deferred $(14,746) $ - $ -

Total $(13,915) $ - $ -

During 2001, the Company recorded a deferred tax asset of approx imately $4 .0 million and corresponding reduction of goodwill, for the tax benefit o fforeign net operating loss carryforwards relating to a previous acquisition . Due to the impairment write-off, the deferred tax asset, and remaining netdeferred tax liability were also written-off.

The reconciliation of income tax benefit attributable to net loss applicable to common stockholders compu ted at the U .S . federal statutory rates toincome tax benefit (in thousands) :


Tax benefit at U .S . statutory rateGoodwill amortizatio nIn process research and developmentLoss for which no tax benefit is currently recognizableOther, net

2001 2000 1999

$(197,346) $(63,268) $(22,428)2,849 19,405 1,23 3- 8,698 5,11 0

179,338 34,529 16,08 51,244 636 -

$ (13,915) $ - $ -

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reportingpurposes and the amounts used for income tax purposes .

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NOTES TO CONSOLIDATED FINANC IAL STATEMENTS - (Continued )

Significant components of the Company's deferred tax assets and liabilities as of December 31, 2001 and 2000 are as follows (in thousands) :

December 31 ,

2001 2000

Deferred tax assets:Net operating loss carryforwards $ 130,321 $ 100,477Tax credit carryforwards 13,047 6,808Reserves and accruals 58,418 8,760Capitalized research and development 7,580 4,232Intangibles amortization 8,396 9,07 8Deferred revenue - 1,353Other, net 610 994

Gross deferred tax assets 218,372 131,702Valuation allowance (218,372) (131,702)

Total deferred tax assets - -Deferred tax liabilities

Acquired intangibles - (18,565)

Net deferred tax liabilities $ - $ (18,565 )

Realization of deferred tax assets is dependent on future earnings, if any, the timing and the amount of which are uncertain . Accordingly, a valuationallowance has been established to reflect these uncertainties as of December 31, 2001 and 2000 . The change in the valuation allowance was a net increase ofapproximately $86,670,000, $88,182,000, and $18,976,000 for the years ended December 31, 2001, 2000, and 1999, respectively . Approximately$47,172,000 of the valuation allowance will be credited to equity when realized .

As of December 31, 2001, the Company had federal, California and foreign net operating loss carryforwards of approximately $281,923,000,$126,338,000 and $111,283,000, respectively . The Company also had federal and California tax credit carryforwards of approximately $7,776,000 and$8,109,000, respectively . The federal and California net operating loss and credit carryforwards will expire at various dates beginning in the years 2002through 2021, if not utilized . The foreign net operating losses have an unlimited carryover period.

Utilization of net operating loss and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitationsprovided by the Internal Revenue Code of 1986, as amended, and similar state provisions . The annual limitation may result in the expiration of net operatingloss and tax credit carryforwards before full utilization .

11 . Segments of an Enterprise and Related Informatio n

The Chief Executive Officer has been identified as the Chief Operating Decision Maker (CODM) because he has final authority over resourceallocation decisions and performance assessment . The CODM allocates resources to each segment based on their business prospects , competitive factors,revenues and operating results .

The Company views its business as having two principal operating segments : Cable Broadband Access Systems ("Cable") and Telecom Carrier AccessSystems ("Telecom") . The Cable segment consists primarily of the TeraComm system, the CherryPicker Digital Video Management Systems, and theMultigate Telephony and Data Access Systems which are sold primarily to cable operators for the deployment of data ,

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video and voice services over the existing cable infrastructure . The Telecom segment consists primarily of the Miniplex DSL Systems, the IPTL ConvergedVoice and Data Service System and the Highlink, which are sold to providers of broadband services for the deployment of voice and data services over theexisting copper wire infrastructure.

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


2001 2000 1999

Cable Broadband Access Segment :Revenues $ 245,828 $ 303,524 $ 97,00 9Operating loss (465,435) (132,643) (69,088)Total assets 455,836 902,262 301,23 6

Telecom Broadband Access Segment :Revenues 33,653 36,025 -Operating loss (297,697) (54,834) -Total assets 10,810 524,465 -

Total Revenues $ 279,481 $ 339,549 $ 97,009Operating loss :

Operating loss by reportable segments $ (763,132) $ (187,477) $ (69,088)Unallocated amounts :Interest and other income, net 44 6,710 5,008Extraordinary gain 185,327 - -Tax Benefit 13,915 - -

Net loss $ (563,846) $ (180,767) $ (64,080)

Geographic areas :Revenues :

United States $ 50,291 $ 83,974 $ 15,59 8Canada 113,300 118,491 41,00 8Europe and Israel 51,480 61,741 24,74 6Asia 61,815 60,985 12,75 5South America 2,595 14,358 2,90 2

Total $ 279,481 $ 339,549 $ 97,00 9

Long-lived assets :United States $ 36,106 $ 339,55 9Canada 256 -Europe and Israel 4,145 337,493Asia 243 177South America 2,020 -

Total Long-lived assets 42,770 677,229Total current assets 423,876 749,49 8

Total Assets $ 466,646 $1,426,727

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued )

Two customers, both related to Cable, accounted for 10% or more of total revenues (33% and 13%) for the year ended December 31, 2001 . Threecustomers, all of which related to Cable, accounted for 10% or more of total revenues (17%, 17%, and 11%) for the year ended December 31, 2000. Fourcustomers accounted for 10% or more of total revenues (24%, 17%, 14% and 11%) for the year ended December 31, 1999 . No other customer accounted formore than 10% of revenues during these years .

12 . Defined Contribution Pla n

During 1995, the Company adopted a 401(k) Profit Sharing Plan and Trust that allows eligible employees to make contributions subject to certainlimitations . The Company may make discretionary contributions based on profitability as determined by the Board of Directors . No amount was contributedby the Company to the plan during the years ended December 31, 2001, 2000, and 1999 .

13 . Related Party Transaction s

During the years ended December 31, 2001, 2000 and 1999, the Company recognized revenue of $52,445,000, $119,321,000 and $39,664,000,respectively in connection with product shipments made to Shaw and Rogers, each of which has one representative on the Company's Board of Directorsand is a significant stockholder. Beginning in the third quarter of 2001, as Shaw was no longer a significant stockholder and the board member from Shawresigned, Shaw was no longer considered a related party . Revenues from Shaw are not included as revenue from related parties after the second quarter of2001, when Shaw ceased to be a related party . Cost of related party product revenues consists of direct product costs . Accounts receivable from Rogerstotaled approximately $4,006,000 at December 31, 2001 . At December 31, 2000, accounts receivable from Shaw and Rogers totaled approximately$17,454,000 .

On March 18, 1999, the Company entered into a Supply Agreement with Rogers, formerly Rogers Cablesystems Limited, a subsidiary of RogersCommunications . The Supply Agreement and the Development Agreement did not constitute a commitment to purchase or deploy any particular volume orquantity of the Company's product. Such commitment was only made when a valid purchase order was issued to the Company . Under the SupplyAgreement, the Company agreed to make available to Rogers its current TeraLink Gateway, TeraLink 1000 Master Controller, TeraPro Cable Modems andspecified software . The Company also committed to certain product pricing and specifications . Under the terms of the Supply Agreement, Rogers retainedthe right to return to the Company all products purchased until certain conditions specified in the agreement were met by the Company . Accordingly, theCompany did not recognize revenue on shipments to Rogers until the conditions specified in the Agreement were met or Rogers had waived the right toreturn the product . The Company deferred recognition of revenue for shipments to Rogers until the quarter ended September 30, 1999 when the first waiverwas received from Rogers . The Company subsequently recognized revenue only to the extent that Rogers had waived the rights of return for such product .As of March 31, 2000, Rogers had waived all rights of return under the Supply Agreement ; accordingly, the only rights of return that remain available toRogers are those provided under the Company's standard warranty policy . The Supply Agreement expired on April 1, 2000 .

During the years ended December 31, 1999, .the Company incurred approximately $200,000 of expense related to consulting services performed by amember of the Company's Board of Directors. There were no consulting services performed by any member of the Company's Board of Directors duringthe year ended December 31, 2001 and 2000 .

During 2001, the Company paid to Rogers a total of approximately $2,920,000 for co-marketing activities (see Note 1) .

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14 . Business Combination s

During 1999 and 2000, the Company completed a total of ten acquisitions . There were no acquisitions during 2001 . Each of the acquisitions wasaccounted for under the purchase method of accounting . The respective purchase prices were allocated to the assets acquired and liabilities assumed basedon a determination from an independent appraisal of their respective fair values . The methodologies used to value intangible assets acquired wereconsistently applied to each of the acquisitions.

To determine the value of the developed technology, the expected future cash flow attributed to all existing technology was discounted, taking intoaccount risks related to the characteristics and application of the technology, existing and future markets and assessments of the life cycle stage of thetechnology .

The value of the in-process research and development was determined based on the expected cash flow attributed to the in-process projects, taking intoaccount revenue that is attributable to previously developed technology, the level of effort to date in the in-process research and development, thepercentage of completion of the project and the level of risk associated with the in-process technology . The projects identified as in-process are those thatwere underway at each of the acquisitions at the time of the acquisition and that required additional efforts in order to establish technological feasibility . Thevalue of in-process research and development was included in the Company's results of operations during the period of the acquisition .

The value of the assembled workforce was derived by estimating the costs to replace the existing employees, including recruiting, hiring and trainingcosts for each category of employee .

Imedia Corporation

In July 1999, the Company entered into an Agreement and Plan of Reorganization (the "Agreement") to acquire Imedia Corporation ("Imedia"), aCalifornia corporation . Imedia produces routing and re-multiplexing systems for digital video that enable cable operators to select and customize theirprogram lineup for viewer preferences, while maximizing video capacity and quality over standards-based set-top boxes . The Imedia acquisition wascompleted on September 16, 1999 (the "Closing Date") .

In accordance with the Agreement, the Company issued 1,714,814 shares of common stock and 309,256 options and warrants to purchase commonstock to the vested and unvested optionholders and warrantholders of Imedia on the Closing Date.

Tangible assets acquired principally include cash, accounts receivable and property and equipment . Liabilities assumed principally include accountspayable and accrued liabilities . At the Closing Date, the Company forgave Imedia's note payable obligation of $1,000,000 .

The analysis of the expected future cash flows attributed to all existing technology resulted in a valuation of approximately $27,000,000 for developedtechnology that had reached technological feasibility and therefore was capitalizable .

In-process technology acquired, valued at approximately $11,000,000, consists primarily of major additions to Imedia's core technology, which wasrelated to Imedia's planned development of new features . The majority of the intended functionality of these new features was not supported by Imedia'sexisting technology . Intended new features included offering high quality video service over the Internet and multiplexing data with video . Development ofthis technology was completed in 2001 .

Radwiz Ltd.

In October 1999, the Company entered into a Share Purchase Agreement to acquire Radwiz Ltd . ("Radwiz"), an Israeli company . Radwiz producedcommunication access systems based on high-speed IP

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routing, integrated with telephony . Radwiz's systems included both central office Digital Subscriber Line Access Multiplexers (DSLAMs) and customerpremises equipment for small office, home office (SOHO) business broadband services . The Radwiz acquisition was completed on November 22, 1999 .

In accordance with the acquisition agreement, the Company paid $250,000 in cash and issued 1,992,306 shares of Terayon common stock to the formershareholders of Radwiz and issued options to purchase 267,959 shares of Terayon common stock to the unvested optionholders of Radwiz on the ClosingDate . In addition, the unvested optionholders of Radwiz options also received options to purchase the Company's common stock, the fair value of whichwas included in the purchase price .

The approximate purchase price was determined to be $52,700,000 . This represents the minimum purchase price, as specified in the acquisitionagreement, to be issued to the shareholders and vested option holders of Radwiz ($50,000,000) plus the value of the options issued to unvested optionholders of Radwiz ($2,700,000) based on the market value of the Company's common stock on the date the acquisition was announced . Proceeds to bereceived from the Radwiz optionholders upon exercise of their options were not significant .

Tangible assets acquired principally included cash, accounts receivable, inventory and property and equipment . Liabilities assumed included accountspayable and accrued liabilities .

The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $29,850,000 for developedtechnology that had reached technological feasibility and therefore was capitalizable .

In-process technology acquired in the transaction, valued at approximately $3,000,000 consists primarily of additions to Radwiz's core technology,which is related to Radwiz's planned development of new features . The majority of the intended functionality of these new features is not supported byRadwiz's current technology . Intended new features include offering : end-to-end carrier quality of service ; allowing access via an ATM network ; and,providing ISDN line functionality . The Company completed most of this development work in 2001, and the Company decided to no longer pursue theISDN line functionality .

Telegate Ltd

In October 1999, the Company entered into a Share Purchase Agreement ("Telegate Agreement") to acquire Telegate Ltd ("Telegate"), an Israelicompany . Telegate produces telephony and data access platforms that are deployed by service providers to deliver efficient carrier-class voice services overcable . Telegate also provides in-home networking capability for telephony and data, based on the Digital Enhanced Cordless Telephony (DECT) standard .The transaction was completed on January 2, 2000 .

In accordance with the Telegate Agreement, the Company issued 4,440,000 shares of common stock and paid approximately $2,500,000 in cash onJanuary 2, 2000 . The Company made an additional cash payment of approximately $858,000 during the third quarter of 2000 . In addition, the Companyissued a warrant to purchase 2,000,000 shares of the Company's common stock, valued at approximately $34 .6 million under the terms of an agreementbetween Telegate and a customer of the Company (See Note 9) . The value of the warrant was included in the purchase price and was associated with thevalue of the customer relationship .

Tangible assets acquired principally included cash, accounts receivable, inventory and property and equipment . Liabilities assumed principally includedaccounts payable and accrued liabilities .

The value of the customer relationship was determined as the value of the warrant using the Black Scholes model . The warrant was fully vested,non-forfeitable, and immediately exercisable and has a term of three years . The value of the customer relationship is being amortized to cost of goods soldon a straight-line basis over a three-year period .

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The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $21,500,000 for developedtechnology, that had reached technological feasibility and therefore was capitalizable .

In-process technology acquired, valued at approximately $7,500,000, consisted primarily of major additions to Telegate's core technology, which wasrelated to Telegate's planned development of new features . The majority of the intended functionality of these new features was not supported by Telegate'scurrent technology . Intended new features included : connection on demand functionality to extend the product's ISDN compatibility ; the ability to usecordless technology for either voice or data applications ; and, a subscriber end unit that can be used in multi-dwelling units . During 2001, the Companydecided to no longer pursue the cordless technology and the subscriber end unit technology .

Access Network Electronics Division of Tyco Electronics Corporation

In February 2000, the Company entered into an Asset Purchase Agreement (the "ANE Agreement") to acquire certain assets and assume certainliabilities of the Access Network Electronics Division (ANE) of Tyco Electronics Corporation, a subsidiary of Tyco International Ltd . ANE produces DSL(Digital Subscriber Line) systems that provide multiple phone lines over the existing copper telephony network . The transaction was completed on April 22,2000 .

In accordance with the ANE Agreement, the Company issued 1,404,552 shares of common stock, valued at approximately $83,500,000 based on themaximum purchase price specified in the ANE Agreement . In addition, the Company agreed to establish an employee retention program for purposes ofretaining certain identified employees of ANE. The retention program provides for up to 3 annual payments to the identified employees in a total amount ofapproximately $4,200,000 provided the employees remain employed by the Company . The retention payments are being charged to expense over theemployees' respective periods of service .

Tangible assets acquired principally included accounts receivable, inventory and property and equipment . Liabilities assumed principally includedaccounts payable and warranty obligations . During 2001, the Company increased its intangible assets for assembled workforce by $4 .5 million relating toretention payments in conjunction with the acquisition of ANE .

The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $12,600,000 for developedtechnology, which had reached technological feasibility and therefore was capitalizable .

To determine the value of the customer base the expected future cash flows attributed to existing customers was discounted . The analysis yielded avaluation of approximately $2,400,000 .

In-process technology acquired in the transaction, valued at approximately $750,000, consisted primarily of additions to ANE's core technology, whichis related to ANE's planned development of new features . A portion of the intended functionality of these new features is not supported by ANE's currenttechnology. The resultant technology is intended to allow the transmission from a 56Kbps modem without the loss of transmission rate . During 2001, theCompany decided to no longer pursue the development of this technology .

Combox Ltd.

In February 2000, the Company entered into a Share Purchase Agreement (the "Combox Agreement") to acquire Combox Ltd ("Combox"), an Israelicompany . Combox is a manufacturer of broadband data systems and satellite communications based on international standards . Combox's cable data accesssystems conform to the growing EuroModem international specification, based on the Digital Video Broadcasting (DVB) standard . The transaction wascompleted on April 18, 2000 .

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In accordance with the Combox Agreement, the Company issued 1,547,770 shares of common stock and made a cash payment of approximately$250,000 . In addition, the Company issued options to purchase common stock of the Company to the unvested option holders of Combox options . Theapproximate purchase price was determined as the value of Terayon's common stock issued at closing ($92,000,000) and the value of the options topurchase Terayon's shares issued to the unvested option holders ($6,800,000) based on the fair market value of Terayon's common stock on the daysimmediately preceding and following the date the acquisition was announced . In addition, the cash payment of approximately $250,000 was included in thepurchase price . Proceeds to be received from the option holders and warrant holders upon exercise are not significant .

Tangible assets acquired principally include cash and cash equivalents and accounts receivable . Liabilities assumed principally include short and longterm debt, accounts payable and accrued liabilities .


In-process technology acquired valued at approximately $8,000,000 consists primarily of additions to Combox's core technology, which was related toCombox's planned development of new features . A portion of the intended functionality of these new features was not supported by Combox's currenttechnology . During 2001, the Company decided to no longer pursue these new features .

Internet Telecom Ltd

In March 2000, the Company and Telegate, a subsidiary of the Company, entered into an Asset Purchase Agreement ("Internet Telecom Agreement")under which Telegate agreed to purchase certain assets of Internet Telecom Ltd . ("Internet Telecom" or "IT"), an Israeli company . Internet Telecom is asupplier of PacketCable and other standards-based, voice-over-IP ("Internet Protocol") systems and technologies . The transaction was completed onApril 18, 2000 .

In accordance with the Internet Telecom Agreement, the Company issued 377,380 shares of common stock valued at approximately $46,000,000 basedon the fair market value of the Company's common stock on the days immediately preceding and following the announcement of the acquisition and issuedoptions of 10,898 to purchase common stock of the Company to the unvested option holders of Internet Telecom and paid approximately $2,000,000 incash . In addition, as a result of certain conditions in the Agreement with regards to the price of the Company's common stock, an additional accruedpurchase price payable of approximately $14 .1 million is included in the consolidated balance sheet as of December 31, 2000 . This amount was paid during2001 .


In-process technology acquired, valued at approximately $2,550,000, consists primarily of additions to Internet Telecom's core technology, which wasrelated to Internet Telecom's planned development of new features . A portion of the intended functionality of these new features was not supported byInternet Telecom's current technology . During 2001, the Company decided to no longer develop the new features from Internet Telecom .

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Ultracom Ltd

In March 2000, the Company entered into a Share Purchase Agreement to acquire Ultracom Communication Holdings (1995) Ltd . ("Ultracom"), an

Israeli company . Ultracom is a supplier of broadband systems-on-silicon. The transaction was completed on April 19, 2000 .

In accordance with the Ultracom Agreement, the Company issued 536,766 shares of common stock, made a cash payment of approximately $245,000and issued 14,403 options to purchase common stock of the Company to the shareholders and unvested option holders of Ultracom options . Theapproximate purchase price was determined as the value of Terayon's common stock issued at the closing ($57,600,000) and the value of the options topurchase Terayon's shares issued to the unvested option holders ($578,000) based on the fair market value of Terayon's common stock on the daysimmediately preceding and following the date the acquisition was announced . In addition, the cash payment of approximately $245,000 is included in thepurchase price.

Tangible assets acquired principally included cash and cash equivalents, accounts receivable and property and equipment . Liabilities assumed

principally included long-term debt, accounts payable and accrued liabilities .

The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $1,050,000 for developedtechnology that had reached technological feasibility and therefore was capitalizable.

In-process technology acquired, valued at approximately $1,800,000, consisted primarily of additions to Ultracom's core technology, which is relatedto Ultracom's planned development of new features . A portion of the intended functionality of these new features was not supported by Ultracom's currenttechnology. During 2001, the Company determined that it would no longer continue development on the Ultracom technology .

Mainsail Networks

In August 2000 , the Company entered into an Agreement and Plan of Merger and Reorganization to acquire Mainsail Networks , Inc . ("Mainsail") .Mainsail develops and markets next -generation broadband networks that enable telecommunications carriers to deliver multiple se rvices over a singlenetwork infrastructure . The transaction was completed on September 29, 2000 .

In accordance with the Mainsail Agreement, the Company issued 2,969 ,062 shares of common stock and 138,193 options to purchase shares ofcommon stock to the Mainsail shareholders and option holders . The approximate purchase price was determined based on the fair market value of Terayon'scommon stock on the days immediately preceding and following the date the acquisition was announced ($171,275, 000) less the intrinsic value of theunvested options recorded as deferred compensation ($4,719,000 ) . Deferred compensation is amo rt ized over the option holders' vesting period .

Tangible assets acquired principally included cash , inventory and property and equipment . Liabilities assumed principally included accounts payable,accrued liabilities and notes payable .

The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $49,000,000 for developedtechnology that had reached technological feasibility and therefore was capitalizable .

In-process technology acquired , valued at approximately $ 5,000,000, consisted prima ri ly of additions to Mainsail's core technology , which is related toMainsail ' s planned development of new features . A portion of the intended functionality of these new features was not suppo rted by Mainsail ' s currenttechnology . The resultant technology was intended to provide a high capaci ty CPE (customer premise equipment) and low cost gateway . This developmentwas completed in 2001 .

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Digitran s

On September 27, 2000, the Company acquired Digital Transmission Equipment ("Digitrans") pursuant to the terms of a Stock Purchase Agreementbetween the Company and the former owner of Digitrans . Digitrans develops, markets and sells digital equipment solutions that enable broadcasters,satellite operators and cable television system operators to optimize network services .

In accordance with the Digitrans Agreement, the Company issued 394,329 shares of common stock . The approximate purchase price was $15,921,000based on the fair market value of Terayon's common stock on the days immediately preceding and following the date the acquisition was announced. Inaddition, as a result of certain conditions stipulated in the Agreement with regards with the price of the Company's common stock, the company issued367,804 additional shares of common stock to the former owner of Digitrans .

Tangible assets acquired principally included cash and cash equivalents, accounts receivable and property and equipment . Liabilities assumedprincipally included long-term debt, accounts payable and accrued liabilities .

The analysis of the expected future cash flow attributed to all existing technology resulted in a valuation of approximately $550,000 for developedtechnology that had reached technological feasibility and therefore was capitalizable.

In-process technology acquired, valued at approximately $4,950,000, consists primarily of additions to Digitrans' core technology, which was relatedto Digitrans' planned development of new features . A portion of the intended functionality of these new features was not supported by Digitrans' currenttechnology . Intended new features included system on chip solutions for DOCSIS and DVB/ DAVIC cable modems . During 2001, the Company decidednot to pursue these development efforts .

TrueCha t

On December 22, 2000, the Company, acquired TrueChat, Inc ., ("TrueChat"), pursuant to the terms of an Agreement and Plan of Merger andReorganization . TrueChat develops communication systems that enable multimedia teleconferencing and provide increased control over teleconferenceparameters .

In accordance with the TrueChat Agreement the Company issued 534,487 shares of common stock and made a cash payment of $209,928 . In addition,the former option holders of TrueChat received options to purchase 126,061 shares of the Company's common stock . Deferred compensation relating to theoptions is amortized over the option holders' vesting period . Approximately $2 .4 million of goodwill was recorded as part of this transaction. In addition,during 2001, the Company added $0 .7 million to goodwill in conjunction with warrants issued subsequent to the acquisition (see Note 9) .

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A summary of the purchase price allocations pertaining to the above acquisitions and the amortization periods of the intangible assets acquired is asfollows (in thousands) :

2000 Acquisitions: Telegate ANE Combox IT Ultracom Mainsail Digitrans TrueChat

Approximate purchase pricePurchase price $130,553 $ 83,477 $ 98,784 $ 62,265 $57,621 $166,556 $15,921 $ 2,664Transaction and other direc t

acquisition costs 4,483 265 672 1,486 598 2,641 116 21 0

$135,036 $ 83,742 $ 99,456 $ 63,751 $ 58,219 $169,197 $16,037 $ 2,874

Allocation of purchase price :Historical net tangible assets

acquired $ (5,580) $14,145 $ 2,308 $ 1,116 $ (15) $ 306Convertible loans 12,48 2

6,902 14,145 2,308 - 1,116 (15) 306

Intangible assets acquired :Customer relationship or base 34,580 2,400Developed technology 21,500 12,600 12,500 5,950 1,050 49,000 550Assembled workforce 4,200 12,200 1,100 500 1,100 2,800 1,100Trademark 600In-process research and

development 7,500 750 8,000 2,550 1,800 5,000 4,950Goodwill 66,382 44,047 80,444 54,751 53,927 107,692 9,131 2,390Deferred tax liability (6,028) (4,896) (774)Deferred compensation 4,719 484

$135,036 $86,742 $99,456 $63,751 $58,219 $169,196 $16,037 $2,874

Amortization period (in years) :Customer relationship or base 3 5Developed technology 6 5 5 6 6 5 5Assembled workforce 2 2 2 2 2 2 2Trademark 5Goodwill 6 5 5 6 6 5 5 5Deferred compensation 1 .5 1 . 5

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1999 Acquisitions : Imedia Radwi z

Approximate purchase price :Purchase price $106,347 $ 52,667Transaction and other direct acquisition costs 2,345 1,08 6

$108,692 $ 53,75 3

Allocation of purchase price :Historical net tangible assets acquired $ (355) $ 3,058Forgiveness of note payable 1,000

645 3,05 8

Intangible assets acquired :Developed technology 27,000 29,85 0Assembled workforce 2,500 180 0Trademark 4,000 1,15 0In-process research and development 11,000 3,60 0Goodwill 63,547 24,29 3Deferred tax liability (10,998 )

$108,692 $ 53,75 3

Amortization period (in years) :Developed technology 6 6Assembled workforce 2 2Trademark 6 6Goodwill 6 6

As discussed in Note 6, the Company recorded impairment losses of approximately $5 72 .8 million of intangible assets relating to these acquisitions .Approximately $3 .8 million of intangible assets remained at December 31, 2001 .

Pro Forma Financial Results

The following selected unaudited pro forma combined results of operations for the year ended December 31, 2000 of the Company, Telegate , Combox,Ultracom, ANE, Inte rn et Telecom , Mainsail , Digitrans and TrueChat have been prepared assuming that the acquisitions occurred at the beginning of theperiod presented . The following selected unaudited pro forma combined results of operations for the year ended December 31, 1999 of the Company,Radwiz and Imedia have been prepared assuming that the acquisitions occurred at the beginning of the period presented . The following selected unauditedpro forma financial information is not necessarily indicative of the results that would have occurred had the acquisition s

71

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been completed at the beginning of the period indicated nor is it indicative of future operating results (in thousands, except per share data) :

Year Ended Year EndedDecember 31, December 31 ,

2000 199 9

Revenues $ 358,559 $189,21 3

Net loss(1) $ (71 .343) $ (40,728 )Net loss per share(1) $ (1 .16) $ (0.70 )Shares used in calculation of net loss per share 61,349 58,41 6

(1) Net loss and net loss per share excludes approximately $30,535,000 of in-process research and development charges for the years endedDecember 31, 2000 .

17 . Subsequent Events (Unaudited)

As discussed in Note 8, the Plaintiffs in the complaint Evergreen Canada Israel Management, Ltd. v Imedia Corporation voluntarily dismissed the

complaint on March 7, 2002, and the lawsuit was dismissed with prejudice .

18 . Unaudited Quarterly Financial Dat a

Summarized quarterly financial data for 2001 and 2000 is as follows (in thousands, except per share data) :

Quarte r

200 1

RevenuesGross profit (loss)(4)Restructuring costs and asset write-offs(2)Net Loss before extraordinary gainExtraordinary gain on early retirement of debt(3)Net profit (loss)Basic and diluted loss per common share before

extraordinary gain(1 )Extraordinary gain on early retirement of debt per share,

basic and diluted(3 )Basic and diluted loss per share after extraordinary gain

First Second Third Fourth

$ 53,984 $ 65,733 $ 79,603 $ 80,16 1(869) (15,731) 10,368 22,445

(574,744) (2,549) (5,301) (3,449)(629,694) (62,504) (38,752) (18,223 )

121,494 - 51,834 11,999(508,200) (62,504) 13,082 (6,224)

$ (9.33) $ (0.93) $ (0.57) $ (0.26)

$ 1 .80 - $ 0.76 $ 0.1 7$ (7 .53) $ (0.93) $ 0.19 $ (0.09)

Quarte r

2000 First Second Third Fourt h

Revenues $ 59,337 $ 92,019 $125,301 $ 62,89 2Gross profit (loss)(5) 15,389 25,519 34,170 (25,060)Net Loss (28,394) (34,364) (26,454) (91,555 )Net Loss per share, basic and diluted(1) $ (0 .52) $ (0.57) $ (0.43) $ (1 .38 )

(1) Earnings per share are computed independently for each of the quarters presented . The sum of the quarterly earnings per share in 2001 and 2000 doesnot equal the total computed for the year due to changes in shares outstanding and rounding .

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(2) See Note 6 of Notes to Consolidated Financial Statements for an explanation for restructuring and asset write-offs .

(3) See Note 7 of Notes to Consolidated Financial Statements for an explanation of the repurchase of subordinated convertible notes .

(4) The gross profit (loss) includes the effect of special charges of none in the first quarter of 2001, $28,704,000 in the second quarter of 2001,$6,424,000 in the third quarter of 2001 and ($1,622,000) in the fourth quarter of 2001 .

( 5) The gross profit (loss) includes the effect of special charges of $19,000,000 in the fou rt h quarter of 2000 and none in any other quart er presented .

73

Exhibit B

Table of Co n tt ents

SECURITIESAND EXCHANGE DOM MI SS ON

Washington, D.,'~ . .20549

Form 10- K

(Mark One)

E7 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OFT:HESECURITIESEXCHANGEACT OF 1834

For the fiscal y ear ended December 31,20M

or

TRANS TI ON REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SE.C JRITI ES EXCHANGEACT OF 1934

For ti ettansition period from t o

Commission file number DJ3-24647

Terayon Communication S ems, Inc .(Exact name of regf strant as s )ecifi ad I n its charter )

Del aware(sate.or other juris i cti onof

.incorporation or organization)

4988 Great America Parkway

'77-0328533(I .R.S Errployer

Identi fi ca tion No. )

Santa Clara, California 95064(408) 235-55 M

(Address, including zip code, and telephone rarrber , i ndudl ng area code, of the registrant' s pri na pai executive offices)

Sear ities registwedpwsuant .to Section' 12(b) of the Act :

Title of Each Clm Name of Each Exchaiipeon Which Regis a e d

None

Securities regis t ered pursuant to Sec tion 12(g) of the Ad :

Common Stock, per value$0. 001 per share(Title of Class)

None

I ndi cafe by check mark whether the registrant ( :I) has fi l ecial l reports requi red to be f i I ed by Section 13 or 15(d) of the Securities ; Exehanye Act of 1934during the preoedi ng 12 montl' (or for such shorter period that the registrant was requi red to fi i e such reports), and (2) has been a bj ed to such filingrequirtsforthe past 90 days Yes O No O

Indicateby nt.toItemHofRegulationS- isnotoorhanedherein,andwiInotheaontatned,tothe best of the registrant's knowiedAe, in definitive proxy or information staten>etits i ncorporatted by reference in : Part III of this Form 10-K or anyementh errt to this Form 10-K . 0

Indicate by cheek mark,whets'ier the registrant is an aooel erated .fi ler (as deli ned In Rule 12b-2 ofthe. Act), Yes g No D

The aggregate market value of the voting stock held by non-affil i ates of theregisrarit, based upon the dosing sale price of the common stock onJune 30, = as reported an the Nasdaq Nab anal . Market, was approxlrmtei y $61,237,987 . Wires of oonxnort stock held by each offi cer a d di rector"by each parson known to the Con any who owns5% or more of the outsaiding ui runon stock have been excluded in that such persdns gray be deemed tobe affiliates This deternrnation of affil iatesta#us Is not neoeasanly a mnd usve determination for other purposes

As of M arch 18, 2003, registrant had .outstandi rig 73,717,018 shares of common stock .

DOCUMENTSI NCORPORATED BY REFERENC E

Portions of the definitive Proxy Statement to be filed with the Securitieeiand Ex c mange Cony aeon in April 2003, pursuant to Regulation 14A of theSectrities Exd geAct of 1934, in connection with the2C .Annual Meeting of Stockholdersof Terayon COrnnu iration System, are incorporated byreference i nto Part I I, I tam 5 .and Part1 1 I of c hi sArn. al Rep ort .,

TABLE OF CONTENTS

spEciAL NOTE ON FoFnARD-LooKiNG STATEMENTSPART I

Item I . BusinessDIR€CT : S. EXECUT1VEOFFICERSANDKEYEMPLOYEES

Item2. Pri esitem 3: Lwai Proceec#' nc sItem A. Submission of M Cersto a Vote of $ecurity HOIders

Table of :Ccsr tent s

ITEM a Financial Staterneatsand SJpplem ,tary Dat a

TERAYON COMMUNICATION SYSTEM, INC .

INDEX TO CONSOLIDATED FI NANCIAL . STATEMENTS

page

Report .tsf;:Err IAUtt L1.P, : i n 1tors 56Ccns lidated Roarx a Sheets 58 .C,~i o1 ct if °3tata entscaf : ~per~tf~rs ;> .5?Cnnsolldatdd2~enierr[s of Sbodchdder Equ ty 58Ccx~9o1'id i ier[(s oE.'C R ms . .. . . . .Ndesfo Con6nlidated Rnancial St eanents : 63

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Table of Contents

REPORT OF ERNST & . YOUNG LLP, I NDEPEN DENT AUDITOR S

The Board of DimAorsanr!Stockholders

Tomyon Cormwnica ionSystems, Inc:

We have audited the a=wrpmyi ng corvsdidated bal ante aaeets of Terayon .Conn iuftati on Sjr rn, I na..as of Dew 31, 2)02 and 2 O1, and therelated consoliclated statements of opera(on$ stodchol dwdtqy ty, and cai flowafor each of the three yeers'rn the pal od ended Deom-ber 31, 2002 . .Ourauditsalsoind .udedthefinancialr#atetientsd*W8IiseedintheinJ >atItem15(e)(2) .Theeeflnariciaisi2Gen1~ltsa~dscJiedulearetheresponsibilityoftheCompany'smenagen rt. Our responsh lity'istomcpressanopirionanflveofinenccaf datenwftendschedulebasedonouraudit s

We oondu ted ouraudtsi neorordmos with auditing andards ®enerol iy accepted in the United States . Those :s requi re ttr we plan an dor m the aklit to obtain reasonable asanant akiotd whether t efi r~artaal dAirm is are free of rhaferial mi ; Art *dti ril udeswamini ng, on adess :evider<o9:s ,por~ngfhearrountsanddisdosuregin$ finerxielstaterr>enfsAnaudtalsoindudesesaess~ngiheaocou~tirx~principlesusedendfi c a rt e s t i nre2es node b i t rnar aomle t, asweh as e v a i ueki mg the ovetal I f i n a r d a l . statement pr ion. We bet ieve that our audits provide aonabl .e basisfor our. opinion.

In our opinion; the consolidated #inanrial3takeniaitsreferrsc to above present faidy, lnall matern al resoecis , tfieeonsolidefedfyv. dal po9tionofTa ayon Convrntnication Syderns, Ire at Deoorr r 31, 2002 and 2001, and the oonsolidd d rea.l.tsof i tsopar bonsand its.coeh flowefor each of the threeyeas i nthe period ended Deaerrber 31 ; 2102, in conformity with aboourting prinaplesgenera iJy as ted in tt~e United States . Also; in our opinion, therated financial Statementsh~edule,whenoor lderodinrelationtoj ebasicfinancial"armtatokenaasa :Whclle, presentsfair1y,inalI .ri enalneedsthe i nfon ation set forth the n .

As di s i in Note Ito the consoli dated f i t arxi al "einent% effe ctive la m ary 1 ,.2002 , the eorrpr y adopted Statanent of Fi na ci aI Accounti ngStandards No. 142, "Goodwill and Other Intangible Asset ', and effectiveAp.n' 1 1 2M2 the Company adopted State i t of Fin ial Aaoou-thng StandardsN o . 145, " Rescission of FASB Staterne is No . 4, 44 and 64, Arne drnent of FASB Statement No.13, and Tedyii r Correct one

/sf Errt & Young LL P

Son Jose, California

.hn ary 24, 2000

55

Table af Contents

TERAYON COMM UNI GATI ON :SYSTEMS, INC .

CONSOLIDATED BALANCE SHEETS

D%Mba 31 ,

4002 2001

(nihausendsdta~t shsredate~

ASSET SCurrent aamt-a

~and .c> equ vatent~ $ 117,079 $ 140274Short tgniirw rrerts 89,424 233,61 4Atentsr ivau e,1essa[l owaee for doubtful Wwunlaof t3,51 9 i n

2~432.etiFk#i$T,a n n2cx I 18,355 48,386Amowits rew'vabl e from related parties 842 4006E3lt3flr t'reCeivatites 2,587 7,47riventgry . 8,257 16,658

0(1w>if6dtaggets 8,263 13,462

Tote) arrant awls 242,817 423 ;876Property acrd Bquipraeit,'r 17,J06 " .

17,,Intdrobles other assets net 14,987 1 7 ,491

Toth. amts 3 275 .710 3 466,646

LIABILITIESANDSToCKHQLDERS' EQUIT YCt r nt IifltiJ ties

Aomrrtspayable $ 23,920 $ 42,821Awt f payroll an4 related exper 8227 9,441Deferred revenues 497 4,16 9Warr" reserves 8,607 8,368A =ijed resin dear

a6754 8,197

Acaued v endor c W 1ation ges 13,865 17,291Ctr crud Il 1 l[U s 86©9 14,01 5l> freresi +yrabfaar t grt portion of Iong-term debt 1 .155 3 273Current porti on o f capM I ease obl i gati ons 154

,12 6

Total aXraitliatifities 69988 107,701Long-term obl I Qrls 3,421 4 267Long-term portion of c2pital lease obligations 78

,233

Conver4 bl e subortl Hated notes 08,081 174,14 1Com(ri4net Qndcorlbnger~aStockholders' equity :

Preferred stock $10.01 par value.Auttprized ~i-taras- 5,000,00 0I- and o& ng 1a -es- no re i n 20Q2 aitd 2X 1

Common stock $q cQ1 Par val ue;Authorized sf'r 'e®- 25C,D00t0OI a5.ie1 - 73,240,054 i n 2002 and 72, 071 .769 i n 282 1Cut a dng-73C)64,045in2J02ar' i71,943,9Ci0in2n0# 73 73

Addi t anal paid in capital 1,078,144 1 074,203D r efec+ ded'icit (gam 25 (gamefoDaFa reef

) )

Tr 9bock at tom, 156,003 : -pares in 2002 and 127,938 stiaresin(770) (708 )

Accumulate{ other corrprehensve incocr (loss) (3,070) 248

Total stodtl oidwg equity 13X,142 1$0.3 4

Total Iiatiilitiesandstookholderd equty $ 275,710 $ 466,646

See accompanying dotes.

56

Table of Contents

TERAY ON COM M UNI GATI ON SYSTEMS, I NC .

CONSOLI DATED STATEMENTS OF OPERATION S

Yaws Laded rua uas 39 ,

2002 : 2O D1 200 0

(m thausan4ss, acc4zt. Re►s redaa)ferenues

F~roduc revenues $120,30$ $ 2 7,OR$ $ 220,228k19921R8atdd }lattyProthtrevenues 9,097 5Z445

T129,403 279,481 339,549

Col of g~piis8otdCost of pr ado lomv t es 93,640 228,936 224,787

> : C ot :rd 04ty product revenues 7309 33;181 54,744

Total costofgoodssold 1 00,949 258,117 289,53 1

Groasprof t 28,454 16,384 50,01 8Operati ng -p a

R rthandde op n it . :s 58,696 79,927 58,270Cost of product development 8sa take aWeeT ent - - 9 563n-Process F. sectdi aid. dave[op r alt :< 30,535Saiesandm2tkefir 95,704 55,701 45,26 1Oral>and tmi>ii~lrative ;' 158,715 31,3C& 24,809coadw_ill :attortiza lon . - 25,41 QRestnadtt'irxg< sdndaa t Wi to-offs 8,,922 587,149

Total opeatrx,1expai±s 118,037 779,495 237,495

Lor from oprbrabons (88589) (763,132) (187 477)I rterest i rcorne 6,838 18,132 19,794Inttxe~l expeMe (6,174) (15,224) (11,253)Ottrar even- (4,145) (2,654) (1,819)Gan on eedy reb rerria 1 of debt 49,089 185;3$7

Loss before tw (expor>ae) benefit (43,975) (577,761) (180 767)l ncor$ tlx :f ~cpei'i ):b E refit x.2.35) 13,915 -

Net loss $ (44,213) $ (563,846) $ (180,767)

Basoa dd diJuednet(ossperliare S (0 .61) $ (g. . . ., :<> .. . : : $ . .. ( 9&)

Shares uJ in iximppti rg bas c and diluted net I oss per share 72,8. CXi 68,931 61,349

See accompanying notes.

57

Table of Contents


CONSOLIDATED STATEM ENTS OF STOCKHOLDERS EQUI T Y

Aacumuleta dConvmn Stack Additional 9todchdde-d: other Treasury clods: Trial

P td-in Apwmulated erred Notes CQmpr hmsive 9tockhol ef dMares AiT"nt Capital Ditidt Con"$alion Repeivable moon SharW Amount Equit y

(tn ti!~usands gPt chafe ,nt~j

~epetnbar31 ,1M 48,87t1,334 $ 24 $ 408,804 $ 14,361) $ (1,553) : 258.655Ezeeisa of0j on f of

( Ito purd aaeWrtv~r~3ud 1,935,675 3 14,180 14,183

nbrrkgpn:~pck (34,722) 34712 (T~ (23) ! ;cash preoeadaf rom

melonst ockhol ders rote sr Uy a .. . .: .. 3 _ 3

UrwOn{s0apttlpert~ior l>' O Ecltosuc kaptlals 3,497 j3,48 ~

Amortization du l" rka dwnvarWia irdatgdto 3gtk .. . . . . .. . .3,465 . . .3 .46,5 . _ . .

I~f~rre of vdi7Ard to '

Porch-aMmonAuck 44,143 . . . . 4!,14 3

Isumnoe of qpn imndock for Employee6tgck PurdrmaRan 277,Q&) 2, 038 2,086

lsdll2nogof co ir'nott~Igd in r"ontoStodrS 4 l 22 (22) -r.. ~

t.W

~

4MEo (uU~ ofW

vWants 3,687,610 4 (4) -Hc~ alia~s -

Tet~i e 4,400 003 4 95969 95,973AIDE 1 .404553 2 83,475 83,477Inter Tdemm 378,251 1 46,473 46,474Uara n 536,766 1 5E.597 54 .83 8C n>Bs 1 .547,770 2 96.782 98,78 4tv rk'kil 2,968,962 3 162,556 (4,7t9y 357 840pigtr41a 762,133 1 15,320

,15,32 1

TFueC1i9 534 .487 1 2,663 (984} _ _ 2180RWCt~Q e pri ce

adILLtmari on 1999aoq,A atiU s 1,353 1,353

Ck~tnpreheltrve

I naeecu to urvuA izu iOn on sari-tumrri meal sarntooliv e

translation2djiAmaA 1,007 1,C97

Nd Ict (180,767) ,(180,767)

Corrpr~rarsve _k~a (139 .82

Belanoe atDmmb 31, 2000 67266,986 68 1 ,037,964 (329,148) (81788) (3) 661 34,722 (73) 702,68 1

58

Table of Contents

Accum ulatedCommon Stock Additional Stock derv Cthei- TreaslryStodc Tota l

Paid-in Accumulated Defer red Notes Comprehensive Stodchotders!Shares Amount Q ,Itpl Defiut CQffpdnsatiot Rboevetile Inwtne Sheds Amount Equidy

Q rl t hqumnds, ekov S11pr~arl>oVn( ~Ba ance aPo ar at 31, 2003trt,joo f,4",4 j(Et

Czr2sGS9fi . . . . :68 . ' ` 1, 1964 (3rd labq.< (6,78 . . : ; : ;: .681 34.122. (79) i102;8arasoof option for

¢ad,to parcht»corn't 2,507,592 4 12,494 12,49 8

~n0ittrnon9ad (03,117) 93,117 . (6@6) (605)I raeo( opiio is 719 (719) -Arr,attz~im at

Verredcompott"iw 5815 5 875

Adjuslttenlst odeferredvo rnyamlim duelu empl oye stemrr ions (t 234) 1,23 4

Fa~aicegfTeetridaf-M .-Idti ;s o fo r9eYviGVS ided 275;250 123J I A7

Imiceof i n nsoda for EmployeeStock R rohmRai 381,428 196¢ i'g66

S~uerr~YA'uart'attis1~ 1carrxi0hsluck 1,187 1,167 ! :

I samce of commonatodc for tenderdrer 141,442 2,OD1 2,C 1

kreof zrnrrrn.

stockfor rdirerrvrdOf dcbl 1,4643~a9 17 .869 17;87D

Cash proceeds rrompaimart o n9odihddasnotesrye 3 3

1nCCYW :

tncr iwato iirBd1Za1 •---. .pain on diort-terminve;tRt ds 28 208

-traia{4 ona9Jidmeit : (621) (6'21 -

Wri Ic (563,846)

Corriprdtaisv eion (Was0

sa xDeoerntW 31, 2001 71,943,930 73 1,074,203 (892,994) (458) - 248 127,839 .(76 180,304

59

Table -of Contents

Accumulate dCommon Stock Additional Slodchddes' CE her Treasury Stock ToW

Paid-in Accumulated Defer red Naas Comprehensive Stodcholde g

Sherm Amount C,epito Deficit Compatsation Receivable Inowo Shales Amount Equit y

(Irithwsgndsotp ar9aq"It oBalancest

19eambo[ 31,

4Eu rO. 74,943,930 73 1A74,203 (892,994) 5 -( 248 127,639 (768) 1a0,3Q 4Exord 9ai'Opti«i for

call to IUfc*camcpn oar 422 ,073 1,72] t721

E2EQtYtul9ps Mun>.: Af ttomttfixl slaetc I1 .068~ 28170 (~Returndwow

diagsfromTd 4 e

uTsition . ..

(25,077)*0 q nslo10i

e ~k

38Arrort pt d

deferredQ npars4ion 1 471 47

Fs~cbRG7ei{hdad:'. WCtYtYiH3lOd t

tromstook Op ion

'pcwlded 206,00 290 29 0Awelarationd

veging ofarvoyee 9ocitoptionsand sockprd~ho 1 &w! ~t 1 1

8t% PLO,"Plan {94,186 1 QG64 1;~ErG

I tc c so( wa i topurdwwo rrm nstock 26 2H

Cotr~vamwrw

na,ease to urrt"izedgal on shod-ter mirrveame" s (519) (519)

: Cul*xJi2~iYitU41o7

rent (2,799) (2 799)N.21 3(44 ) (44,213)

Cohpetsv alow (44,531 )

BalanceDeng 31, 2002 73,084.046 $ 73 $ 1,078,144 $ (937,207) $ 0$ - $ {3,07( 156,009. $ (73) $ 137,142

See ac oi'nNaiyirg notes

6o

Table of Contents

TERAYON COMM UNI CATI ON SYSTEMS, INC .

CONSOLIDATED STATEN ENTSOF CASH FLOW S

YearsEnded Dectsnber 31 ,

202 2001 20M

fnthausands) ,Opet'attrgacivities sN6tIS~s6 ($44,21a) ( $ 563,546 ) ($180,767)Ad)usat~entstQrec~sid(enaflosstorefoa (used In) ptovidedby

opera5t activitiesSetwet of Net Save cos ax az t recei vabl e 1,118 - -deExedaddl 11,572 15 7. 11,28 4Wn te- off and a wtzaG on of 1 ntxO Il a asqets 3,972 .619,157 106,305In-prresearrliar~dc~evdotf

,3g535

Amorh nation related to stock options 476 5,815 3,405C+akn on arfy red ramant of deU (49 089) ( 1$5,327)Lower of cost or market inventory provi son 6,109 - -1n^paiftwltof irw.e&m itWrite-off of fixadaseafs 2,967_ 1,000CorrQ actsatran per for is iceof eorrr m n stack 3,236Value of caorrtinon ai- I preferred s tock warts i woad 26 505 9,5633

( ar c> tnop~tti ~g a~dlabiliti8sAuoots.reYabla 26,211 (5.614) (28,757)AwdkitY rt6d, 6fronrelated #a fies 3,164 13,448 (10,173I rive, ry 4,065 71,109 (82,776

~ )8Accattspoyable ( 18.801 (81, ) 777110,Accniedpayroll and related <penses (3,214 (3,064) 7,167Defared .re✓ erues (3,672 ( 829) 457

Waranty reserves X39 2,443 3,24 0AoauedrgstrtxXunn9 9es (1,443 8,157 -Arcn~ed enc9arcarir~laGoncharges ( 3,426) (t,7DB) 19,000OtheracauedliatrI ties (6 .725) 8,OQ0 21,85 0Deferredf<oces - ( 18,5@5 ) 7,567Crrerx por i on of I ong term debt - - 10, 853tlttdttp0y3~ie (1,818) (?,'~8p) '

Net cash ( used in) provided by operating activities ( 67,719) (10,461 ) 20,71 4

61

Table af Contents

TERAYON CO MMUNI CATION SYSTEMS; INC.

CONSOL I DATED STATEMENTS OF CASH FLOWS-(Continued! )

YearsEnded beoanba 31 ,

2002 2001 2000

Investiroac vt ES(Jn CfIQt18~11d . . , .

Pv,(t of short-t%rn inve rre fs 08,186) (402,663) (376,108 )Prooaetfs fromsdies nixi mast bes of sfntt-term inv s A3d,348 ....394,15W 240,744Pj cti as of property and equipn nt (71186) (9074) 4(38,534Fd rchase of other assets (17,98Cash paid for azquistion of business5s (14848 )

Netaashprovided by(i.*W in). ibvesting tivitfe5 138,974 (27 k38) (206,715 )

Firranam actiydesF inc p2E 1: 1payTrret # on tai lames (127) (130 ) (12)Prind0 paymertscn (16835)PYjcsec~SfTAtftCbrlg tgm dEbt 484,429Exeraseof o ptip.r.m. -C w .wrfrt to purchaw COn )o7 Aock 1,667 12498 14 1831?ay 6f r~puri a of conxnon stock (5) (605)

,(73)

Ptindpal .payrr ntson to kholde notes receivable - 3 3Repirdtiga ofeeix *:ionotes (57,627) (113428)Proceedsfrom isa rante of common stock Z2D5 h 208 8

NetNet ca (t .in) provided by f m)dr vv ties 03887) (1 .18,82 f : . :0, 618 .. : >Effect of acct ange rate changes (563) ($20~ -

Nef it :ea9a r3ecrae>~a) ink 2r d 5h.eg2talents : : 16,8()6 (2 6741) 314,61 :7C2sh ahd cash equivalertsatbegi nningofyea' 100,274 347,015 32,398

Cash and cash egvval wits at "of ye" $ 147,079 $ 100,274 $ 347,01 5

Supplerent dia oaw of cash flow informatio nCash padforircornetates $ :' 714 $ 31 $Cash psi d for j nterest $ 8,387 $ 20810 $ 365WO a itai noncash invest ng and fi nand ng acti vi ties

,

Con-on 4WOO i%W for settle+)1 -t of conve tbi e debt $ - $ 1790() $Acq",tionof b e r( es $ !

-

,$

-$565 228 ,Deferred cpnpensad cn relati ng to common sock i wed to

,

ren-"0yees $ 38 $ 6(34 -Rak+ctFOnir del~iet€ r parmbandiieto . Ermrgfii~i Df :err iQYaes $ 1 234'I ante of warrants i n mmecti an with purdvm of TrusChat $ -

.$ 682 $ _

See accompany i ngnotes

62

Table of Contents


NOTFSTO CONSOL1 DATED FINANCIAL STATEMENT S

1 . Organization and Summary of Significant Aooounting Policies

Desari ption. of Busnes s

Terayon ConTrxinicati on Systems, Inc. (the Company) was incorporated uxier the laws of the state of Cal i forma on January 20,19M. In Jed y 1998 , theCompany ra r rporated in the State of Ddaware.

The Cwpeny devel op$ marlcels and sell s equiprra t to c bl .e tel evi s on operators, telecom carriers and satel lite network opa'ators who to theCompany's products to deliver broadband voice, video and data servi .cesto rea dential and bLA naes sheen bars

Baesof Consolidation

Theoorwil datedfiranaalstatements indudethea ursoftheccompanyanditswtwllyowned ardmajorityownedsibs cfarier.All intercompanybalaricesacdtrai tionstrovebeen elltnnated.

Accounting Chang e

Effedi ve the beginning of 2()02; . the Company adopted Staitement,af Financial . Accounting Standwds (SFAS) No . 141 ; Busi newCornbi nations," ai idSFAS No. 142, "Goodwill and Other IrdangibleAssets' Asrequired bySFAS No- 14Z theCOmpar y diseorirtinued aniortiaing the raiianirig balances ofgoodwill of the beginning of fiscal 2002 . See Note 5.

In April 2002; the.Company a opted FASS iswed SFAS No . 145; '°Resciedon of FASB Stat is No. 4, 44 and 64, Amandrnent of FASB SaternentNo . 13; and Tedxiical Correction' (SFAS No. 145). SFAS No. 145 altows only those gains and loseesonthe extnguishrnerit of debt that Meet the criteriaof extraordinary temsto be treetedass xh i n the con l idated finarxi aI satements Accordingly, the Company is now reporting thegain from re i en ait ofConverti bia Notesin aperating resifts Asa resitof adopting SFAS No .145, the Company redaseifi ed the $185.3 triill ion previously recorded i n 2401 asextraordi nary gai n as a component of operab ng results

Use of E- ,;b mates

The preparation of theaoneolidatedfiran ial statementsimmnforrnitywithgenerallyacceptedaccountingprindplesintheUrrtedStatesrequiresmanagenienttomakeedt imatesadaesj itionsthataffectthemourttsreportadinihecoris7lidatedfinahdaisl8berrientsanclao~ompaiyi ng notesEs ti mates we based on histori cal scpei ence, input from sources outs de of the company, and other relevant facts and a ruS ano3s Adtral real is couldd ffer from those estimates Areasthat are pardcwfady si gnificant i rdude the Company ' s revenue repogni bon policy , .the van wton of itsaocounts receivableand inventory reserves the a 7tnett of recoverabi I ity and the rneas<rement of i mpaimtent of fixed assess and the recognition of re"ur ng removes,

Foreign Currency Trandation

The Company rewrdsthe effect of foregn .eurrericytran5abon inaxxerda cewith SFAS No. 52, "Foreign Currency Trandation . For operationsoutside the United States that preparefi naneial statements- in curena es ottterthan the U .S. dollar, resitsof operationsand cash flowsare :tra -dated ataverage ecivinge rates during thepenod; and assnsa dliobilitiesaretrarsslatedatsnuf-of - period exchanga rates Tr2nsla6onadjuArnentsareindudedasaseparate component of aaxrmiated otfier eonprehaiave income (losQ in stockholders egaty . For tie threo years exi d Deow bar 31 2002 trans! at ongainsaidIose@qwerenot significant Realize.dforei gn a.rrencytransx#ion.geneardlosessareindudedinrss Itsofoperationsasincured , andhavenotbeen sgnificant to the Corsi} any ' soperatirig resitsin any year presented.

63

Table of :Contents

TERAYQN COMM UNI CATION t"YSTEMS, INC .

NOTESTO CONSOLI DATED Fl NAl' CIAL. STATEMENTS-. (Continued)

Conca trationsof Credit Risk, Customers; Supplierr4 and Product s

The Company operatesi n twoacorn) . The Company sa l ►sprii

ard .Telecom Carriet,Actess 9ynducfng related parties ( ses1Note 12). Theasses have historical (y been withi n

rranager sexpedadonsTheCorrgaany MarlO nsiarsserveforpotentJ glyumoll.aMbleao ntsrecervablebeadonana sr~sntofcollscti hility .TheCorya~s- . oullectibility.b edonanuriber'offactors includlrigpa st history . tienurnberofdaysanai ntispritdue(bas3doninvoiredu e.date), charQes i n credit raft rigs of aromas arrant ever>tsarxi dra. n anoes re iardinp the lxi~i rlessof the Company's diem s:cu qrr rs and other factorsthat the Company hdievesarerei want dvii~for L ddasaoampOn tofrietrevenueintheconsulidatedstatementofoperati ons At December 31, 2002an61200I, the reserve forpoYentially inoolledilileaoi untswac$3.5milliongrid$7 .2nmillion , resp erbvel y. A r advdysrellcumber of aoon saaas,tfora ignificartpercentageoftheCorrpxny ' srevenuesandaonounts .receivabla. TheCompanyexpectsthesaleofitsproductstp alimited nurrS of customersind reeaiierato oo finueto account fora high percerrtageaf reverx Cross Beam Neworks, asubsdiary of9ixiitomo , accounted for more than 10% of the Cotepany'stotal revenuesfat .the year ended Dwerrtber 31, 2002- Two aisto rrer$. both related to the Cablesegue it , a co r ted for 7 Q% or more of the tatal revenues .(3% and 13%) for the year ended December 31, 2001 . Three customers, ail of whom related totFte Cabfe :s It accounted for 10% or mo'e.of total revenues ( 17% . 17%, and t 1 °/.) forthe year :ended Deranber31, 2000.

The Company reli eson single source suppliersof materiatsand labor fortha dgnif!oant majority of its prpduat inventory. Shoti d the Company' scurrent suppl !ere not produce and del ivy inventory for the Company to sell on a tin-Wy bass, operating Pend is may be adversoly i rr a tad

TheConWlyplaces itscai"cash equivalentsinavariety offinancial irtstitutonsandlimitsfhearnnuntofcrecitexposretfxot +diversificFionaid by investi ng in only high-gradegovernmOtaid cwrnnieraal teasers,

The Company invests its excess catb in debt instrurrientsof g o v e T i m w i t a l agend Ps, aixicorporA rrlswith credit rabngsofAAIAA- or better or Al/P1or better, r wtiveiy .TheCor yhasestablishediiidelinesrel .at :ivetodiversificabonandmattitiesthatattemptto : hidniainsafety and Iiquidity .TheCompany has not superierxed any significant l asses on its cash equivalents or dhort-term inve stment s

Revenue Recognition

The Company sells i is produhtsdi redly to broadband ,a global service providers and to a l ear eutent, resell ersa d i ntegators aid reoogri zesrevenue upon shi pn - t to the rx igarner when tits e i 9transferred . Revenues related to product sal as ere reoogni zed i n accordance with SEC SW Acnoulti ngBulletin No. 1Q1, " Revenue R tionin Flnar>eial ztafernenta' (SA9 101): (1) pare veevidenoethatananaigement 6 cis~s (2) delivery hasoaxuredor sarvicesharet~ rendered the~ler' sprioetothe buyer isfixedor dsterminablQ and (4 ) oollQCtibility isreasotrably as5~red . A provision is madefor esti mated product returns tinder fie warranty terms

64

Table of .Contents

TERAYON COMM UN1 CATI ON &YSTEM 61 1 NC .

NOTES TO CONSOLIDATED FINANCIAL. STATEMENTS- ( Continued)

Research and . Develbprnent Expenses

Research arid.developmeit scl ones are.charged to ecepense as incurred .

Shipping and Handling Costs

Costsrdated tosfii ppirg and hard ing are i nduded in cost of sal esfor all Periods .presente .

Advertising Expeinsee

The Company accountsfor adverbs ng cos s as ee(pettise in the peri od in which they are incurred . Advertising expensefor tfie years ended December 31,7002, 2001 and 2€i00 wen3 $0.4 mil I ion, $23 mi I I ion, and $1 .0 .mi II ion, respectively .

In Deoe rber 20701 , the C o mp any e n t e r e d into co-- market ng arcangemer is wi th 5 1t aw Corrnu c a ti o n s , Inc. ($ ) and Rom sComrrionicati ons, I m(Rogers), arid a t e d party . The Company paid $75mi l l ion to Shaw and $0 .9 million t o R o g e r s , and recorded these amounts a s ottw current assets I n My~D3 the Company began arrrorftng these prepaid wets acid dsar rin t iaii i st C erevenues in accordance with Emerging lsaiesTa9c Force(EI TF) 01-09, "Aocotnb ng for Cons deâtion given by a V eridor to a Customer or Resel far in lion with the Purdiase or Promotion of the 5/.endoe sProducts" Amaxntsdh aged agai rest rerenueetn 2002 totaled apprxximately $2.8 ni Ilton . The Coirany wi II continue to charge the arrorb zati on of theseasseha age rest Cable rarenuegi n e+aEh of the n~ct toir qua tersthrough Decant 31, Z XX3, the term of the related attangernert at the rde of $1 .4 millionper quarter ( e Note 13).

Net LossPer Share

Historical bagcanddiluted ndioai.per fewascatixtedWngtheweightedaaeragenlrt'>beòfoommonsharegout~.tarding .Options waara tSrestri cted stock, preferred dock, and oonverti bl a debt were not included in the computation of hi sfarical X i l aced net :l oss per share because the effect wouldbe antidi I.utive.

Shares used i n the Calculation of basic and di I uted net lo ss per there fof I ows(i n thm wnd% wcept per share data) :

YearaEndod Oeo wnbs 31 ,

2002 2001 2000

Net low $.(44293) $(56::48) 4480,767)00000"M r. r~rrirrr

Shares u sed I n computing ba sic and di I uteri r et I oss per share 72,803 68,331 61,349

Back and di lace d net loss per share $ {061) $ ( 25) $ .::::{29r) .. <

Optionto purchase 14,635,025, 20,007,686, and 21 ,489,536 sharer of corrrron stock were outstanding at De owr i e' 31, 2002, 2001 and 2000;ressectivd y, and warra itsto puthaee 2,425,683, 2,408,300, and 2,072,318 shares of common stock were outstanding atbecember 31, 2002, 2001 and2000, respectively, Iiut were not I nd uded i n th e computed on of di I uteri net loss per share, s rice the effect is a itidil uti ve.

Derivative Financial I nstrunieits

The Company reoogni zes el I deri votive financial i ns4'ument such ss foreign exchange cMit in tl-e Por»I i dated financial statements at fair val ue,regard) easaf the purpoee or ft i ntent for hol ding .the i ne7ument. Changes in the fair value of derivative fl r"al i ndtruments are either reoogni zedperiod cal ly i n i noome or i n stgckhotders equity as a component of©ornpr erui ve i none depending on whether #*derivative financial i n umerdquaiifiesfor hedging ao x utting, and if s v, whether it qual ifies as a far value

65

Table of Contents

TERAYON COMMUNICATION SYSTEMS, I NC.

NOTESTO CONSOL I DATED Fl NANCIAL . STATEMENTS .- (Continued )

heckle or cash flow hedge. Generally, diangesi n ffir val ues of derivatives accounted for asfeir val ue hedgesara recorded in incor v along with the onsof the d xlesinthafai rvel softhehedgeditermthat.gelateto thehec~sd ri"Changesinfairvaluesofdeivativesacoounfedforesc fl owtothee~cte they a reef fe~fiveashe ges,are reardedinotf~eroompre ive :inwme,net.ofdeforr dtaxesChangesinfairvalueofderivativesusadashedges of the net investment n fora gn operations are repotted i n other cornprehensve i ncome as part of the :cUmulab ve trwi di on adjustrrient . Charges infair value of derivatives rot qualifying as hedgesarereportedIn Income

The Con s®ny had no deri vative fi rrand .al i ns truments outsbarrli ng as of De a nber31 ,2002,.2001 or 2000.

Cash Equivalentsand Short-Term I nvesirnents

The Company i nests itswcBffs cash i n money market accounts and debt i rsa rand oon6i dersal I highl y I squid debt i nsGuc tspurchased with anoriginal maturity ofthree monthsorIesstobecashequivalet51 Investmentswithan original mebrityatthetirrreofpurchaseofoverthre .emonttsaredessifiadasthci -erminvestrwft,regardlessofmaturitydateasallinest tsarec#asafied aeaval abfe-for-saleandcan be readily liquidated tomeetcurrent operational rx~eds

The Cotroany accounts for i nve rte is in accordance with Statement of R nand al Accounts rig Stan&rds No . 115, °Accouatting for Certain I nest rieritsin Dell and Equity Saintsee . Malegementdatermnestlteeppropriatedassificztion :ofdebtascribesatthetirneofpi d,aseand reeial ualessuch.desgretion as of each balance sheet date, The Company's short-term rwost ents, which conast pimarily of cogm 'dal paper, U .S. govemrnentandU .S. government ogency obi igalions and fi xed income corporate Bear ties are das®fied asavail aH a-for-salsand are .arn e~i at fair market value. Realizedgelnsax1Icress anddidinosinvaluejedgedto beother-then-temporary onavaIab(e-for- sale sec n tiesareindudedininteresiincome .Theoastofseam4essaldisgeedontheVedfieidentificationmethod.TheCorrpaiyhadnornat®rial investn~inthort-teltnequity tecuritiariat 31,2002 or 2001 .

During thethird quarter of 20OZ the Comp®ny received approximately 35 .9 mill ionshare of Net Servicostle ComunicaCao $A (Net Serviaos), acustomer, val ued at i .+pproxin ately $2.5 million Woet anentforall out#W 9ng socounte .reodv9bl .esduefrom Net Servfcas . Theshereaof Net So viooseretraded antheSaoPauloStockExchange: AIIrevetxaeandthecostofsafearefstingto fhe receivat!eshaQheondeferreddu~atocKtandedppymenttermsoffered i n the original sal esagrcamatts The Company recorded a I os ; on ifie sett) ei sit of the Net Serviocs twelve *eaof $02 mil lion, wiv ch was chargedto cost of goods sold i n thethi rd quaff of 2002 :

The Company I iqui dated 32 .9 ftil I ion of these shares val ued at $2.3 61 1 ion i n the fourth quarter of 2002. The Company recorded revenue and therelated cost of sales as the siareswere:sol.d and cash was received The remains ng 3.0 mill Ion urea are dasd fiied asavai Iable-for-sal a and are I nd uded inthe coneol i dated bat a ce theet as short-term investrtrnts of $0.35 mi II ion .

66

Table of .Contents

TERAYON COMM UNI CATI ON ?STEMS, INC.

NOTESTO CONSOLI DATED FINANCIAL . STATEM ENTS-(Continued)

I nventory

Inventory is stated at the l ower of at (fir-4-in, first- out) or n- 1cet . The corriponenis of i rwentory are as fol lows ( in tJ ioi rxls);

December 31 ,

2002 2001

F3ni etlgncx X5,9 $Work inproms 769 2~6E avi ratsri s 1;57 3 OW

$6,257 $1:t?,t ,e

GroS;invaitoryIevds decreased duri 2002 due to thetr2nstion oftheCompany'smanufactuin0functionstocontract marwfact tuers, andasaresult, the Company wasableto significantly reduce its purchases of row materials

The Company recordslosses on aormit`rieritsto purifaae :inventoiy i n aocordanoe with Shat i0 of Chapter 4 of Aocounti ng Release BulletinNo. 43 . The Company' spolicy for valUatlon of inven#o ry and a n tmerrCst> p~ rctra9e inV.enbory, indudi ng the determination of olie , tete or excessinventory, requi resit to perform a detail ed as neat of inventory at each balance dv tdadewhich i nd udes a revi&v of ,of

other factors, an e~tlmatsoffutredeman fforprodur within spedfiatimebenzcn generall y ~xmonthsorIes% eswellas product Iifecyde. andprock~ctdevelopmer* plans. Thee; matesof future deirand O u t the Company usesin theval:uabon o f inventory'are the be Sfor thsrevenue f o r e c a s t , which iselso carte t with its>#wit-berm ma nufactu ri ng plat. Based onthisanalye theCorr~pany redioesthecostof rove tory that itspec fcalky id tifiesand c~nsderscaeolete orwcceeavetofulfiIIfduasalesestirrabesTheConipanydgfinesobeoleteinvsrrtoryasinvenlKlry tfntwilInolonggrbeusedinthen ar~uir~gpraoaeaExoess inventory is general I y defi red as inventory in excess of projected usage, arid i sdstert iced us rg thet Comp" ' s bed esfi nmte of future demand atthe time, based upon informa ti on then available. The Company ci roses of ex ce s and of wl etei rwentonesi n the nomial course of bus nees See Note 3 .

Goat of goods sol d for The year a ided .Deeanber 31 ,:2()02 included a reversal of $15.3 mil I ion of special charges taken i n 200 .1 . for vendor, oarxreliati onchar'gesand inventory considered tobeeaosmand letc.TheCompanywasablatoreversetheproviaonin2002asitwasabletosall inventoryor iginally cons dered to be excess and obsolet e, . I n addition, the Company was abl a to negoti ate downward certain vendor carxse! I ad on d a ms to terms morefavorable to the Conpei 'iy.

Cost of goods sotd for the year ended December 31, 2001 and 717Q (31indtided $33. 5 miIlion and $19 . 0 miI lion of sped al charges for inventorycon9 dared to be excess and obsol ate. Duri rg XQ2, the Company recorded a .diargeto cost cif sal esof $6.1 miI Iionto reduce cerfai n 1 nventories to the Iowe rof cost or market as average sal I i ng prices fell bal ow fhe :cost of these .products

Other Current Receivables

As of Dumber 31, 2002and2001, other current receivabl es is primarily composed of interest, tax04 and non-trade receivabf e$ and includedapproxi rr*W y $1 .4 million and $5.2 million, respectively, due from oonfracf manufadurersfor raw n2t"s ptxdlase from the Company .

Property and Equi pa nt

Property and equipment are care edait cast I sea accumtdated :depredation aid amortization . Property and equipment are. depreciated forfinancialreporti rc purposes us ng the strai ght-I i ne method over the estimated Liedul I Ives, gerwal l y three to seven years Leasehot d improverrotsare amorti zedusing thestrai ght-line

67

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NOTES TO CONSOL I DATED FINANCIAL . STATEM ENTS--(Continued)

trrathod .over the shorter of the useful lives of the aswts'or the to neof the leases . The re«overatii I ity Cf the mrryi ng mount of Property and sgii piivnt isas~seed based on estimated :fuhre undisoounted ca1 flow and if an inV. airm®nt W04 the chageto operat % onsisme tred asthe a cessof thecarryinga nail over the fair value of the asset Based up..on thie nvd)od of ng :reovverabi G ty, the Company recorded $13 rriI lion in ascot i rr rn~entsprimarily related to the Company' srestrtx trx'ingiri .200'l and $16i Ilion inaasstimpairriienisdiririg .2001 related to .as®atsaoqui redinthepurchaseofAooess Network O echorres Div►son of Tyco E(ectronicCg. rpcrrtion (ANE), No asset inpa nrit ocarred 1 f 2 CQ.

Property aril a uipment : "asfollows(In thou ids):

Dursn ff 31 ,

2002 2001

Saftscrareahd IDSsiw*s 1 $ 2~S,32RFNrrr Lure arid Kp prr)ant 31,032 29,754L.basafidd Improvai Its 5.M B 3,573AutOMPbi l es 16 _ 37MrArirfi on Ira progress '' - 4,805

Fogerty X4 equi p Tent 6 16 7 ,5 63,497AcparWdawocia" a arrottizAiton (4 75f} (38, 38 )

Property and equiprne t, net S 17,906 S 25,279

I Mang files

I ntangi bl es and other assets sted of (i in tnous3nds):

December 31 ,

2002 2001

ft t n i bleS net T . .' . - $x,767Other as 14;987 13,724

Total i ntangiblesand other assets $14,W7 $17,491

12131/2002

AccumulatedGram Amortization Net

Pnnrbzsd ntargbieas5etsGoodwill $4974 $20974 $ -P s ~italed Workf irce: 3,472 3# 72

Total $24,046 $24;048 $ -

17/37/2009

Accumulate!Gross Anratlration NO

Arnor aid intarrlea isGoodwill $20,764 $(4$,251) $2518Assirr Qd workforce 3,372 (i $ ) 1,249

Total $23,841 $ (20,074) $ 3,767MMOMM

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TERAYON COMMUNICATION SYSTEMS, I NC .

NOT ES TO CONSOL I DATED Fl NANCIAL. STATEMENTS-(Continued)

Goodwill is the excess of the pcrd%mo oe ever the fai r value of Identifiable W asks aoqui red i n bus now ooxt i net one aoeat,A,ted for as purchasers.During 2002, $02r i II ion wIasadded .tci goabviII relating to a reda~fication of the originaii pcrd>asa ice of Digitrais(see Note :14).'During 2001,$4.5 m i I l ion was added to a ssn r iol e c $ w n r k f o r a relati r g to rgtenti err payments 1 n conjundlon Hritfi theacgUston of (ENE (sse Nod 14). During 2002; eCompany reclassified$1 .3million of amrrbledworkforce, rtetofsoctmIstedantdti #ion, with 2nirxiL# irite life, to ;goodwillat the date of adoption ofSFAS No . 142 see Note 14.

Otherassets pri ma i ly consist of obi igationssafipotten by letters of credit See Note 3.

Other Assets

Incl uded in Other Ammonthaconsoliidated $alaxeShostatDecember 31,2002 isneetricted cash of approximately $9rnii lion related to the,Cor ipany'ssiroreft lease. See Note 3 .

I rri irmeritof Goodwill and Other Long-Lived Asset s

Goodwill aid ot erlong-liveiiassetsarereviewedforinpairmentwia, erevehtssuchasproductdisoori6r , .plantcfosures,product.tfapoetionsor other es i n d rarrAances indicate that the carry[ng amount may not be reooverabl e. When 5.x#t events ooar, . the Company con es the cerryi ngamount dlartg of the aseststo undsoounted expected future rah fl ayes If tH saompanson irxi c atestt of there i s an i rrpai anent the arno~rit of the i rr iarment i stypi cal ly calculated! us ng d'soounted expes#ed future oaf fl os The discount rateaplo1 ipil to thoee c f lows isbased onttie Com ty' s weigfrted averagecost of capital, which rePresartsthe blended cods of debt aid equity .

During 2002 and 2001, the C,onilrany recorded . impairnterrt charges for goodwill, assembled workforce, and other 1ntarigibi .e assets, See. Note 5.

The Company determi nesi n rment rel ated to its equi ty i rwesfinents i n aaordanoe with SFAS No. 115, 'Account ng for Certain Investments in Debtaid Equity Secuibes" and Semwibesand Exdla'ge Comrrii96on ( SEC) Staff Atxbtriti rig .Butletin ( SAB) 59, "Accenting for Noncurrent MarketableEquity 5ecuriti ed, which provi de g ui danoe.on determini rg when an i nvesiment i s oth er. `than-ternporari I yirro red . Applyi ng thi s gui dance requi res.

judgment I n making this] udg rent, the Con'ipeny evel uates, among other factorq the dura ti on a nd adept to which the fa r value of an i awes unit is lessthan its cast; the financi al heal th of and bust mess outlook for the it eaèe, i not id factors such as i ndu~ry and sector pertorrtpno9 , charges i n technology,and operational adfi nand ngcrash flow, avsilabiafi nand 21iriforrrption,andthe~y' sintentandabiIityto hold the, investment See Note

Warranty Reserves

The Company provides a standard warranty for nest of its proc& generally I a<,ting one tD five years from the tiateof purdla9e. The Companyprovides for theed net cost of product warrsttties ak the tiinerevenue is reoogii zed. The Gompeny'svrairotlyobiigation isaffected by p(odyct Maniocsrater, rreten al usage and service delivery cots i nou red in correct rig a product failure : Reserve eIEti mates are based on historical experi once and expectat anof future condi ti ors. See Note 16 .


The Company aooourdsfor its employee stock pi am i n accordance wi th Aocounti ng Pt rr pi as Board Opinion No. 25, "Accountf ng for Stock I seuad toEmployoos'(APBOpini onNo,: 25).and ndodest sisdosure-onlyprrwiaonsasregui red under StatementofFirwyial ACaounti ngSta~1 atds No .123,Acoountingfor Stock- Baeeci C ereelian° XSFAS No .12 ) . The Corr arty provIdes a id6onal pro fomiadiadogaesaasrecpirid under SFAS No . 123and SFAS No 148, "Aoco~a~tirig far Stock- Bas3d Corripeieetion , Trarrshonarid Qisdosare in Note 10 .

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TERAYON COMMUNICATION WSTEMS, INC.

NOTES TOCONSOLIDATED FINANCIAL, STATEM .ENTS (Contihued)

Equity indn.rrwtsg wkod to c hs ltantsare .aooouited.for urtii®rfhe fairvaluer'rietfiod, in aooordancewith SFAS No . 123and Emerging is+euee :T kForce No . 96-18, 'Aceountirg for Equity I nettunentsThat Are Issued to Other That E pIdysesforAO iriri or in Conjunction with Selling, GoocJsorSeryicee;' us rig the Black-Si ales opti.an pri_. ,g model and are recarde~! in the:equity eection.of the Cafnpany' sConsoll dated Balance Sheet asdere redcompersafion These in u ntsare es+t .tap odiereveluedonswortheirvestfngterms Theetpense .isret zeda,'theiretrumaitsvest.

SFAS No. 148 ar andsSFAS No . 123 in December 2002 to require that disclosures of the pro forma effe ct of ud rgt a fair value rrethod of accountingfor 5tocIE-based wTi pyeecomper sati on be c1 ql eyed more promi roty and i n .a tpWar format , For purposes of pro forma,ci sd osretg , the a -mated fai rvalue of the options granted and ES}?F>#x~restobe wsued is arxtrti zed to ~i over their reepecfive veear~g .periods lied o r er ti on> osi for theCompany' satodc-Fsseci cbmpertsati oh pl ens been determined based on the ai r val ue at the grant t}ates for awattfs under those plans cons stmt wi th tttemethod of SFAS N0. 123, theCo r ny' s net loaeppplic*4eto Qorrtr n sindthcIdasand net lossper ~hareappl ii bfe W'c~onxnc~n docK ldeswould havebean i ncxeassd to the Kro forma a xits i ndi sated b lc ~iri thbusaxiS ertoept per Jtare data ) (See Note9j;

YwrsEnded Deownber31,

2002 2cX 1 2000

. .. . . .. . . . . . .. . . . . . .__. _Net Iom 3(44,213) x(56 , a(t807h~ ,Sfocicopdan .glans (3SJ4~ {12F ( 114949Ernployee .stdtdtPuro e~~ (1; `. { ~k (g9f5 is

Pro forma net Ic $(79,8550) $(692779) f (3a 666)

£1ti :f.Ex rcla :l ascarid:thl xeil h®t 3tie~ fzet ia® $ (:1:14) $ (1 O. 4) 1 {d 8D) '

Accumulated Other Comprehensive I name (Loss)

Accumulated other cunpreher veineome (loss):preserded in'the aoaontpanyingcorral ir edhai anoeteeisandowlidatedstatestatements ofstgckhoider sequi ty Coneatsof net unrealized gai non wort-term i rNestrr ts:and aagxr 4ated net for.eIgn erranc y, trertis on I osr,

The fol lowing are the componentsof comprehensive income ( loss) (In thouQids) :

Yeaeended Deoernba 31,

2002 2001

Netlo S'444,21 '2) $(563,845)Currwlativetrar-iatonadyuamao (2,799) (621)C*ge inunredized gain (toss) onwa~ Iabie for -:ai e

inve~W (519} 26

Total comprehengveloss $(47,531) 3(664,259)

Redas§ficati on

Ce-tain :amounts reported in previ ousyears have been redaWfied to conform to 2002 presentation . Such redasifications had no effect on prev'ioudyreported resA is of operations, total assetsor aoasrnd eked der, at

I mpact of Recent y Issued Accounting Standard s

In Oecon -2002, the Financial Account ng Standards Board (FAS8) iseied Statement of Finana al Accounti ng Standards(SFAS) No . 148,"Accounting forStock-Based Compensation-Trarveti on and Disclosure-an anendn .mtof SEAS 123" (SFAS No . 148). This stateme,tanendsSFASNo. 123,

70.

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TERAYON COMMUNICATION SVSTEM$, INC .

NOTESTQ CONSOLIDATED FI NANCIAL STATEMENTS-(Continued )

"Actounti ng for $toclc'Basad Camper ati on," to provide alternative me#wds of transti on fora voluntary diertga to the fair vaf ue based nwftd ofaccourrp ng for stole-based en oyee camperob'on. I n ad lion, ihi s at nmt amaxisthe des oaxe re rernw is of SFA S No, 1.23 to regal re pro rri meritdi 9closwes i n both annual and i nten m fi riartci al ~taE~rrieri :at~out the, mdttocf of aocaunti ng for Stock-based employee oorrp€rtation and the effect of thenVI-od used on reported remits : The :Ccin*21y will apt theamual diedosire proviaorsof SFAS No , 148 in its quarterly firiaiicial reports ming intheftrstquarterof2 003 . Asthheadopti onofthiss ldinvolvesdiscloauresoN y, theCompanydoesnotexpectemateriat inpartonitsresintsofoperati or is, financial po siti on or liqui di ty.

In Novar43w 2=, the FASB saied BFAS Interpretation No . 45,' Guarantor'I r 6reot GL sites of l ndebtednessof Othets (FIN ~ FIN 45 requires that LPOIfar value of an obligationa9aaiitad underaguarwitee IN 45 also requiresadditiostatements about the obl igatcnS aeoa a d With guarantees issued . The reeogdtiorafter December 31, 2002. The clad oawrefregui rements are effective for financial atThe adopti on of FIN 45 Is not :antk peed to }lave a nateri of e(fact on the CornpEn

In November 2062, the EI TF reached a consensuson I ssie No. 00-21, 'Revenuei desgy cianoe on how to socount for arrange nentsthat involve the delivery or per

eyed uat No .

noaand Disi los re ;Requirementsfor Guaanbeea, Induding7f a a guarantor must recogni ze a l i atii lity for theures~gua-aritor in iisiuterim and srvia financi als fFIN45areeffectiveforanyguaraltees .isaiedormodifiedf interirnor amid penodsending after December. 15, 2002 .I position, resitsof operations or cash flows

Multiple Deliverables " EITF Issue No . W-21e produc;% services and/or rights to use assetsbeonnit~q after lone 15, 2003. The C i~pany isons and finatid mnrit on.

n,Idy 2002, the FASB issued SFASNo : 146, "Amounting forCosts A9eodated wi h Exit or Disposal Artivlties" (SFAS No . 146), which requirestheCompany to recognize costs associated with ed t or di sal atfiviti es when ttiey a'e i naxred rather than at the date of a commitment to an exi t or disposalplan .SFASNo .146reolpoesE~ ng ItamTasli:Force(EITF) IsaacNo.94-3;"LiabllityRecognition for. Certain Ert oyeeTe(rrsmtionBanefitsandOtherCoststo Ecitan Activity(inducing Certain Costslncured in a Restn. Luring) " Theprovisonsof SFAS No.146aroto beapplied pros ivaiy toexitor Jgosal a blvitiesifiitiated .afts't)rrtier 31, .2002 Theeffedof adoption of SFAS .No . 146 isdepeir dant or1the Coni: iaiy'srelated activitiessubsequent to the date of adopt on.

In April 2002, the FASS :i sled SFAS No;. 145 , " Res : isa on of FASB Staternents NQ. 4, 44 aid 64, A ri irtrient of. FASB Statemarit : N o. 13, andTechnical Corrections (SFAS No.145 SFAS No. 145 aliowsonl y 1:hose gains:and loseason the ext ngui mentof debit ed meet the alteria o fextraxdi nary items to be :treeYed aasxh in the consjli dated fi nanc iA statarr~errks SFAS No . 145 also requires salesrl easebadc amounting for certain leasemodficationsthathaveeoonomica ffertsthatare3rrmilartolease-becktran ionsTheCompanyadoptedthaprovisi onsofSFASNo.145inthe pondquarter of 2)02. I n accordance wi th ifsadoption of SFAS No. 145, all pri or peri ods reflect the adoption of SFAS No. 145:in the .mnsoli.dated financialStatsnferlts

In August 2001, t e FASB isaxecI SFAS No . 144, "Accounting for the I rrpai rment or qiqmsal of Lmg-lived Assets" (SEAS No. 144) . SFAS No, 144sapercedes SFAS No. 121, "Aocovn6 ngfor the Impairment of Long-li ved Asaats and Assetsto be Di sp osed Of" and#he agi ng and reportingprovisonsofAppounti ngPIndpiesBoard Opinion Na 30,'Report ngtheReaAtsofOperations-Repo ti ngthe .Effects of Dill of aSegriait Of a.Business, and Extraorcinary , Unusual and I aquenty Occurring Events and Tran ons" SFAS No. 144 .a1sp arnaidsAccouiting Research BulletinNo . 51,"Consolidated Financial S in6nts " to eliminate theacceftiontooonsdida ti onfora.aibeidiaryfor which control is Ii hety to be temporary . Theprovi s ors of SFAS No . 144 were adopted by the Company e ffective January 1, 2002. I n

71

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NOTES TO CONSOL I DATED .FI NANCIAL. STATEMENTS-i(Continued )

acoordanoewithSFASNo.144,theCon mnyrecordsinOrrnerttIo9eson1ong=livedasaftu edinoper2bonswhen:ooft- nddreurrganeesindicatethat long-lived swats might be impaired and ttie unifisomstted cads flowseWmeted to be. geriaated by those assets areal ess than ihee carryi ng a rerun softhose assets The Comparry recorded i nVei anent I oases clui ng the eeoond quarter of 20Q2 amc dated with the SFA S No . 144 irnpai rment review es furtherdescri Led in NOW 5.

In lune 2ab1, the FASB issued SFAS No.141, ' Busi ness Cofr i neflons ', :and SFAS No. . 142, "Goodwill and Other Intangible:Assata (SFAS No . 141and SFAS No. 142), WAS Na_ 141 requires that the piudrdga tttetttod ofaoo siti rig be used. or ill .buanes50Dmkiinatiottsi ryti ated ofta Axle 341, 20(11 .SFASNo . 141 alsoindudss g uWenoeontheiriibd r .eaocgnihonOrdMe rernantofgoaderiIl intangi6leaasgCsar iarising from business .oombinati onsoom~i eted after tune 30 2001 . SFASNa 142profii bitsthsa 1 tzation.of goodwill a 'd intarvilbl amtswlth indefinite usefwl I fives SFA$IVv.142requreeti>attl>es a tsbe reviewed forImparn conti nuetobe amortized ovaoxires i rrreted used ul lives Additiorol I y, SFAS No . 142 regii reslhat goodwi II irid udad i n the cairyi ng value of equity method i nvestrner*s ro I ongit beamortized.

The Company adoptedSFASNo.142onJv xsry1 , .20Q2: IdentfialleintangibleaseetswithincleiiniteIivesv eredasafied , asdef i nedbySFASNo . 142, to goodwill at the dateof adoption. The ry tested goodwi I I for imps anent usi ng theetvvo-ste i procxM preach bed in SFAS No. 14Z Thefi rs: step i s a screen for potential i mpairment , w vi le the second stga nieaaxes the xrxxnt of the i rnpa rmar t , if any . See N ote 5.

The foil owing pro formalnfoni ab on refl ectsthe ifnpec t on not i ncorre (I oss) and net income (!ow per snare assuming the adopti on of SFAS No. 142had occurred on January 1, 2000 ( in thousands) :

Yearse sled December 31 ,

2001 200020D2 Q roforme) (Pro forma)

Eteportedn tli (44.213) 5$(56&46) $(180,767 )Amore22bon of goodwlII ad intangblaassetswith irddiri to1ives - 53,946 104,01 5

Aofo narietlosa Sfdd:13) $(510,0 ) f : $(76,752), ._' '

Bas,c an d di luted net beeper share:12gaor d net bass: $ (0A.11) $ (8 ) . :! .. . . . >$ (2 .95)Adjus ~ rd aced to atxxtZakion of good ill aril intangiblaassets

with . ndefirte lives - 0 .79 17 0

Pro fauna net Ios,pardae $ {0.61) $ <(746) $ (1 . 5)

2. Fair Value of Finan ci al Instr uments

The amounts reported as xi and cash equ vala" azountssrecei vable, a unts payabl a aid accrued I i obi I iti es approximate fai r value due to theirthort-term maturi ties The fair value for the Company's inv eetments in marketable debt aid :equty :sectcities is o3timated based on quoted market prices

The fair value of tort-term and long-term capital Ie®e.an d debt obligation is ash mated .based on current inte eet ratesavalabl a to us for debti nstruma tswi th s rr l ar terms , degreesofrisk and rema ni ng rrraturifies The carryi ngvaluesof these ohl i gat ons, as of each period presented approximatethe.rre ivefairvatues

The fol I owi n g eeb mated fair value amounts hale been determined us ng aver I able narks I nforma ti on , However, cons dbrQU e j udgrnait is regal red i ninterpreti rig market data to develop the esti mates of fair value

72

Table :rf :Contents

TERAYON COMMUNICATION SYSTEMS;! NC.

NOTES TO CQNSOL.I DATED Fl NANCIAL . STATEM ENTS-(Ca ttfil .We3)

Accordingly, theestirn" presentee[ herein aettot.tteceswi lyincic bveoftheampuitsthattheCorrplnyt d :realize in:acurrantmarket ,cct e.

Dece nb& .31, 2002

Gross CxpgsUnr lzad Uni®lized Estimates

Amortized Cod G. sins Lc Fair Velue

Short-tec :minvestments( nthousand~ .

•Irrrestmdts rnraturirrg in IeESthan 1 year.Ca runes el paper : $16,00[1

-

$ $ (26) $15,974Fixed i r come axporate sawrib es 12920 13,11.6G60. eminent 4)er4 c6icpt CX15 18,30C} 260 18;Corporateegtitys9writies 202' 151 - 353

Total 4,422 6Q7 (26} '.' 48,903 .Ir rrvintsrroturiny in 1-2 year sFixed tntoinecot rate seninties 2,fbb 145' - 2,i45Govennn-u t agency obligations 39,000 276 - 39276

Tol 41,000 42'l. 41 .42 1

Total $88,422 $1,028 $(26) $89,424

Deournher31, 2001

Amortized Cod

Grove Gux'Unre9lized Unrealized EstimatedGains Lc es Far Value

$h art-term investments[ nlhous dsJ

lnwestrnentsri taring in lest- n 1 year :Gor ncn iA }FxedirPomeoorporateSeCUnties

$ 77,67040,194

$ 24 $ --6 -

5 T7,69 440 20 0Govemment agiency ouigato-Is 7,954 (6)

,7,948

Tottrvei1mentsrr tiring in 1 2years

125,818 24 J 25,$4 2

Fxedincornecorporakesarzuities 31,276 568 - 31 844C,ovemment aQency:oF~ligations 75,4 8 440,

75,928

Total 106,774 996 107,772

To $ :23 382 y 1 , .. $ - . $ :23361 4

Real ized gans aand toss were i r»gnificant for each of the years in the three year peri od ended December 31, 20W-

3. Commitment s

Leases

The Company Ieasesitsfaalitiesand certain egtiiprnent under opera6r .I es,TheoperatingIe far the Company' swrporateheadgLtartersarpiresin 2009. The operati ng lease for the Cornpeny' :s I sues

73

Table ofCantents


NOTESTO CONSOLI DATED FINANCIAL STATEMENTS-(Continued )

headquarters eapi min 2005 . The Coripar y sott+er operating leases expire at vanousti nrosttx'ough 20M Rent expsr~sewos opproxi matef y $7.9 million,$7.2 mil lion, and $4.2 mi 11 ia ; for the years ended Deoember.31, X002, 2E)0'I, and 2000, regect vd Y. The C<xr y sublea~ a small port on of itsfaci l itiesto rturd parties The .CorrpenY'ssrble®serentsl inc~onswamapproximatefy $0,4 million, $0 .1 million, and$02 rniIIion-for the yegrsended Oeoamber31,2002 2f701, and ZX .

The Company Isamsc&tain equipment rul er n nc lease agreamentstl-at areaccoultedfor as capital Ieas Equiptrtant under capital encearrar> err>ar indWool In propefty "uiptlant a9yregaletl $07 million and $1 2 n .Il i0tt at Der ttber 31 21 L2 atxl 2Q01 re~ec~ively . Relatedaximulatedarru nationwt$$0.6mglionand$0:$m'lbonatDoostber31,2002and2001,rmpooively .Ama'6mUon.eatpm rdacedtooa9aeFsunderCEO a l senses i s i nd uded in depreci at ion Eaperree The capital Ieasasare waxed by the related equ pment and the Compaq I s n e q u l red t o maintain I is II tyand property damage I nsurarxe .

In2002,theCon y entered into anoperatingleasearraigam enttoleaseacorporateeirexaft . ThisIease .artarcarlentissacsredbya$9,0millionletter of !cre di t at Dece mber 31, 21702. The Lease commi tma tforthe d rcrett is. nef tided l n the table bd gw .

Future mi ni mu n I ease payments undw noncancelable opwati ng leases and capital leases as of December 31, 2002 are as fol lows (in thousands):

Operating Leases Capital Lames

20(33 $ 8. s6 'i $16232004 7,%0 802005 6 7232D03 4,430 -2QQ7 3,107 -Thereafter 5,56 2

Total mrrmum payinaks

Less amount represent ng interest 1 7

Les;currerd portion 154

LDng term port on 78

There are no future minimum sublease payments to be rweived under noncan fabl a subleases due to the term na4 on of the lease

Purchase Obligationsand Sped a[ Charges

TheCompany has purchase obiigati onsto certain of itssuppl ierstiiat support theConipeny'sabiIityto menufatttreitsprodi The obligationsconsist of purthzs orders placed with vendorsfor goodsand servi aes and require the Company to purchaea nv nimum quantities of the sappliars productsat a epeci fied price . Asof Detlember31, 2002, $45,5 n Ilion of pxdxe®obliged onsasoutdancli ng . Asa reoitof dedinesin forex$,theCompany,hasCanceled certain pirdase .ordetswith its contract: rrmarxrtachrersthak had ding inventory on hand or on order in an tidpation of the Conlpeny'searliorforecasts Consequently, theCompany accrued forvendor caiodIadon charges repre . ting ni , s esti mate of the COmpany'

s for itsinveiitory commitme is At Dedernber 31, 2002, accrued vendor car.W lation cttergeswers 13.9 rni Ilion and we included onthe .Corr olidatedBalance 3 .est asac ruedveridor

74

Table of Contents

TERAYON COMM UNI CAT! ON 1?STEM$ ; I NC .

NOTES TO CONSOL I DATED FINANCIAL . NANCIAL.STA(continued )

cancel I aeon eltages, and U ie rerrrai ni ng 531 .6 is aftribitabl a to open purl mo ordere The rerr+ai ning obfigati'onsare:epcpefed to be#xr+e payable at varioustim trdu out 2003 ,

Lettersof Credi t

As of Decai>liet 31, 30D2 ttie Company had $10 .4 million i n u mmd outtardng l otters of credi t pri Teri ky requi nod to sipport operati ng l e®sxs, whichexpireatvariousdatethrough 209 .

Royalties

The Company has purchased, ttrough itsacqui 9 Lion of Ra twi z Ltd . (Redwiz), certai n tee irdogy that was developed by Radwiz and a forma astercompany utilizing fundi ng provided by the 1 saes i CNef Sa enlist of the M i ni stry of I r dustry and Trade (OCS). The purc a of the tethnol ogy wasapproved by the OCS. Asa cordtion far this ap fxoval , the Ccirrpany ha cx rrirNtted to pay myA tfies to the Gov®rrvne t .of I sr-A on prode6ds from sales ofproducts based on thh stechnology . Royalty rates we3°/b-5%. RoyalUasare payablefrorn the:corm+erroerr+ent of aJ es of p roducts based on the tec*v d ogyuntil the cumukadve: amount of the royalti es paid and aaxued by the Company equals 100°%of the fur di ng received from the OC S.

Additionally, the Company has various royalty arrarx~err+ents, which require it to pay nominal .ar+a!ntsto voiaussppi iers for usage of licensedproprstyprimar primarily related to DOC&S.moden- a

The Company's total ax uedobligadon for royalties at Deoernber 31, 2002 ; was $0.6 mil Iion.

Guarantees

TheCompanyfromtimeto timeenteraintooarhaintypesofcontradstht oonti.ngeriitly requiretheCompan toIndennify partiesegai t thirdpatydams Thew 061 i gati ons pri mai I y M ate to obtain agreernaitswi ih the Company' s off! oecst directors and ernp1oyee4 under which the Company may berequi red to mdernnify such persons for I iatril it as a"ng out of their employment rekationafiip .

Thet&Tmofsuch obligatonsvay Gomel Iy,amaxi mum obligationisnotmcpkiaflystated . Becasestheobli gated amountsofthese typesofagrearxnksoften are not expiici tl y dated, the overall . maximum amount of the obligations c a not bereeeorrably ei rr+ated . Histodcalls, the Company hasnot been obigatedfo make anypaynwntsforthe obligations,and no 1iabilitieshave.beainxx* 6d fortheseobligationsonitsbalanceslvetsasofDecember 31, 2c02 .

4 . Accrued Sejeranae Pay

Several of the Company ' s eubsdariesare:a+jset to Israeli Iaw .and labor agreements underwhirh they are n3quired to rnake .suveraxe:payrrmentstossedemployees2rxfeir$ oyeeskeavir~gits :~t~I oyme~ltinCetainottle + cis The itsdiafie ; sstetaf ce yIiability toitserr loyees,

which isralcul f theiated on the Gassof sal of ead~ em epotted yew multi +pl ad by the years of such employed stF~a ary ptoyee for the last monU1 oarploy n~ent is i nd tided i n the C cxr~pany s c~nnsol idated balance fiaet on the accrual basis , and i s partial ly f urxled by a punts a of insurance pokici es i nthes~bac~arie~ name : At Des~rr>F r 31, 2, $ 1,6 million foraccrued ~verar~re pay was incl uded in nt w for - termr+bligatidns In amordatxswi th EITFNo . 8g-1, " Datemti nati on of Vested wit ON igati.on for a Def irie[f BSnr#it k on Ran," the Cornpny i nd uded $1 :1 million rtl ed ng to the arrairitsfunded by the ps

~

ase of I nauanoe polio esfor the t erect i severanc e .l noon l ity I :n i is consolidated bd arccs sfiaets asOther asedsat Decenil& 31, 2DD2

75

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TERAYON COMM UNI CAT! ON SYSTEM, I NC.

NOTES To CONSOLI DATED FI NANCIAL.5TATEM ENTS-(Continued )

5, Restructuring ChargesandAsaatftite-offs

Restructuring

Dud ng the tN rd quarter of Z )0 the Company's Board of Di ras#ors .approved a restrudun ng plan to coniorm :the expense and revenue l oval s aid tobetter postiontheCon enyforfuturegrowthand :ei itualprofiitability .ThsCampanyinarredrsstnxtwingrhar intheanountof$3 .6611 ion ofwNch $23 million related to employes tkrmination oasts and +* rerr a ni ng $1 .3 million r®I atedto oostsforwcesswsed facilities At beceriber 31, 201)2,re4truduring charges of $1 .5 mi Ili on rerr ai n aoc aed. Asof Deoanher 31, 2002 , t e eircl oyniant of 147 empl oyees has been temii nsted and The ~ypaid$2 .1 rriIIionintarrrinationcods.Ttier rrWningemplogeewveranoacostsrelatedtoanadditional6employeaswiIIbesipallypaidin TheCoroatyantiapaoestherenairingrestrts 11n accrual, prirr riIyrel :afingto exomI:e3sadfadIitieelIndudedinthe lease omvNtmmtta a nNote 3,Will be util iZed for cavlq rtq opsaG n9 leas3 Payp ertts ortiegotlated lxryout of aperatl ng i ease corrrn tmertts through 200

The Company redasafied$0.1 miIl on,wi thhad onginalIybeenamuedfor astirrptoyee termimationcoststo accrued exte9sI ease fagli tycosts dyeto a rev i sion in e3itnafe.

A summary of the 2002 accrued .re nuturir dutges1sasfol laws ('inmiIIion):

fxoea4LeemlFadiitiesan d

Invofuntuy Ca'icAledTer.min4ions Contrails Total

Total U-age $ 23 $13 § 9 .6

) 0.1 (2.1)

ssfcat ~Recl a

Bal ance at December 31, 2002 $ 0.1 $1.4 $1.5

Dun ng 2001, the Company' s Board of Directors approved a re ructu ri rig plan to streernli ne the•Company' sorga ni wtional s ructire worl cM ide. TheCompany incurred raMWtsi ng diargesin the ariouit of $127 mil l i on i n fi mW year 2001 of wlvch $8.2 mil I ion remained. accrued at Decanter 31, 2001 .Ofthetotal restrUctvingcharges. reaordedd1j1 rg fiecd yaw 2001 , $3.2 millionrelaA:edtoemployeeterminationcostscaveririg293 .tsdrical , productionand admi rv stra ti tire employees Asof December 31 2002 the Company had pat d approxi madly $2 .0 nri [I i on i n terrrination costs At Deoeriiber 31, 2002,restru turingchargesof$5 .3miIlionrenvin so=ijad,pnmadlyre}atgdtoexcessfadlityor4andempltyseterminatiom The, Cor. anbri pates

I the re'rai ring reetnicturing accrual , which relates to servicing operating lease payment or negoti ated buyout of operating Iease cormitmeite ;though 2005.

In2002,theCompany redas'§fied $1 .1 milI ion, wii had original I y been accrued for as empl oyee termi nation ooststo accrued . excess lease fad I i tycosts clue to a revi a on in e sti mate.

76

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TERA`! ON COMM UNIGATI ON YSTEM$; INC .

NOTESTO CQNSOLIDATED FI NANCIAL-9TATEM ENTS - (Continued )

TFe~follawl taU a surrrriarim the oosts"ecb vib eeduri ng 2002, related to the 2001 reshueturi rg (i nrniI Ilans) >

ExcessLeasadFadlitiesand

Involuntary CancelledTern nations Contracts Tatal

Salaioa at i3eoattiba.3], 20Additions 32 9 .5 12. 7Cash %ftnenks (2 OJ (25) 4.5)

l3.ala c.ea D:e wmber 31, 2001 12 7 .0 8 .2 : .4 a5hF y+tiehts (fl I) (2- 8) (9) ;_?Redasaficatiori (1 1 j 1 .1 -

B ascs.aG:Qederi tier 3f, 2032 $s

$ 5. 3t:

S .5 .3s

Asset Rite-offs

Asa result of restructun nq artivi ti as in 2OO2 and 2(101, and arid fled i ne in demand for A NE pros tS certain property and equi prnent wasdetermi ned to Have no rerrtairi ng u 14 life Accord ngly, th e asa#swere written down to fair value, which wasdearned to be zero:

During 20171,$1 .3mi llionof fixed aseetsberarneirrparedand were written-off, The:lmpaired.fixed asa r . wentthenetbookvalueofidlemanufacturinge*iipram , leasehold, and office equipment . During 2001 ,$ 1 .8 million ralatedto fixed asaatsa 4 redfromANEweredeterminedtohaveno remain ng useful life and were writtterroff,

In Mardi 2001, the Company evai uated .the carryi. rig value of certain I o g ,.li.ved sand aoqui red i ntang bIBA conssti ng .pri magi ly 'of goodwill. I trecorded on its consul i datedbalance sheet, pursuant to acownti ng rulesi the rr+ajori ty of the :qaodwi I:I was recorded based on stock prices at the ti m eacquistion a earrienlswereexecuted and arioi . oed. Cyoodmil I aid other long-lived aseeRsar +~ reviewed for impairment wherever events such as productdiscontinuance, plait closures ; product dispostions or other diarges in ci rc urnstatioes i nd cabs that the raryirig amount may rot bereoovei able. When sucheventsoca.r, the Company compares the carrying am punt of theasmtsto undiaxxxted expected future cash flows If thisoompadson, irxicaltesthat there isan i mo rrrtent, the amount of the impairment is based on the far value of the.aeaets typlcill jy cel wlated us ng discounted expected future cam fl ows The .di scour,t rate applied to these cash flows .is based on the Company' sWei ghted averege oast of capital, which representsthe hl ended .codsof debt and equity .

From September 1999 through December 2(XD the Cortpany .aoquired ton oorrpeni es'The i nterkled result of these aoqU sti onswas to offer customersand potenti al o orners a robust farm l y of product offerings that integrated Many of the acquired techtiol og e5 In order to adm'e thetxper led integrationof the products and realize the synergi es of combined infrastructures, the tedYiologi es nee led to be fiirthei deuel oped, acid the pro iucts needed to obtainmarket acoepta x*

None of t e products from these xqui red busr weed a J ieved the lev el of market as ptanpe that was forecasted at the ti me of sch a x ii ti cansAdditional I y, certain product groups have not aChiaved theieael of tedxplogical dwsiopment needed to basalede or to expand the market This restlted i nsgiificaitlytower than exil edrevenues, Adcitionally,thegenera(economicslowdown,andthehightedrrologyslowd ninpaticlar,fad as giif i cait impact On the ConfMy' s .operati ng results, just as i t had afro i mpeded the r4mUts of a mi 1:ar oorrpii es i n its sector . Ri or to the fourth carter Of

2CXX) the Company had ex pertarcedagnifioattquarter-over-quarter growth andcma ; eritlymetthenarketIs :expe one

T7

Table of Contents


NOTES TO CONSOL I DATED FINANCIAL. STATEMENTS -- (ContinUed)

The Cornpany'sstockprice dramalic ally declinedinthefourthquanerof2000withthededi neinexpectedoperatingrea tsfortttoquarter.Theprincipal reawnfort edecline inoperati ngreailtswasa slowdown inort sfortraditional cable prodct s

Downturnsinthabroadb j dswvicesandteleoorrmuhicationsntarketsareateduniquaciraird iceswi .thragwdtotheasessanattof .goodMII andother[ntangiblea etsforrecoverability :AsareeuttoftheCompany'.sdedsontosuspendcortsinproductIires end product devel opment efforts dud gthefl rst gualer of 20101, i ntangit~l a agsats total ing :$163 .1 million rel ated to oerfai n i~oguisti or were deemed to be lrr eared with no f ure vat ue werewritten-affandincludedin.assetwrite-offsi,n heC,rxrparryycnns?fidate] aterneitsofoperationsin2001 .Firther,theaforen.vrtoneddiowntumsInthepri rid pal marketsi n Which the CompAlt~r carrti nues:to opr3 -ate #ra~re negaBvel y impacted the forecasted revers eland cast f[owsfrorn oenai n othercon~peni8s a~u red duet rig f l seal 1999 ar~1200Q I n accotdatce!nnlh'the Con a1y' s pot iCy, the oonWisof of the discounted a peeled fuhtlre Casts f1 ows tcthe canvinn arpunt of the related irttarlgibie assets resuited in a wri davm of t# assets, reiated to both theOabte and Telecom Worrentso f

The Carp" y adopted SFAS No. 142 on . l a n u a r y 1 , . 2 0 0 2. The Company reds f i ad $1 .3 miI I i of asearrbied wgrkforoe net of ao wmulatedanortiza ti on;with anindefinite li fe;to goodwill at thec eofadopti on . The Company tests.goodwlllforIr V. ani'.aentuarg .thetwo-step prod" prescribedin SFAS No. 142 ThefirEt slap isa eaeen for potential impel rment wftil i the Gt rne~ures the amount of the i tripe rment , if aW . Tl first step wasco rr~pleted tkti rig the s s d o rr r J querber o f

20MThe c o n iy oompl abed the initi d goodwil1 .1 n rn et trevi ear ag of the beginni rigof M, aid found no

i rrpei rmerrt D ue .to a cifficult e~ononi c envi orwr it and hdghtened pri be aoh~pehti on in tF~e rrorlah and tel a Com bis nesms dud rig the three monthsEnded June 30, 2142, the Conpeny ecpeii arced a si gnificant drop i n its market c-- pitai ization, and th® refore proceeded to perform an interim test to measuregoocWII andintangibieae5steforimpaimiens o Jas30, 2002. Bowes.on the Conlpeny ' sforecast, theed rrdedu,diSxountedfuiure .cadrflowsfromtheuse of the:goodwi II would be I ass than its carryi ng amourt . The Conymy deterni ried ffv t the outcome of this:test ref) acted that the fei r vat um of thegoodwill was zero, This resulted i n a non-cash charge of $4 ;0 mi I lion to wri te off the rerna ni ng goodw i 1 1 of which $3,0 mi l lion is related to the Cablesegment and $1 .0 mil lion is related to the Telecom segment . 5ubseuerrt to thi s w ri te -aff, the Company has no intarx bie awete, : which ire deanad tohav ei ndefinite useful lives

The Company aWgned goodwill toitsreporting .entitesbegadonthet ueofthe underlying bu nees :acquired . The .aoqui si tionsmadabyttieCompany in 199:9 and 2000 were designated to one of the Company's .two reportabl a segments at the time of the :acqui 5ti on:

Du ri ng 2001, the Company recorded a defer red tax ase:t of approximately $4:0 millionaid conespondingredu Lion ofgooddwill , forthetac benefitofforeign net operating loascaryforwardsrelating to aprevio sacquistion . Duetotheimpaaimientwri te-off, thedeferred tic aloe.; and remaining netdeferred tax liability were also writtsn-off.

78

Exhibit B

Table ot :Cantents

TERAYON COMM U NI cATI ON SYSTEMS, INC .

NOTE$$ TO CONSOLIDATED FI NANCIAL. STATEM ENTS- (Contihued) .

The Company did not wi i to-off iiy i ntangibl a assts i n 2000 . The following table dew I besthe i ntangibl a aaeetswri tten off dici ng 2001 :

Devdgted Cu9aner Cu stomer AsecmblaGootlwHI Techndogy Trademark ROIAtions Bow Workforce Td A

. . . . .. . . .. . . . . f n t hatsand ;:, . . .Cawa Segrr~etitUlbacom $ .4 2 $ Q9 $ - $ - $ - $0.J $Con ox sus > 1ao - 02 77Ex5I mw.a 47 .2 2Q.Q 29 - - p .3 7Q4,pigi#rals' 8 .2 05 - 03 AbTelegale 52.8 17.0 - '20,2 - O .'a 90 .8Intartlt Tefeoxm 98.1 5.0 - 01 44 .2True-Chat - - - - - - -

Total Cable Se r nt $2588 $634 $i20 $2a2 $00 $2 .0 $337.3' 'Telewm Segment .Main ail '470 44.1 0,6 141. 7ARE 33.5 10.3 05 - 2:0 4,5 50. 8Rnz 18.7 23.1 0.9 - 03 43. 0

Total Telecom SegrTmt $149 .2 $ 77.5 $ 1 ,4 $ 0 .0 $ 20 $ 5.4 $236.6

Tt3te ! Cabl a acrd Td 9oam -$4013-0 $1300 $4.3 .. $20,2 $ 20 : $ 7 .4. . $5728?.

The fol(owi ng table des xi beadle i ntargible assets wdtten off during 20022

Devel oped Cudoma Cggornflr Assemble dGoodwill TWhnW9gy Trademark Relations 9O- WorkfotcA : Total

(nlh--ndfCable y»' t .Ultraa?m $ - $ - $ - $ - , -$ $01 $0 1C.om8ox I 1-, .

- 0. 1Digitrats 0.2 -

- - -02

f ntemet T6 K imTrueCfut 2.5 - - - - - 2 :5

Total CaN e Segn { $ 2.7 S -' S $03 $3,0Tel wxxn Segment :MalnSAiI -ANE

- - - - 0.5 0 .5

Tot Td emm : Segrnait $ - $ - $ - $ - $ - $1 .0 $1 .0' '

Total QableandTelecom $2.7 $ - $ - $ - $ - $1 .0 $4 .0

6 . Impairment of Long-Term Investment

TheCompany'slung-Iiveriastaetsincludelong-term equity inveskyer sDunng2DD2;theCompanydeterminedthatonearchequity ir eartwtinaprivately-heldcomparrjwasirrWredandrecorded .animpairment dlargeof$4 .5million, In2p02,theinvesteesfotecaswefenotmetand.rra'kofconcitionssgnfica itIy deteri9rated: The Corrpany'se~inate of to fai r vat ue of the long-term i nvesfinent was dependenren the performance of theirrveArnent, as well as the volatility inherent in the 2ocbe" markets for thi s investrnent .

79

Table .of Contents

TERAYON COMM UNI CAT[ ON SYSTEM, INC .

NOTES TO CONSOLI DATED FI NI NCIAL . SIATEM ENTS-( Continued )

7, Convertible Subordinated Note s

In U y 2000, the Company issued $500 ni Ilion o f 5 % %% Comet ble Subordinated Notes due I n A u g u s t 2007 ( C orwet ti®N6t* resulting I n netproceedsto the Con my of approx rraWy $454.4 million . The Coryertibl e Notes arethe.Corr ny''s .general unsecured obligation aid are .s:,>bordirrdied inri tof pay rr to all asn~.rgand futuresaiioritiihbtednesaardtoalI of. theliabi[itesofthe . Contiiany ' ssuberdanea TheConverbbleNote;;areconverti ble i nto araresof the CornFmy ' sdornrnon atock ata dt nrw stop pd oe of $84 .01 per 4iae at arty ti me on or after. October 24 2000 through natlxit y,unless prsviQudl y redaen ied or repurchased .. The Company may radeorn : 8o►ra or:ahl of the Convertibi eNotes at arty ti m on or der O tober 24, 2 I 0 andberore Aigu t 7, 2X03 at a nedwrptton prim of $1 ;000 per $1 ,000 pn rdpal a~slount of the Convertit#e Nate a usacat' ad and unpaid interest, if any , if thecl oa ng pm is of the Company ` s stq~k ecoeeCls 1aU% of the convey on p1 ce ; or $126.01 for at 1e~st ZQ tract rx d yswnthin a pert od of 30 consecutiv etradi ng days glding on the tray ng day prior to the :date of mail i ng of 1fie rederr Uon nofiae The Coripany will also rnakean a <iditi br~al payment of $193 .55per$1 ,O a Annapal atrourit of Czrnrer>iiiiaNotes, lesstheanx~urtof Any Inteti actually pad~onUtheConve~tifile Notesbeforethec eof redemp .on. TheCompany :mayredee itheCawutibleNotesat a.rg.r timeonoraf terAt ust7, 203at~eafiedpncesplusaxruedandunpaidinterest . 1 *erel# ispayablesemi-a ~nuall y . Debf i ~~neenoas rel ated to the Converti ble Noteswere 2pproxi maCef y 81 .5 6 mi I l ion and ae anorti acct over seven yeas. At17ecaiiber3l . 2a iortizeti .onoF dek t isa~anoeooststotaied $14:2 m l .Ron..

In 2001, the Company repu~i approxinratdy $325,9 million of Convertible Notes for $113 .4 mullion in cash and $17.9 rnilI ion in stock resultingin againatapproxi mately$185.3niiIIIon, netof related unarnortizediasuancecoats of$9.3rdIlion.In2002,theCorrpany repurchasedapproxnately$109.1 million of Convertible Notesfior $57.6 n>i I ii on Incasf►, result rig i n a gai n of appreA mete) y $49. 1 mi I I i on , not of related Unarrior tized issuance costsof $24 mil lion .

In Aphi12002, the Corripar y adopted SFA5 No .145 an i .deterrri ned that the mcti nguisixr nt of. its clMbt cud not n the criteria of an &ctraDrdi nary itemasset forth i n SFAS No, 145. Accordingly, the Company is now reporting the gain from red rerneit of Convertit~l a Notes in operating. resits Asa result ofadopting SFAS No 145, the Compenyreda ffedthe $185:3ntr lllonpreyiousiYrecordedin2)01aseactra narygainasacor anent ofoperaingresult

Approximately $65.1 mill ion of Conve ti bl a Noteswere outstanding at December 31,200)2

8 . Contingencies

Litigation

Beginning in April 2000,eaveralplaintiffsfiledIawsuits lnstthe first of these lawsuits purported to represent a classwhose mathThe oorr taint alleged that the defendants had vlolatedthefederal sipdiadoesmaWal informetionreeardingthe Company's technology .72000, all of theseIawsuitsweremnsdidatedin the nitedStatesDi3

and certain of its off cersand di rectors i n federal court . tinti ffin11, 2000.t to

and, on

o n

On September 21, 2000, the I ead plaintiffs fi l ad a consolidlated d ass action narr(l ai nt t orttai rr ny factual al legations mewl y identical to those in theoriginal lawsuits Thecorsolidateddassaction complaint, however, allegeddainsonbehdfofadasswhossm nbarspurdxwdorothewis=agquiredtheCompany's securities between Novernber 15, 1999 and Apri l 11, 2= do Octobw 30, 2000, data itsmoved to dismi sothecx ietlidated d as actioncomplaint On March 14, 2001 ; after defendantd motion had been fully briefed and

80

Table nf .Contents

TERAYON COMM UNI CATI ON 5'STEMS, I NC .

NOTES TO CONSOL I DATED FI NANCIAL . STATEMENTS- ( Continued)

argued, theCortisa danordergrantirjginp artdssndamts' motion .aadgivingpl.gintiffsleavetofileanarnandedr ofriilaintOnApril13; ;2001,plaintiffs.filed their first arr ided consolidated dai s a ct ion cbrnpl ai nt . On Jule 16, Z 1,: clefsrxiants rpaved toff snaesttrs new oornplai nt arnd oral ai gurnent on themotion occurred on Deoen~t~ar 17 X2001 . . f5tn M ardr29, 2(X1Z the oourt deni ed the

Mandante' rrwlion to diarii5s The pertl es ere novy i n the ~:iisoovery

process. Inaddition, thecourt fiascertifi :edtheplaintiffs! proposedd "and a5edutled trial to begin on November 4, .M03.

The lawsuit seeks an unspecified . amou t :of damagesi in addition to. other forms of relief . The Company and dersthe lawsifsto be without merifandi ntends to defend vigorously against these al l egati om However', the (tigatio.n.c ul d prove to be: Cosily and tirxie consomi ng to defend, and there can be noassurances about the eventual outoama

On October 16, 2CXX) a laws.i t wasfi led egaini# ttie Company and the i r divi dual defaidarrts (Zaki Rak b, Sei im R ld b and Rayrre nd Fri:tz) in theCalifornia Superior* Court, San LuisObi:spo County . Thislawoui t is ti Ued Bertram v. Terayon Communicatons9 errs Inc (Bertram) . The Bertramcomplaintcontansfactud alIegati oneaniIar to thosa alleged in the federal securities dassacti onlaivaiit. Theoomplaintaeaertccauaesofad4onforunfawful business practice unfair anditaudulentbusrwesspro*cM,andfalseandmid eadnga0verti sng. Rainti ffspurpor to bring theaion on bdf ofthornaelve*and as representgivasof " a 1. persons or enb tles in the State of Cal ifomia ands h other pernsor entiti eadulside California fhat have-bean andaeadverse y affected trydef endants activity,ar 'dastheCourtdalldetermineisnotimmmi steitwith theeeeidsaoftheCourts1unsfidion." Rartfffsseek egei:tabl a and i nj uncti ve relief. Deferxtar removed the Baton tie to the 11.ri tact States Disbi ct Cou rt, Central District of C ali fomia and, onJanuaty 19, 2r)01, fi fed a moti on to di bttti9sthe complaf rat A Ite6ring on defendant motion was held Math 28,:2001 Arid the turf grated Defetxlants .motion do tpsnisstheactionanddeniedP(ar ff motion requestingrerr nd .OnApol6; 2001 , Defierx1lantsmov9 I fotan order reijuiringfuiherproceed ng if any to talcs place in the Nora n District of Catlfomia F1ai ntiffsdi dnot a~ose this:mDtion and eventuall yy entered into a stipulation to gofonnthe i n the Northam Di srf d. On July 9, 2dp1 a status oonfere~ce was held in tNs rase E~efore dx1ge Patel . Plai miffs did not appear for the oonferencand the court requested that defendratta5~rt rrti

two

nier dsiti sling the Reriram Ion with pro mi ce, Which the defendants ha ie A,n i tted to the court-OnA i. 7, 20( 2, the court held ; another opnferenop at wfii ch it entered an order dismi sang The Bertram c m The oour Border permitsthe individua lpl a ndffs in the Be tram

case

to purare any day msthet ~gy may have as mernoers of the .pu rpo rted d agsi n the related :aonml i dated aces action di sa,seedabove. Rainti ffsha~~s appealed thisorder, and the Court Of Appedshassetabnefirigs edi~lefortheappeal .

The Company. heli westhatthealIagationsintheBertramroes, aswith: thedlegati onsinthefederalwcuri6ascase, :arewi .fhoutmadtandintendstocontest the matter vigorously .

On May 7,= a sharehol der fi (ad a derivative I awsut purportedly on behalf of the Company against five of itsarrent di rec torA two former d rectorsand two former officers Thi sl awsuitistltlad Carrpbell vs F;aRib, at al ., and is pendng in the California s4)aeior Court, Santa Clara County . The Companyisa tort nal defendant in thisl aasjt ; which altegesd a nilrelati rig to essenfially the serve purported y mi si scaling staema>tsthat are at isave in th epen ii rg warttiesdassaction; I n that I ifigation, the Connpany disputes making any misleading statements. Thederivab ve c o nplai nt also al iegesd aimsrelati rig to took sal es .by Certain of the director and offi cer defendants

On JA y 12, 2002, a shareholder filed, a derivative to mit purported y on behalf of the Company against three of its a„rrent directors, one fw net officerand ttreeformer investors This lawa t is titled CY Brien vs Raldb atal ., aid is.pending in the C2lifornia &47erior Court; San Francisco County. TheConpanyisanorrirWdefendantinthislarvsait,whichallegesdamsrelaingtoa .swnti allythesam®purporte ly nisleeding .statemaitethatare :etifteinthe per>dingeaarri5esdaesaction.InthatIitigallon,theCompanycisputesmakinganymiskearingstatemer s T1Tederivativecomp)stetalsoalIegesduims .relating to stock sales by

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NOTES TO CONSOL I DATED FI NANCI .AL. STATEM ENTS- (Contihued)

certai nof the director and officer di3Fent orft The Alai ntiff in the, O' Brien case Fiasd aii seed the investor-dall tda it ithout prejudce.

Since theCanpbella-idO `Briencaseswerefiled ; tfie_parti eshate taken stepstotiaJrrtt ca soatsoliclatedin .ttheCaliforniaSuperior Court, County

of Santa Clara On C.ekoba 4, 2X)2, the.Cal ifomi a -Sul for Cart County of San Franc = entered art order provi d ng fortis tratsFer of the 0 Bri en case .On October 29, 2002, pl ai nti ff i n thaO' Brien ease subMtted owt4 n nvtmial s to ttte Cal ifornia S1{seitoC Court, County of Santa a am to effee±uatethattrader, Which is now complete. The O' Brien .ca s is now eonsol i.dated:wi th the Carrpbel I cas e

The Company bei i eves titat there are many defects i n the Carrpbel I_ and 0' Brien deri vabve oorrv ai nts

company, (tAmrubarid)filed arequest forarbitration with theZurich ChartberofOn January19,2003 , Ontii band Group United, a Russia nCortrneroe daimng darr~esin ai err xrrt of $2,t ,97Q allegedY caused by the Carr~pany ' s ixeah of an agreement tv soll to Orriit~2nd certainequipment p zaatto ai agreern it between C~nub -id and Radwiz Ltd., the Conpany ssibsicfia'y ck#ed felxuary 22, 2000.On Eebruary tQ 2f7)3,the

P rof

the

Zirrch Otlarn6er of Cam7eroe appd rated tfie Ctmi rriran of a ttree m~r~ser panel to prestde :dver tfieart~itrati on proceedings The Conpanybeli!aies that the all egaii onsarewithout merit and i ntendsto present a vigorous dEfense i n the, arbitr~llon prooeedvg s

On Septetr* r 3, 20Q2, Ur or Ltd . (an Is,-Ai company under voluntary Iiquciation) and Flextronics(Isrse! ) Ltd., an Isadi aorrmpa y ,(FlexVonic fliadadaImwiththeTel .AvivDistrictCourtinIsradagainstthe .CompaiyandRatMz;'fheCompany' saabedary, alleglrgthati ofIVIS25 .W0(apprRxirratdy) ~5n llionuSdr11a5) were.causedtothe ibytheC.ompanysallegedfakxotpoarrplyw+ithitsmntr iMoblig~oristoaccept and pay for oDmponents manufa tzed by. Fl e~ttroru cs in the firstic~rerter of 2001 ptirsua it to proles ons i t had received ffonj RzM iz. The Co npanyfl l ed a staterr~erti of defense denyi rx~ the al I e i oCts after wN ch the p~rti esar c tad the Co s i eciorm~eridad oj1 to trai vfer the Caaa to non-f i nti ngmediation .

The Corp" is currently a party to various other Legal proceed r qe~'i n addi tion to tho noted above , and may become I r volved from A me to .tln-e i nother Legal proceedings in the future. Wil le the Company current y bel isvesthat the ul ti mate o utcome of these other prooseri ng~ individually and in th eaggregate, will not have a material adverse affect ontheCompany' sfirwrciai positi on or overall trendsinrEeulGsof operations,titsgaioniss acttoi nherent cncertai nt es Were an unfavorabl a rid i np to or i n any of the Con pany' s i egal proceed ngs thswe ed sthe pose bi l ity of a material adverseimpact on the Company's results of operations for the period in which the ruli ng occurs The eat mate of the potential impact onthe Company' s finana al.poshon or overall nee lts of operationsfor any of the above legal prodoo c eoul ddtange in trings e future.

9. Stockholders Equity

Common Soc k

In February 2000 , the Company' sboard of di rectorsapproved atwo-for-one it .of the soutstarxi.ngsheresof camt7 onstock to beeffected in the form of a stock dividend, subject to stockholder approval of an i r ease i n the Company ' s authori zsd shares of conmcn stock . I n Apii 12000,theCgrr~peny' sstoakhoiders approved an1na~eaIn the, CQ m~ny'sauthori zedsharesto2DD, 1 Q(7Q.TheCompany' sBoardofDirectorsa equenpyestablished the rawrd d a t e for the stock spl it asA pri 125; 2DOO and the stock dv$ dend was distributed on May 5 , 2000. The changes 1 n ft capital structureresulting from the spit were given retroactive effect i nthe consolidated fi nand al statements

In Novanber 2001, the Company 's Board of Di restore approved. a tender offer, which permitted errpl oyees avid member of the Board of D i reotorstheability to exchange all unvested opti ons granted with an

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TERAYON COMM UNI EATI ON SYSTEMS, INC .

NOTES TO QQNSOLI DATED FI NANCIAL . $TATI= M ENTS- ( Continued)

werase price perishare equal to or greaEar than $9 :00 fora.contr n stock award, On December 8; 2001, 9,480,829 outstanding options were exchanged for141,442 s h a r e s of common stock. The value of the eon on stock i sacred was $20 mi tl ion, using the dos rig pri oe of the Company's corrrnon stock on thedate of isswarioe of $14.15 { mare, acrd was recorded a s Con1xn ion eapense i n 2001 .


Inoxnjuncionwith a1998prosrred stock flraid rig, the Company issied Shaw a warrant (Anti-Dilufimrxurber of sharesofcor mstook .TheAnti- DilutionWarrantiseocadsableat.theoption .ofShawduringtheCompany and i n the evert the company issues near equity eacurities at bd aw Thecixrmt market pri ce dWinedeKerd se pri ce is$0.50. The Company i ied oerfai n equity: secutftiesth~ as of Dooer'riber 31 200"2 ar d 2001 ,17,293 2nd 35 ,982 wararft to purdttese raeepf corm)ondoc k req x lively, purer art tofihe Anti -Dilution Vacant Dui rg tie2000 no equity seaariti aswere Issuedthat teeult~d i nthe inctea ;~ in the number of #wesis.. cable prra~ni to the Anti-pilution Vrecorded wp~enees of approXitriaWy $26,000 and $G2 mil I ion rela4 t to the isu" of warratfs pumuent to the Anti - Dil utimn Are vdy and cane i n 2000. The .eltpense i s ri.cU ed by md tiqyi ng the anrx a l iced fair market value of the company sackat tri buEableto theAnti- Di 1 ution Warrant Asof December 31, 203; theAnti -Diluti on Veirreint wase~ter cisable:for an aggre~te cCompany' soonmon stock .

diliiticthe

On March. 18,1999, the Company entered into a orie- year Product Deuelopff it Asa stance Agreertient (bevel oprn" Agreement) with Rogers Undertl~e :tetrnsof the Development. Agreement, RagersaB eed to provide the Company .asd star im with the choral rizati on and to W rig of the Company'ssubsai bar-end and head - end voice over cable equ' pr neat. In addti on, Rogersagreed to pro 1 de theCon y tedfxiol ogy to aW st :4he Company i nconnection with its effortsto develop high quality , fieldproven tec hnotogy. soluti omthat are DOGS S (1 .t ,1 and 1 .2)-oonripl lent and packetcable-ootnli art. Inoofl derati onofRogersenterinil into tieDveiopir~entAgee ,the Companywarrarit each to. purchase 2,0W, ODD tiaras of common stock. One warrant hasana era se price of .60 per there and one warrar t hatarri ex Sad se pri ~ a of$18.60 per share Thewarrantswere eKgrd§ bie infU Iorinpertthrough March31, 20 .. . Thefatrvalueofthetwowarraniswasapproxi.mately$45.0 million i. rig the Black Sdwl es model anc! resulted in a nanca<h charge i nd uded in. op~hons over the term :of the Deed oprnent Agreeme t Asaresult of the Dereloprnat Agreement , the Company sresJtsof oper2tior~sforlhe yearse~idetr December 31, 2000 ind.uide nonrdrtt diargesof $ .9.6 rri Ilion.nFebruary 2000,Rogesexerdsedthe warrantsonaea lees bass, resultingIntheisilo'caof 3,687,618 twos of this Company'sconvtonstockandno

proceeds to the Company . Asof December 3l, 2(Xr2 no fer#mr shares of the Company' sst ock wereexerd sabl a urxler thi swarrant

In October 1999, a cu mer of the Company entered into an agreement wi th Telegate Ltd ., an Israeli company (relegate), witi ch was negoti.atrg wi th

the Corr any to be argired by the Company , wherelay thecu~ton oorm~itted .to an investment in Tel egate:in correctionwith the aoqu sit on of all theoutstandii rig shares of Telegate by the Company . The Cu stomer committed to provide this i nves Trent in the scent that the aogiis ti on of Te1.egate by theCompany c lid not d am In anuary 2000 ,.the y i eased thec uetcmer a warrant to pErdx~e 2,000 , 000 sf es of• the Gornperty' s ocxrrrion st odc ateOnce of $30.75 per dare; the d osng prioa of 'soorrrnon stock on the date the warrait was i ss ,md. The warrant is fal l y vested,non-forfatable, and i mmedutel y exerasablaend has aterm of three years, The fai r value of the warrant , detenrined as amIoxi mately $34.6 nii I Zion usngthe Black Scum es model , was ind Wed i n the Tel agate purdiase pri oe.and Wasa a aced with the val Ueof the ptistomer rd atlonef p . The value of thewarrant resulted in :a non- cam charge to cost of goodsagld to be amortized overthetftee - yew term of the warrant In tfiefir~ quarter of 2001, theCompany wrote-off the i rrtaigible aeaets ref ati ng to the purchase of Telegate (see

aae an i ndeternv Hateowns equity in theon Warrant The agge toany to isee an additionalyear ended Dec ibel 31 ,

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NOTES TO CONSOLI DATED FINANCIAL . STATEMENTS-(QontirtQed )

Note. 5). For the yea endad Decernbe!`2D0i the Company i r~aured no ariiorfirati on wcperipe related to ti warrant. For the years ended Deoernba' 31, 200'1and 2000., the incurred approxin-Ady$Z9mitlionard$11,5millioninarmtizetionacper related tothe'warant,reqectvdy .AsofDecerrber31, 2 TelepatewarrantwasexsrcisaWafor anaggregateof 2,tlfl0OWsharesoftheConTeny'scournonstodc .TheTelegatewerrantwpired in .l3ru y2)G3,

n February 2001 , tfie Canpany ism.ad a wa iaot to: pirchase 2M,pdosngpficeoftheCompan~y' soglrvnonstockonthedaketlwwmantH(TrueC tj Under terms of thewaarait 1 .00,000 hares are vested and expcerciSabla at the rate of 1124th per montt7 : . mrrlg January 31, 2001 .B) ask-5chd as method and was reoordsdas tiotml .tAn darafi on ratwaseocerasakilefor ana egateof 200,000 doves of the Corrcany'sa

ny'•scornmon stock at a price of$5.4375 per thane, the, n w. hh:tFe Decerr>ber XI poquiationvof Truer-hot, Inc:and therernsini ng 100,10DQ resve at and becomeran ,erl of approxiniatd y $0.7 miI I ion was c t;U at®d uang theTruel at. Asof Dactin r 31, 2QUZ the TrusChat warrant

In i.ne 2001, the Company iaeued afdlyveeted immediately mcerdsabls, warrant to pcreh ass 100,01J0 shares of i .Company so trfnonstock at aprice of$.5.98p -shamtoFfiilips3errwoorK ors1nc .(Fhilips)inConsderationforthe:pcntinuAffonof theiretr ordaior iipwiththeCompeny>Thefair value of thew arrank calcul ated Ls rtg the Black 5dhd as method of aofroxi m tsiy $0 .3 mi i I ion was recorded asoost ofyoodss71d diri ng . 2001 . Aso. fDecernbw 31, 2(02, the Phil i pswarra t was exerd sabl a for an aggregate of 100,000 shares of the Company' s common sock

Stockholder Rights Pla n

In Febnia-y 2001, th e Company's.Board of Di rectors approved the adoption of a Stockholder Rights Flan under wflich :all stockholdersof record as ofFetxuary2Q2001 received rights to purchase shares ofanawseriesofprderred stock The rights were distrilxteclaspanonr taxabladiividendandwiIIeXgte in tee ye2rsfrwn t e :recorrd data. The rights w ill be exerci k31 eonly if a p ei n or gaup angti.res75 Percent ormor of the Company ' s oornnu'istock or announces s tender offer for 1 5 percent or more of t h e Co rnpmy' s cornrrron slodC I f a person or groupwcores 15 percent or More of theCompany' scan n dock, all rights blot cars eec t thebuyawi tI be anti tied to adqui rettie Company's oonvmn a#odc at a dislount. The Board maytenri nate the Rights PI an at any time or redean .the rights pri or to the ti me a person or group aco}iresmore than 15 peroerit of the ' Corr~any' soonxnonstock.


Canmon stock reserveafor Issuance isasfollows

C-Um"rn stock qA cats,.. .Cornmon Stoat wartards , . .En loyeesodcpurda9a .p1dn

©e fter 31,2002

43,54T,8312,425,5933,Ifa].

48,973,4224

Stock Option and Stock Purchase Plans

In .March 19%, thSCompany's Board of Qi rectors approved a stock option plan (181)5 Pan) ttmiauthorizsd r#~aresfar fuk~reiaPUar a to be granted asaft~e shares of the .Company's common stoat . As of Dsoe~lrbar

.31, 2002 a total of 4,223,494 : shaès haae been audiori zed for IL-ti a relatedpurc

h to the options to

1995 FI an.

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TERAYON COM M UNI CATI ON SYSTEMS, I NO .

NOTES TO CONSOLI DATED FI NANCIAL STATEM ENTS-(Continued )

InMarch1997 ,the. Company ' sBoardofDirectorsaf?proved n equity incerttivepkan(1997Plan.)'d* Uw. ,'zad1,800,000Daresforfuttrelea""1o be grarrted as o~arsto purchase sfiaes of the C rpeny ' swtrnon s#odc. In Jive 1998 , t e s Bawd of Di i x tots authori zsd the a~ G' on oftoamended 1997 Ran , i nveasing theaggregate tuAnber of stares atRf iori zed for i sa~rrtae under tf~e 1 . 7 Flan .to 6,t'~1 ]o;000 ies(5,ODD,0( ''additi onalglares). The amenth . t atao provided for an inor taithe authorized mares each year on ,•a uary 1., st+argng Wii th Ja rtua y 1,1999 , if tt,e rxarirrer of maresreserved for future i ~uxxse w I esstlian fve'peraierrt (5°%) of the Company ' s ouistsard ng corrrrwn stock , tf ien the atAhoriaed shares woui d be i rxreased toa bai atxe equal to 5% of the Corr non stook .oqt . . . . . ng, Th:o were no i ncreases'to the t997 Plan 1n :1 -c% or 1999, On J vary 1, 200D : .2384,528 s w swere addedto the 1997 an for a .toti of 84,5 aces

The 1997 Ran was .an id d an June 13, , ) to i ncrease the ares.a izeil for isan-ce by 3,770;t7X additional trans and to provide for atincrease in the number of ales of *on i stock beginning ;may 1, 400#ntg#► A~ 1, =7, by the I anew of five pero nt (5%) of the cot't m ndock ciut 4 ng on erdt bnuary 1 or 3,0Q6000#4es As of Deoeinber 31, 20(32 a total. of 18,754,528 Wires have been authorized for isalaice related tothe 1997 Plan .

In J" 1996, the Company s Boars! of Di rectors autlhori ed the aiopiion of th e 1998.Non-E.r rtgl oyes D i rectora Stock Option Pl en(1998 PI ai),:ntto whi di 4X0,000 dwes of the Company `s oom1non ock have been reserved for future i swanks to nort ernp byes ci rect rs of theCoirsa . .I n

2002, the Company' s Board of Diredo sairrendAd the 1998 Flan to increase the fires auN sized for iss lane by 4 ,OQDadditi oral shares As ofDecember 31, 2002, a total of 9f10 .000 uses trays been authorized for r ose rel eted to the 1998. Ran.

In r 1wr1999, theConganysBondof Directors .sthorizedtheadoptionofthe1959Non-OffscersEgtAtyInaentiveRl an ( 1999Ran) . pursuantto which &, , OD9 resof the Campariy'soorrrrton stock :have been resaved for fut4re issuance to non-offiw smpl oye+es of t. GaTany. In 200X, theComoary' s Board of DIrs tors a mr ded the MO flan to increase the n rrber of autlu i zed shires to 16,500;000. In 20X1 , the Company, s Board ofDirectors arnenied the 1999 Plan to i s ews the number of a *horized siwes by 1O, 00 ,000.. As ofD.ece r>lr 31, 2 002 a total of 26,500,000 shares havebeen authon zed for issuance related to the 1999 plan

The i 9SS and 1997 PI am provi de for i nnaruive stock opt ons or nor" i fled stock op ti ons to be,i steed to ernpl ayees, directors and c a itaitsof theCompany. Rioes for i rx~r~tive stock opti orb may slot be less tltan lhefai r rY~arket val ue of tfie c oirrnc~i Sb k at the elate of gra~tt Ri ees for nongr ifi edsto k options may not he It3ss than 85°x; of the fair m®rlcet vN r oft a cmm~gn s(oSk at the cite of .gran} C)pti ons are irrrr~ecf atel y exercisabl sax!vest overa period not to exaaed five ~rexs from tlae date of prams Any unv ed doek isr3 led ies~hject to repurth by the Company at ttte ati pi nel is iaFxe psi ceapont..nationo€ theopponhoIde senployment Unexercisedoptons~cpiretenyearsafterthedataofgren t

The 1998 Han providesfornon-dis7etiorrerynonqualifedstockoptionstobeisaaedtonon - riployeecIrectorsofthe Company autotabcalIyasoftheeffecti vedateoftheirelediontotheBoatd 'ofDiretorsandarwu I y fdIc rg each annual stoddholdermedir~ Prim fornorx alifiedbptonsrnaynot be less than 10096 of the fai r market val ue of the oonxnon stud at the date of grant Options generally ved and become ec erd mU a over a period not toexceedtfeeyews from the date of grant. Unesc secoptionsecpiretenyeasafterthe data ofgrant.

The 1999 Ran provides for nonquaiIfi ad lode optionto be iced to non-offlaerempl oyeasand consultants of the Company . RI oes.for nonqualifiedstock options may not he le$tha - 85% of the fair market value of the o mrron stock at the cake of the grant Opt ons generai ly vestand become exerd s9l eover a period not to exceed five yearsfromtha :tlateof grant. Unexeroisedopfortsexpiretenyeersafterdateofgra t

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TERAYON COMMUNICATION &YSTEM S;1 NC .

NOTES TO CO NSDL I DATED FINANCIAL STATEMENTS - ( Continued)

During the years en idol D31 , 21702, 2001 and 2iX ttwComps V recorded a e p defeRed txilY enr i on of apps xlmawy $38,O DD .$35,000 aid $35 nii I I ion, rdspedivef y , represent ng the c4 fferertce b tween tt ►e grant pri38a d the_deaned Ur val ua of the CoftVa ijr'scorrrnon stockoptlonsgrantedduirg the , periodThe.ai rtizarlionofdeferredoon1pertserbonisbeingchargedtoopEations 4isbeingangdzedover thevesting periodof the options, which istyptog ly five yEers I n eachsttiecf:lent reportit>g pofiod(tYrkh lnevestirky .petl od) theimniaininQ defor[etlcortpertsad on wi11 beren aged. For the Years ended December 31, 2032, 2001, and 2000, the armdzzdi on ei penes was apExoxitnately $0.5 million, $Q5 mi I IIon and$0.6rnillion, reepeehvely.

In ,Axae 20Di, the Grxripeny i-sisued 166,000 stiaresaf the Company's wrrxrpn rock to members of i is Bond of Advi sons and recorded $0_6 mi l l i on i nrd ated corrpt on expense. The con ion expense wasealaaated ud ttg the d osi rig price of the C o npeny's obmtrion stock on the date the stock wasissued at $3.72 per #a e.

Dudng2001,theCompany isaied115,250) aresof-com n stocktoitsernooyees andrecorded $0.6.million inrelat loon #ionexpenwThecompensation expense users cal d aced using the do si ng pr cs of the CompaiyI s corn i n stock on the date the dock was i ®rad at $5.57 per fide.

Dudng 20102, the Company is; .ied 20,000 nonqualifiad stock options of comm. on stock to amember of its Board of Advisors arid recorded $38000 inrelatedcorr tionexpense Thecon,pensatianexpero-Iwascalwlatedusrgthedot ngpri ceoft e .Company'.scommonstoekonthedatethestockwasiswed of $1 .95 per thane,

During 2002. the Company id 200,0100 sflaresof common stock to a .oonsaltantand recorded $29Q.000 in relatekl comperes fort ~c agnse. Theoorrpernsati on expense wascal d afed using ttie d osng.price of fhe .Corrtparty's colrrrion stole on the date the stock ways squad of $1..45 per share

Thefoll owi ng i sa .s rnmary of additional irtbrrrtation with regiect to .the 1955 Stock Option Flan, the 1997 EgUty I noan6ve Ran, the 1998Non-Ernpl oyte Di rectors Stock Opi'ion Plan, the 1999 Non-Officer Equity incentive Ffa , outtardng opti .onsas5umed by the Company in conjunct onwith its busHessaoquigfions of (sae Note 14) and option .graits made outside, the Plans (if 'erg!) :

OptansOutstanding

weighted -Options Aveag e

Available, Number :of fb(e-at eft( Grattt Shares Price

B a ceat it 31,1999 ! 3 2BR;G _ . 1€,542 333 $16:76Optia~sa.~t razed 1$ .6GA,52S - -nptionsgratited (16 ;937,301) 16,937,30f $511 4Qptiom%ardsed $ 7.26dpbonscart ied 2853,236 2,£ 13,236) $ 1 .3 6

Balance at Decernber 31, 2000 8,840,090 21,489,556 $39.27Optime a&iari Zed 13,00( Lbb -Optionsgranted (22925,565) 22,925,565 $ 6.25004ns:8!c9r6 aed" :«« (2924,274) $ 4,59Optionsrarieeled 21,483, 141 (21 , 488,141 ) $35.99

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TERAYON COMMUNICATION SYSTEMS, I NC .

NOTESTO CONSOLI DATED FI NANCIAL . STATEM ENTS--(Continued )

0piionsOuluandi n

QptiptsMeltable-for Grant

Number of$herec

Weighted-AverageEiierdas

Price

Balance at Decanter 31, 2(J01 20 7 F3eB 2007,$86 :>options aud-orized 3,400,0 -€}prlons ranted (1,734;4) I,734,4G0 $ 5A0Opttt~nseuerased - (257,521) $ 3 .95Qpbone coaled 6 ;843;540 (6 ,3411) $ :42:66

Balance at December :31, 20x2 28,91Z W6 14,M,00 $ 11 05.

I n add ti on, thefol I owing table summarizes inforrnalion about stook optionsthat were otdstanding'and eKercisadeat December 31, 2002 :

Options Outstanding OptlonsExqrd,sabl e

Number of Weighted Wei ghte dWeighted Average Average Av

erage

Number Renainl ig Exercise Exerci sable ExerciseRanged EtercgsgPriaes Outstanding Cont raaual Life Pri ce Options isrice

$001 !$6,53 4 .22B212 7 .89 r, $ 4 .08>'r 1,x443$3 $ 4`135S7 - $650 944,357 832 $ 612 252 558 $ 6 .21$6,60 - $f 8'f 7;493,268 8 .15 $ 6.80, 4,479, 550 $ 6 :80$684 - $82.78 1,933,188 7 .93 $ 20 .35 877,926 $ 27 .63$123.50 38,QOo 7,20 . . . . . 1.12150- : 1 s 8t)o $123:50

Total 14,635,025 8 .05 $ 8.05 7,383.2B7 $ 8,92

At December 31, 2022, approxitra#ely 657 shares of oomrnon stock outstardng were wbj act to repurctlase by the Company .. Conwon dock subjact torefxrdiase represents any a vexed shares of common stook hd d bryi an option-id der, which, upon tie ni nati on of the optionhol der's employment, may berepurchased by the Company . Such shares are subject to repurchase at the r origil nal i sauanoa price . Repurcf>aspid shores are recorded as Treasary stock .

n June'1998, the: Board of Di recWrsapproved , and the Company adopted , the 1998 Empl oyee :Stock P rd~aee Plan (ESPP), which .isdw. ' fined to al loweligible emptoyeesof the Company to p ha dares of cox sat stock et awii-anrwal i r* vpl sthrough periods peyrol I deduoti ona I n 2002 , the ESFPwas ascended to add an add ti onal 3,QW W0 shares to the ESPY. An aggregate of 4,400 ,000 shares of common stock has been reserved for the ESPP, and1,400,000 shares have been i ssued .through December 31, 2002. The ESIPPisirriplarriented in a Seri esof s cress ve offering periods each with .a maxi irxrnduration of 24 months, El igibl a empl oyeasm have up to 15% of their baser sal~ a~ r p deducted that is to be used to pu diam dares of the common Stock:on~ea fi c dates determi red by the Board of Di rectors (~ to a maxiam of $25,000 per year bated upon the fair nvrket value of thethwesat the beginningdate of the offeririg) . The pri ce of oonvrton sEoclc purchased [ rider the ESPP wi II be actual to 85% of the lower of the fair market value of the oo mion stockon the oommenco'hent date-of each offeri ng period or the q edfi ed purd ose d a t e . I n November 2002the Company's Board of Directors aided theESPP after the o. rent OFferi ng Period ®cpirss (no [Aar then July 31., 2)4) '

The Company has elected to follow APB Opirdon No . 25 and related intevpretationsint couriting for itsanployeestock plansbecatige, asdisx edbelow, the al ternative fa r value a r g provided for under SFAS No . 123 requi res the use of valuation moddells that were not developed for use invaluing employee stock

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TERAYON COMMUNICATI ON SYSTEMS, INC .

NOTESTO CONSOLIDATED FINANCIAL, STATEM ENTS -(Continued )

instruments Ur ><ier AFB Opinion No. 25, when the. exeraair pri aeof the Company' s 1ployee stook opti ons equal atho market pri ce of the underlying dockon the date of grant; no compensation eu pense is reoog i zsd.

Pro forma information regarding net l .oes is raga red under SFA S: No. 123" iscaliutated as if ft Company, had aoi ;oirtted for its employee stocko ptionsgrantedduringthe .yearsendedDecember31 , 20022001and2000ericlforitsESPPsharestobeisstedunderthefairvaluemethodofSFASNo, 123. The fairvaluefor rployee4ockoptonsgantedandESPP a~swasestimaledatthectateof grant based ontt BI I Sdideerrioddusingthefallowing weighted average asa,rnption e

Stock option plansEmpl oyeestock purchase plan

.Stock option plan sEmpi oyes stock purchase pl an

Stock option plansEmployee stock purchase plan

Risk Frei Risk Free Ride Free:d4lil Rate I Merest Rate InteraM Rat e2002 20Qf 200D

422% 4 .50% 5::96 %436°16 4 ;14% 6.35%

Dividend Vnlitiiity Vt atility VdalilityYield Fads Factor Factor

All Years 20()2 2001 2IXID

0.0 1 1 50 1 .50 1,200.0 1.50 1 .50 120

Weighted Weighted WeightedAverage

E d LifellAver age

E lled LifAvg age

E d Li(xp e e2002

xpe e400'1

xpa ta e2000

5 .0 5.0 5.00 .5 0.5 0.5

As di scusaad above, the val uati on models used under SFAS No . 123 were developed for use inesti mating the fair val ue of traded optiorsthat have novesti ng rest i cti onsand are ft1I y transferable. I n .additi on, valuation model sreq i re the input of P igMy subjective ae"riptionq ind add hg the expected IIfe oftheoption. Bez;auss the Corrpany'semplvyeestock op6onshave diarac :r9Eticssignificant! different from operaof tradedoptionsand becausecfiargesinthe"e tiveinputa5swrnpttonscanmateriallyaffectthefairvalueestimate ; in rr r 1'sopineon, theexistdngrrmodelsdonotnecesm iyprovideareliable single rheas re of the fair va! ue of its employee stock instruments

SFAS No . 148 amends SFAS No.123 in December 2002 to mire that disd oe fires of the pro forma effect of ua ng tide fad r val ue rrietfwd of accountingfor stock- bated employee compensation be di spl ayed more p rominartly and in a tat UaforTn . For fxxposes of p ro forma cf sill os rw~ the estimated fad rval ue of tt)e options granted and ESPP shwesto be issued is argrU zed to etc peI1~ over tttetr respective vesting plods Had compensation host for theCompany' sstock - ha~c1 eompersatl on plans been detami nod based on the f4i r val ue at the grant clatesfo 'awards header those 0 erns coma steitwi th themethod of SFAS No . 123,theCompany' srietIossa, ica61atooarmonsbckholdasandnotIosspersnareappligWeto ..coll~rYton

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TERAYON COMM UNI CATION SYSTEMS, I NC .

NOTESTO CONSOL (DATED F1 NANCIAL. STATEMENTS :-(Ct ntinued)

stockholders wool d h we been increased to the pro fort ha armor tits i11 c ated below (in thousands sXOept per mare data) :

YearsEnded Deurnber31 .

2002 2MI. 2000

Net l oss .$44,21 } 3846) .. 1, PE37)Stock apbon.plar>S V.1747 ) 1213,721) (118,0$€rrpi6yea stocii larct~ase.pan (f;9W), ( ( Ll~

Pro formanet Ioee $(79,950) $(69Z.779) $(3CD,.666)

Praforma:l aad rlutec# t~lfass}~eF iae` $ 1{ $ . .( :1Oi4) .. &. . ;{4 .90j : ::i

The pro formai mpact of opts ons granted and ESPP thareato be isaiedfor #* yeave ended December 31, 2002, 20 and 2W O i s not repreeentative ofthe effects on net income (loss) for future yearq asfut re years will i nd ude the cone sued effects of options. vesti ng aswd I asthe inert of mul ti ple yeasof stock opti on grant--.

Tha option weighted average grant date fair value, which istlte value aeagned to the options under SFAS No . 123, vras$4.98, $583, and $43.81., foroptions granted during 2002, 2001, and 2000, reepedivel y . The wei gNed eaaregraft date fai r val ue of ESPP dieresto be i sand was $228, :$3.99, and$9.30 for the yews ended Decm> r 31, :2o02, 2001 and lobo, reqxecti vely.

10. 1 noome Taxes

For the yease xted December 31, =and 200..1, the Company had an pcome tax ecperm of $0.2 m Ilion, and an income tax benefit of $13.9 mil lion,reelyetively .Daetooperating Iose andthe ir»biIity tor ognize thebenefits, there isnoprovisonforincorrtetacesfortheyearended December31,2000.

Yews EndedDecember. 31 ,

200¢ 2001 2000.

(in ihousand4GurrertFederal $ - $ - $ -State 2{} -Foreign 21$ 831 -

Lotai current $ 238 $ $31 $ - 'pared $ - $ - $

Feder~t_

StAeForeign

Total deferred $ - ( 14,746) $ -

Total $238 $(73816) $

During 2001, the Company recorded a deferred tar asset of approxi rrratel y .$4 .0 rrul I ion and. corresponding reduction of goodwi 11, for t* tax benefit offoreign net operating loss rarryforwardsrelating to a p r e v v i a u s acquisition. I n fiscal 1999 and 2400, the.Corrpany acquired ten ca es I n fis~l 2001,Carta nintarx0ibleassets from ttieseaoquia ti onswere wri ttai off. Aspart of record ngthewrite -offst erelafeddeferredtarliahiI were: alsowrittenoff .T.Nsresultedintherecordrgofadeferredtaxbenefit of$14.7 millioninfiscal '2001 .There vuae lsifore)gnincometa(esof$0 . 8rril lion forfikel M.

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TERAVON COMM UNI GATI ON SYSTEMS, INC .

NOTESTO CONSOLIDATED FI NANCIAL .5TATEM ENTS--( Continued)

Thereoonciliation of inoometaxbenefitaft buta etohetloseappleoabletomrnmonstockholderscomputedat1treU .S.federalsta oryratesto

income tax benefit (in thousands)

Years Ended Deanba 31,

2002 2001 ?:

Tax b itat l1 S . Aatutoiy rate $ (15, 1) $09 , 4 $( 2GoodyA II amorii Lion - 2,849 19,406,tn-prone re search and d®vslopm-t » » - 9,698

os~for wild no to benefit isarrently racogr~ able 15,391 179,336 34,529kEtiefl teat 238 1244 <. $38

$. 23$ $ (13915) $ -

Deferred income tax esrdlec t the net tax effects of temporary dfferenoesbetween the carrying amounts of as istsald .l iabi litres for firarx ial reportingpurposes and the a nou tsussd for i rcove tax pu•poses 5igrr fi cant a rrnponerits of.. the Company' s deferred tot Sand l i abil it es as of Decerr >ber 31 ;202 and 2001 are. as follows (i n thou s) :

Decanber 31 ,

2002 2001

Deferred tax aSSA SNet operating loss carryforwerch $ 119,021 $ 134,321Tai crecirtCarryforwat'th 14,936 't3,04 7Reserves aril accruals 98429 56,41 8Capitalized research aM development 4,872 7,550Int"blesarmrtination 2616 8 .39 6Other, net 8,43 l 6t©

Cro%deferred tic a~ets . 244,803 218,372Valtizationelluys .nae (244,8033) (218372)

Total deferred tax.as $ - $ -

Realization of deferred tac assets isdeperdart on future eaning$ If any , the 6mingand.the amount of which are uncertain . AooordIngl y, a vonallowarxehas been sstabfi wedto refledthecauncertainli esasof Decambw31,2X12acid2(1)1 .The in thevaluetonaII iowarm wasanetinGreeseofapproximatel y $26 :4 ml I i onn $86 .7 rr i II i on, and $88.2 rnillion for the years ended December 31, 2002, aid 2000, respectivel y . Approximetaly $44.2mill i :on of the val ueb.on allowanoe .wi I I be ¢edited to equity when reel ized.

As of December 31, 2002 , the Company had federal , Cal i forri sand foregn not operati ng l oss Earryfawards of ap ao i metal y $244 . 5 mil l ion, $136:4million and $1115 million, re ecti vel y. The Company also had federal and Cal I forma tax eiredt oarryforwartJgof approximately $8 .7 rri I I ion and $9 6million, respective y ThefederalandCalifomiar opera~ nglossa"icreditcarryforwadswillexpireatvariousdatesbeginningintheyears2(X3ttrough2022 if not Lid I ized. Theforei gn net operating losses have an unlimited carryover period

Utilizat onof net operating lossand tax crecit rarryfotw dsmaybeabject .toasubetaritalannuallimitationdueto theoWrie ip cfrbtxlelimitationsr ovi ded by the I nternal Revalue Code of 1966 as at> d, and a mi I ar state provisions The annual I i rr itati on may resift i n the etpi rati on of net operate ng

and tax credit canryforwa-dsbefore full u'l ization.

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TERAVON COMM UNI wI ON f,1'3TEM&; I NO .

NOTES TO CONSOLIDATED FI NANCI AL . STATEMENTS- (Continued)

11 . Defined Contribution Pla n

During 1995, the Company adopted a 401(k) Profit 9' ati rr Plan and Trust that ral l aws of i gi bI a of toyeesto mentributi ons siAmt to certainIimitat ors The Can pany may mice tisrretior ry s7mfrihu6onsbasad on profifi lity :ast rriined by the Board of Direct= No: alrqunt was contributedby the:Corrpany to ttielilan dud rig theyeamerided Deoeiriber 31, 7003, OQ1, anc12000 .

1Z Segmentsof an Enterpriseand Related Informatio n

The Corripar/ s Chiof Execut ve Officer hasbeen identified asthe Chief Op ati rig Deci si on Maker (CORM) b a he hasfinal ajftdty overresource al location dad bi or sand perfo rmance i srrkint, The CODM A locates 0661dr sta each segiwlt based on thei r bu:i now proepe* cor petibvefaotorsi . revar iesand operating rescdts TheCComparry does riot al locate non-operakingincomeore~c~per sto its tsesmerMornentdoesnot use theiriformadonto measure tftepeeforma e:of the operat i ngaegr,ents

TI*Cornpeny vie eitsbuenessashaviritwoprincipal operafinpuoyient Cake B €oadbondAtcessSyatsns(Cable) 2rdTelecomCarrierAtceesSy sterns (Tel ecom) .TheCabla~ cone tsprinlarilyofitsTeraComm5yatem,TJlineofD£7GSYSe ble .noderrr~pluewaveIinsofDOCSISCablaModem.Termi nati onSysterns (CMTS),and .theChertyF' ica'femiIyofDigitalVideoMart SystemstF.iateresoldprimarilytocable operators farthedeployment of data, vi dap a d voi cawvic. esoverthe ensti rig calif a infrastruture. The Telex m segmentnonssts pri manly of Mini Flex DSL Systen AI F?L Conv erged Voice and Data Service rystern and Mai rGai I products, whi Ch are s old to providers Qf broadbarndsavitiesforthe dept oymerit of voice anddata vices over the esxiating copper wf re Infrastructure.

I n€onnationon reportable segments is as fol I ows (i n thousands) :

Yew&Ended Deoaiiber 31 ,

2002. 2001 20D3

Cagle Broadba id Act 5egirien~Revenues

Tom System $ 68,753 $ 192,757 $ 238,358T,1 D OCSI S c abl e maderns 23,459 25,069 24,736Video ptodu is 20,833 16363 19,71 408w 6,284 11,639 20,71 6

Total Ca e revenues $118,923 $ 245,828 $ 303,524Depreaahon wperl9e $ 10,347, $ .. .12,028 $ 1Q,69 9Op6ra ngIoss $ (78,731) $(405,43Ei} $(132,643)

Telecom Srgadb" Ac SegmentRaveriuEs

M i rr PI e( D SL Systems $ 8,366 $ 23,417 $ 33,363Other 2,168 10,236 Z682

Total Telecom revenues $ 10,474 $ : 33,653 $ 36,025Depredation exile ae $ 1 ;225

.$ 3,700 $ 585

Operating loss $ (1 .,852) $(297,697) $ (54,834)Totai revejues $129,403 $279,481 $ 339,54,9Total depre iatonexeere $ 11,5572 $ 15,728 $ 11,284


NOTESTO CONSOL I DATED FI NANCIAL 5TATBM ENTS :- (Continued )

YewsEred December 31 ,

2001 2001 2000

Opa 1~g Ir bX>eportahlesOgmBrts $($9,593} ${763132) $(187,477)Ut1 1o d2LYi6tili4 . : .

nteres# and other irraxr~e (ocper~e}, net (3,481) 44, 5,71 0ix :der! y l t cierst o{ debt 49,O 183,327

Incometa( (mkper se)benefit (238) 13,915 -

Natlow $(44,213) $ 583$46) S(1801767)

Geooareasevery

urYted States $ 41 .15Q $ 54,291 $ 83,974Canada 17,247: 113,300 118,4 1Europe 11,381 34,952 37,969

Israel 8,283>, 16,528 23,861

d37,214 37,721 36,61 2

a eaducfrgLfapanA 11,843' 24,QM 24,37aSouth America 3,289 2565 14,358

Tots < : $129 4 3:,;~■

$ :271,4 1.rrrrrnr

$. . 3B,SA9 .ter.

December 31, December 31,2002 2001

AdsCable Broadband AiX Segment $ 217, 531 $ 455,836Teleooh~8coatlba~d.Ac dent SB .1 79 : .̀. tt $fiD

Total assets $ 275,710 $ 466,646

Long Iwecf.l3~etsUri ted States $ 28,169 $ 36,106Canada ;r 787 2556Europe 170 3883 sael 3442 3,757Asa 207 24 3Soulh Amafca 118 2020

Total long-lived amts 32,993 42,T7 0Total at,rent as a't 3 ,3t7 4AS76

Total assets $275,710 $456,646

One vustorner, related to to Cable segment, aueounted for 10% or more.of total regenues for the year anded December 31, 2Q02 (28%). Twocustomers; both related to the Gable segment; acom;ntsd for 10% ,or more of the total re e u s (33% and 13%) for the yea ended Dente r31, 2001 .Three o stomers, all of whore'related to the Cableseg ant, accounted for 10°'k or mere of total revenues (17%, 17%, and 1104) for the

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TERAYON COMM UNI GATT ON SYSTEMS, INC.

NOTE,5 TO QONSDLI DATED .FI NANCI.AL STATEMENTS-( Continued)

yea girded Deceniier 31, 20M No other customer accounted for more than 10*A df revenues durt rg these yeas One::custon'ie; related t& the Cablesegment; accounted for 10%/6 or more of total aooouxts recei vabl a for to. year ended Decernb ®' 31, 2D=(28%),

13. Related Party Transactions

Duri ng the years girded Deownber 31,2002, 21)01 aid 2000, the Company reoo9ri zed reienue of $9 .1 rnil l ion, $52.4 million, and $119.3 mi I I i .on,respectively in connection witt prodrd ipmetsmadetcrelated parties Prior to .thetbird q . er of 2001, bothst and Ro w eech of which had onerepresmtativeontheCompanyà .Board:of DI rec swereayhificarit kidders'andwerefeltedpatiesBegirnir Inthethirdquarterof2001,Sfiawwas no longer a s gnifi cant stodthddet' beaau9s Shaw no longer aces sect voting rightsover' its sharesi n the Contpei~y, and the board merry f mm Shawres geed. ACCordi rigly, Ens was no I onger cons dered a rd ated party . Revenues from Shaw are:not ind utled as revenue.from related parties afters theeaoond quarter of 2001, when 5aw .ceased. to be a r'el ated party. Al ek Kro i c, a rnerther of the CotnR2ny':5 board of a rectors was the Sani or V iceFR eNdent of I nteractive Sera ices, Salesand Product Develo it for Roge wrtl 1anuary =- In May 200(3, Rogerswwil l no, longer be a related party tothe Company .

L aoi s Sol orcpn, ameCn4er of the Company's Board of Dl rectorsand chairman of #W Compa ny sAud t Corrrrwttee satso amerriber of the Board ofDi rectors of Harmori c Inc. (Harrnonid) a manufaefuna and sal ter of broadband pros I n Apri 127f71: the Cornpen + entered a reset ter vreemerit withHaman c to sell certain of the.Compeny'sproducts Theeerrantappoints Harmorrc as an authorized, non-pcdus ve read ter of certal n of theCorrpany svi deo producCs I nthe year ended DeceFnber 31, 2f1D2, revenuesfrom Hanroruc of $1 .1 Hill ion are ind sided as rare efrorn rei ata1 patties .

Co of related party product revenues consist of erect product costs i n cost of .goodsscf d in the ConVanys cone Lidated tateme is of operati ons Noindi red costs are appl iedlo the cost of related party revenue . Accounts rewivabl a from Rogers:and Harmonic totaled approximates y $0.6 mi 11 ion and$4.0 million at Decembe r 31, 2002 and 2001 , respectively . None of the related parties is a aippl i er:to the Company .

I n Deoerriber 2001, the Company entered into co-marketing arrangements with Shaw and Rog er s The Company paid $7 . 5 nil lion to Shaw and$0.9 mill ion to Roger. and recorded th ee amountsasother oJrent ass is 'The Company entered into #*s3 .errt gerw tSwith Shav and Rogersto promotethe Company' s braid and identify its prodx t& The Cort imy will charge.th e amorti zation of these asses Val nst Cabl a reverx m si meads of the next fourquartersthrough Decaemb er 31 , 2003, the term of the ref ated ;arangement , at the rate of $1 .4 mi I I ion per quarter . Am , ntscharged a di nst re venues in 2002toed app roxin tely $2 .8million. See Note 1 .

Between April 1998" March 1999 , toCom iy i sued v ri ouswaraits to Shaw and Rogersto purdtase shores of the Company's common stock.See Note 9 ,

In October 2002, the Company incurred a market ng expense of $150,000 for Team Honor , an organs n tion that supports a profesd oral sail i ng teamOne of theConfrany`sBondrnanbets , Aleks derKrsfajicisthefounder aidPr esdentofTeemHonor.

14. Busi ness Combinations

During 1999 and 2DOD , the Cady completed a tats[ often acquisitions There Were no aizluisi tionsduri rg 2001_ Each of the .acquis ti answasaccounted for under the purchasemethod. ofaccountinginaooordarx . ewithAccountingPrinciplesBoardOpinionNo . 16(APB16); Therespectivepur epriceswere al located to thea sacquiredandliabilitiesase ;imedbasedonadeFeirinabonfrorrmanindepententaprxais~l of didrrespecbve .fairvalu®s'inaccordance with 1 mergl ng I saw Taste Forces No . 99-12

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TERAYON COMM UNI GATT ON &YSTEM& ; I NC .

NOTES TO CONSOL .LDATED FINANCIAL . STAT EM ENTS- (Continued )

(EITF 99-12). The methodol ogles used to value intatgiti4eara~atsaoqui red were consistently awl ied 1 o each of th e sogtiid ti ons

To deterrriinethevalue of thedeveioped technology, the, expected futurecash ioW attiitxdedtb 41 adding technology wasd&x cued , taking intoacnountrisksrelatedtothedharareWsiasanciapplicationofthetaehndogy, existi ngandfuturemarketsand assessrrvx*s of the Iifecydestageofthetechnology ,

The val ue of the i n-proomrest and .davel opnient wasdetermi ned based onthe .expeded cash flow attrtbut®dto the iin-process proj ect~ taking intoaccount revat ue that isatfribit etc preyiou4 y devdoped tec#nology, the level of effort to detain the in-proosse reaaach and developrrlent; thepercentage oft o npla ti onoftheprajectand .thelevel of risk assoa2tedwntlithein-proosesti3dtrtal ogy, Theprgjectsidentifiedesin-processarethosethetwas i n c $ w a y a t each of the aoqu red o o n p a n i asst the ti me o f t h e s tion and that requi. red tonal eFfortsin order to establii tec iol :o~i ca(feag txlii y. The value of i n- MOM res~arch ancf c e'eI .o meryt war i r>d uded i n the Compal~y' s restJ :ts of operaq one dui rxj the period of the aa~crs ti on.

Thevalue of toaseer led workforce was derived byesti rnatingtheooststoreplacetheexilirgemployees ; Indudingrecruiting, Nrirx; andtralyd.ngcosts for each category :of employee;

As discussed in Note 5 , the Company . recorded fosses ciue .to the irrpai nT ent of goosiwill and intangible assets :of approximately $4.0 mil l i on.and$572.8million relating to these acq uisti.ons in Deco nber 31 , 2002 arid 2001 , re spectively. No I ntd gi bl a assetsrelriained of Deoa bar 31, 200 2.

In conne ction with the aoquistionsof In a ar h Telegdte , i n 1968, the Company gave one of itsd redors, Levi .s Solon on a gra" of 50,000non-q opti pany byuali fi ad sboclt onsand an additional arit of 20,000 shares :af restricted oonxrion stock for coneulfi n9 services provided to the Co mMr; Solomon for hisas3stawewith theCa y'sstrategicpaitnersh ipsandacqulsitons

I media Corporati o n

In:J iy 1999, the Company entered into an Agrearnentand Plan of Reorganization (l ri Leda Agreenait ) to :aq.tl reI media Corporation (Imedia), aCaliforri acorpgr Lion I media producesrou ti ngandre-rr" tlptex fnga}stamsfortigtalvideotltatenable cable operatorstuaslectandaa . omizetheirprogram Ii rre uQ for vi ewer prderenoa while meci mi zi ng vi deo capacity and goal i ty over stanccx'ds-based set-top boxer. The I rnedi a acgii s lion wascomp) eted on September 16, 1999 (1 media Cloei n9 Vie).

In accordanoewith t h e I media Agree nsrrt the C o m p a n y issred 1 , 714,614 s h a r e r common stock and 30B,256optionsaxiw arrantsto purchasecorrmn stock to the vested and unvested option holdersand warrant hol dersof I made a .on the I riled a CI oe ng Data The approxi mate purchase price of$91,0 n i II ion wasdetwmi ned astheval ue of the Co 'svomnion stock isa led at do.9 rig ($77.0 r illion ) and the value of the optionsto purct se theCompany` sdta'es i sKied to the urrvested option hol i 14.0 mill ion) based on the fai r rrierket val .ue ;of the Company' s common stock on thedatrsimmediately preceding and following the closing date of the acqui sition.

Tangible ae®ts acquired principally i nd ude cath, aooax is rani vatile and property of d equi Exam. L iabi l ities aas .rned pri rx pal I y ink! ude auAUnismedi a'snotepayablaobligationof$1 , 0rr>i Ilion.

The and ys s of the expected future c ash flows attributed to all existing technology resulted i n'avaluation of approximately $27.0 mil lion for developedtechnology that had readied technological feasibility and ther®fore Was aapitalizable .

I n-process technology acquired , valued atapproxirriatidy $11 .Omillionconaded primarily of majoradditonsto: Imo a score tetradogy, which wasrelated to I media` s planned level opmerit of new features

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TERAYON COMM UNI CATI ON SYSTEMS, INC.

NOTES TO CONSOL) DATED FINANCIAL . STATEMENTS-( Contirwed )

The majori of the Intended functionzl ity of these new fe>3tttes was not alppotted by In eda"s then-tu'rent technology. I ntwxied flew fekturesi rd udedoffering high qual ityvideo service over t}~e 1 nternet and mul ti pi exi rig data with video . Devel opmmt of thi s tedviol ogy was completed in 2001 .

RacM z Ltd .

In October i9g6, the Company entered into a Share Pur Agreement (RadAz Agreement) to aoqu re. Radwiz. Radwiz produosa :oorm unli ationaccess; systems based on hi gl t-weed I P routing , i ntegraeed wi th telephony. Ftadwi Y s systems i nd uded both osettrA offi ce DI gital Subscriber LineAaoesbMulffplexers (DSLAMs) and izlstomer prom wsei)iipmentfor I office., home .office (SOHO) fxisness binailband sefviws The Radwiz ooquis ti onwascompleted on Novembw X2,1999 ( Radwiz Clos ng Date) .

I n aecordarx with the RadMz Agreernent, the Corry pet d $0.3 mil I i on .i n cam and i ced 1,.992 )6 iWesof the Con any'scon art'etook to thefomner areholdersofRadMzaidissiedoptionstopr&aw267;959~sheresoftheCompany'scorrrnonstocktothheurveeedoptionholdersofRadwizontheRarJwizClosingDate.Inaddrtion,theinvestedoptionholdesofRadwizopionsalsoreceivedoptionstopure eaatheCorriNany''soonxnonstock,thefair val ue of which was indnded in the purchase prioe .

The approxi rtate purcftase price:wasdetertni red to be. $52.7 million . Thi srep'esentsthe minimum purchase price, . as specified in the RadwizAgreement, to be issued to the sharthdl tiers and vested option hol ders of Radwt z ($54) .0 mi Ilion) pl usthe val ueof the optionsi sued to invested optionholders of Radwiz ($2.7 m I lion), based on the market value of the Comp y soomrnon tockon the date the acouisiti on was annoi .nced. F?oceeds:to bereceived from the Radwiz optionholdersupon exercise of their optionewere not significant

Tangibi a as acquired principally included cam, accounts receivabl e, inventory and property .ar d equipment. Liabi liti es a$umed included accountspayable and aocximcl I i abil ities

The anal yd s of the expected future cash flow attri baited to A) exi s:i ng tec*noiogy rea Iteti i .n a Valueti on of approxIrni ely $29.9 mi 11 i on for devel opedtechnology that had reached technological fea9 bility "'therefore was captilizable .

In-procx stechnology acquired in trwswd on, valued at approximately $3 .0 million consi sted pri mariIy of acU tionsto .Rsdwiz' scoretechnology,which wwralated to Ratiwiz `splanned development of new features The majority of the .in tided fur%Aonality of these r ow feah . wasnot :eupported byRadwiz` sthen-currenttedinotogy . Intended hew featixesiriduded offeri ng' end-to-end carrier q uality ofs9rvice; allowing acoessviaan ATM network ; :and, providing I SDN line funeti orraiity . The Company oontplsted mod of thisdaveloprnentwork in 2 )01, and the Con ny de ci ded to ro longer pursue theISDN I!nefuncti onality .

Teegate Ltd .

In October 1999, the Company entered into a Share RrchawAgreemmt (Tel egateAgreement) toacgjre : Td egate. Tel egate prociiicestel ephony anddata sooesspiatfomistl taedeployedbyservioeprovidersto 4elivereffidvrtcarter-dassyoiaeservicesovers Wbie. Telagatealsoprovidesin-homenetworking c pabil ity for te! ephony and data, based on the Digi tat Enhanced Cordl ass Telephony (DECT) surd . The tray acti on was eorrpl eted on.inwary Z 2X)0.

Inaccorthicev ththeTelegateAgresmard,theCompanyissued :4.4milIionsharesofcomn-o.nstockandpaidapproximately$2.5millioninrasìon,artery 2, 2030. TheCompany rrradean additional cash mentofapproximatei .y $0.9 million during thetlirdquater of 20M. The:approximetepurchaseprice of $100 .0 n it I i on was deterrr i ned asthe value of tha ipany' seomrnon shock issued a th , closing basedon hefa r rarket val ueoftheCompny'scommon stock on the days irrni aey precedi rig and fol l i ng theanno ncemerddateoftheaqu J.sbon.

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I n addti on, the, Company isand a warrant to prdvxo 2, 0 mi Ilion daresof the Corr4x iy'srornmon stook ; valuod at approxin-def y $34,6 rni Ilionunder the tams of an agreen>erit between Tel egate and a customer of the Company (Sae Note 9). The Val us of the warrant was i nd u led 'i n ttie pcrrciprice ax1 wasd a s f a as a aistomer relationtip.

Twvi bl a awls aoqui red principally i nd uded cash , aaoounts neoei vabl e, inventory and property and equi pmnt . Li abi I i ti es asaxned principally i nd udedaooountspajet aatdaoauedIiabilffies

The vaf ue:of thea~gomer eela4oruhip Wag deter i ned asfhe value of the warant.ua ng the 81ack -Sokol esiriodd . The warrant wasfuI ly veiled,non-forfeitable, andimmedi +atelyecarcisaHeandhasatermofureayears Th eveiluaofthecstomerreledonshipisbeinga ortizedtocostofgoodssoldon a straight-Iine bad,sover att -year period .

The anal yss of the expected future cam flow attri bated to a1I pci sti ng technology restated i it veil LO on of approxf y" $21 .5 million for dcvel:opedtechnology ti-athad ieaciiedtecfxiologicgl fwebility aridtl e -eforewascaitaliiable.

In-prooesstecimotogy acqui red , valued at approximately $7.5: trill ion, cordsted priirtaril yof major edditionstoTel .egate'scoreteannolo9y , which wasrel ated to Tefega' sple i ed devil bphlent of new f skures: The rrraja'Ity of the intefded functionality of these re features was not supported by Telegate'sthen-current te&r of ogy. Intended new feeturesi ncl uded; eon ection on dainartid functionality to extend the produof s I SDN aornpeti bi f ity .; the abi I ity musecordless t & h n o i ogy for v o i c e cabana; and, a sbstibar end unit that can be used in mul ti -dwell ing units During 2001 , the :Compa iydeer dad to no longer pursue the arde5stechnology and the subscriber end unitteohnology .

Aoco%Ndwork EledronicsDi i n of Tyco EteotronitsCorporatior

In February 2OOp, t h e Company entered into an Asset Purtha Agreement (AN E Agreement) t o acquire certain alas and assurne certain I lab I ities ofANE, a company that provides rrxl tip(e phone linesover the exist ng copper td14:'ionynetwork. The transaction w. wrompleted on April V 2000.

I n accordance wi th the AN E Agreement ; the Company Issued 1,404552 shares of wrrm n -tonic, veil ued at approxj cret y $835 mrf l ion based on thefair marketveilusoftheCompany's conr1onstockonthedaysinTned2telyp'a*Mngah1followingthean rtdateoftheacidstion .Inaddlion,the Company agreet#to eatelzi it an employee retention program for purposes of retaining certain i :deitifiedsmployees of ANE . The retention programprovidesfer up to fteo annual payments to the identi fied employees In a total aMou'd of approximately $4 .5 Mil lion provided tttie employeasrenmainemployed by the Company . The retention paymentsare being bhorgedto expense over to ernployesd respective periodsaf servioa:

Tang de assets acquired principally i nil uded aunts regeivable, inventory and property and equ prrlalt Liabi I i ti es red principally i nil ude d.accounts payabl a and warranty obligations, During 2001 ; the Corrpany increased its I ntangit eassets for assembled workforce by $4.5 mi I l Ion related tor ntionpaymentsinconjunctionwiththearxluisitionofANE.

Theanalysis of the expected future cash flow attributed to all e(i .ng tathnology resulted ina valuation of approximately $1 Z6 million for developedtechnology, whi di hed reached tae hrialogi cal feasibility and therefore was capital izabl e .

To detami he ft value of they orner base tie expected fuhxe dash flows attributed to existing custoit swan dismounted . The analys s yi el ded avaluation of epproxirnately $2,4 million.

In-prooesstechnologyacquiredinthetrarctlon,valuedatapproximate!y$0 .8rnillion,consistedprimarilyofadclitionstoANE'scoretedtndogy,which was related t o AN E`s pianned development of new feahxes A portion of the i ntendad fur lona(i ty of these new featureswas riot supported byANE'sthen-

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NOTESTO CONSOLI DATED FINANCIAL . STATEM ENTS-( Continued)

current tadhnology . The resilta t tachrmlogy isintendad to allow thetrartentission from s 56Kbpstrmodenl without the Iossof tr ansrisson NO. Duti r-o2001, the Company decided to no longer pirate the developn rt of thisterd oology .

ComBox Ltd.

InFebnrry2000,theCornpany entered into aShareFjrth eAgreanent(CornBoxAgreement ) :to :acqureComBoxLtd (ComBox),an lsaelico mpany . ComBox is a marxfadurer of broadband 'data sysfansand Betel l ite oorrrroic ti ons bused on i nternahional starxierda ComBox.' s cu l e dataaccesssystairsconfonrttothe wing EuroModsminterruti orralspecification, basedontheDigitalVideoBroad stirg (DVB)mod.Thetranoctionwascon - J€ted onApril 18 ,

In aco rdance with the ComBox Agreement the. Company Iswed I ,547,77Q flaresof c mmn stock and made a cash payment of approximatel y$03mi I I i on. In adciti on, the Companyiss.ied optionsto purchase common stock of the Company to the invested op ti on holders of CvmBox options Theapproxirr a p Lxct price wasdeterttuned ast evalus of the Compan s cormgrl dock issued at nosing ( 9201ni l ort~ andthaval ueof the opti onstopurdume the Company's auras i sated to the urweded option holders($6 8 ni I I ion) ba sed on the fair markst val us of the Company ' s women stock .on thedaysinTrrc tdy preceding aidfolIowingIhe.date.thsaq.Wiationwasarvaunoad . Inerldi:tion-, the cahpaymentofapproximately$0.3 mi fliorewasirid tided in the purchaw pence. Proceeds to be received from.the.opti on holders end warrant hol dars:upon ecerdse weranot agr9 fi cant

TarnC lble assts avquired principally ind ude cash and call equivaiar tsand .aocaunts. reneivable. Liabi I i ti es a-aimed pri nci pally ind ude short and longterm debt, accounts payable and aoorued I i obi I i ties

The anal ys s of the expected future chit flow attri buted to aj I exi .irg :technology rwA led i n a val .ua6 on of epproxi metal y $12 .5 trillion for deal opedterhn046gy, wNdi had readied taehnologi cal fee bi I ity z d therefore was capi tal itabl a

In-proce$ terinology"U.redvalued atapproxi metal y $8.Drrlii1ionponsbted primed Iyofacld onstoComBox's core driology , vtithwasrelated.to CornBox ' splanrrad development of new features. A pardon of the intended furl ionalitji of these bent features wag not supported by ComBox'sthar-current tedmology . During 2001, the Company deeded to no longer p4rsrethese new features

I iiternat Telecom Ltd .

In Mich 200)0, the Company and Tel agate, a subsidiary of the Conlpiny, entered into an At PurcltassAgresitisntQ ritaT Tdemm Ag'aWnent)under which Telegateagreed topurdvwcoldn assats of Internet TeleeomLtd .(InternetTelecom),anIweallcorrcany .InternetTelecomisasupplierofPacketCableandother standards-based,Vona-over-l .Psystemsarxlte nologies ThetransaclionwasoampletedonApril 18,2DQD .

In accordance wi ththe I ntemet . Telecom Agreement, t e Company iar ed 37380 des of common Mock val wed at approximately $48;0 ml II ionbayed on the fa t rnaricet value .of the Company's common Mock on the days i rrrneti atel y paced rig and following the arr ouncernenrt of tho ac qui citron an di sa ied o ens of 1n,B to p act a oormion stq* of the Yo the unvestad option hol cars of Internet Telecom and paid approxi rnatsl y $20 mi I I ionin cash. I n addition, asa result of certain cctidl iotsin the Internet elscam .Ageetnent with regardsto theprice of the Comparty'sconin ri stock anadditi onalaccrued purth epricepayableofapproxinately$14,1rniI Ii on wasindudedintheconedidatedbalancediestasofDeoerriset31,Z10).Thisamount was paid during 2001 .

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The areal ys s of the atpeded future o* flow attn bated to al I ax ing technology repulted I n a vel uafion of approxi n ataly $a O rrti I I ion for developedtedinology, wli d had reached technological feag bi laity and ffiereroi 'e¢vras capital itabl e,

In-prooe~te~tirie~logy acquired, valuedatapproximately $2 .6 million, fisted pn marily of adclitionsto Internet Tel emrn'score technology, whichwas related to Internet Telecom's planned :devdlop ant of now featurea A portion of tha r* ndsd :funcfiord ity of these new featureswas notsjpported byI ntemetTeleoom'sthen-ourent technology . During2001,theCompany decided ..tonolonger develop thenowfeatures'frornInternetTelecorr i

Ultracom Ltd .

In Mach 20D0, the Company entered into aSharsRurthY Agreerli&t to .accl ireUltracor (UltraoomAgreenxe it), an Israeli company . Ultra oni isasupplier of broadbarKisystwr on-Silicon . Thetrar ctionwascompletedonApril19;3000 .

In acoordanne wi th the Ul tracom Agreement , the Company i scud 536 ,766 snaaresof common stock , made a cash payment of approxi matel .y$0.2 mi ll ion and issued 14,403 op ti ons to purchase common stock of the Company to tha reholcters and unvested option h l ders of Ultracnm opti onsThe approximate purchase pri ce wasdeteri nedasthe val ueof the Co ' s

= Ilion)isaied itt the closing ($57 .6 rri ll ion) ahd the val ue of the

opt one to purd~sa the Cq . s shares issued to the unveoted o~ on to r) s ($t1.6 million) based on the fair ms+rket val ue of the Cornpany ' soomrnondock on : the caah payment ofapproxin ately $02millionwas included in the purchase prim.

Tangible aseemaoquired princi pally included t ash and cash equivalents aocoun s receivable and property" equi p neut. Lialol ittes.asau nedpri ncipally incl uded long-term debt , aocountt_payakleaxfa xsd liabili ties

Theanayssof the expected future cash flowattributedtoallexising :technologyresultedinevaluadonofapproxim ely$1 . 1 milIionfordelelopedtechnology tat had reached technological fear bi l i ty and ttlerdore was capitali zaI e.

In-processtechnology acquired, valuedatap,roxiwretchy$1 ;8million,consisted pimzrilyof adc onsto :Ultras m' storetectx4ogy, Which wasrelated to Ultracom' spl9nnoddeveloprientofnowfeatres .A portion ofthelnterdBdfuncdord iiyof these n wfeatureswasnotsuppo rtedbyUl4racom'sthen-current tedr~ology . Dunng 200'1, the Corry determined that it:would no longer co rmnuedevelopment .on the Ul traoam technology,

Mainsail Networks

In August 200), t h e Company entered into an Agreenot and Plan of Mergerand Reorganization ( Mai r i l Agreement) to acquire M ei.nSai I . M qi nSei ldevelopsandmarketsnext-generation broadband networksthat .enatatel eeommuiicationscarnerstodelivermultipleserv es ovaa sngle networkinfra tt,re. The transaction was completed on .September 29,20.W.

In accordance with the Mai nSail Agree nen the Company i wW 29 ,D62 siaresof oormgnstock and 138193op ti onsto,purdma sharesofcommon stock to the M a n$ai l shareholders and op6 on holders The ~proxi mate pu chase prieewas de termi ned based on the fa r market value of theGorrpaiy ' scorrrnon dock on tfie da~+si rrcnedi ateiy preceding and fol lc M ng the defe the aoqui 9ti on was weiouhoad ($ 171 .3 million) lm the i ntitns c valueof the unvested options recorded as deferred cornpenssti on($4.7 million) . Deferred compensation is an ortized over to option hd dens vesting period.

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NQTESTOCQNSOLIDATED.FINANCIAL STATEMENTS-( Continued)

Taiblaamtsaogui redgrindpallyindudedpad- inlrentory and property and equiprrart .Lial?iIiti asasairriedpYirxipalfyindtidedaoexxtdspeyahle,a=ued liabilities" notespayable.

The anal yss of the expelled future bai flow att i bated to all exi rig .tech iogyresllted i n a val uefion of apprd%i ti atel y $49.Q n iflioh for developedtechnology that had reeohed technologicel feasibility end therefore was gpitdi z 31 e .

I n-prooess technology acquired, valued:at approxi rrratel y $5.0. million, consi sted pri marily of a idi ti ons.to :ManSai l's core technol ogy,.yvhi'th wasrelated to ManSil ' splanned developrnentof ne ' .feat res A pprtion of ftie intwdedfutx onality of dine' feabxeswasnot s{~ported by Mainsail'sthen-current tachnology . The res~ltanttechnology was intended to provide a high rapecity CPE (a stonier premiss ec~iprnent ) and law c ost gateway . Thisdeveloprnentwascompleted in200'1 .

Digitrans

On September Z7, 2000, the Company acquired Digital TrarrsrniWon Equiprnard (D[gifrari Puna A to the terms of a Stock Purchase Agreemen t(DigitransAgeeirient)betweentheCmrpenyandthefotrrier owner of Digitrarus Digitransdevelops,markets andsellsc1 tal equipmentsolutionst1vtenable broadcasters, s; l ite operators:and cabl a televis on system op"orsto opti rni ze network services .

I n accordance wi th the Di gi trans Agreement; the Company issued 394,329 stwes ofbased on the fair market value of the Company' s common stock. on the.days subsequent 1removal of all oon.bNerxias Inaddition, aprovison intheDigitransAgreernentwithO ibelow the purchase pri ce on the bate the Rod "onStatoner t filed In bonhoodon wi th ,

millionthe

formerd-rehol ders of Digitrane , in the fort of stock , the di fference between the pirdiaas priee .of -$22A5 par dare and the val ue of $x.13 per sure of ttea gja ti on shares divided by the purthaea price, multiplied by theorigirgf share is .Ja of 394,329 stares Asa result of thisprovision and an addi tionalissuance of 4,455 tharea the Company i :saed a total of 367,804 ad diti onal at>aresof its corrm n sock to the former etockF ddersof Diobansin Sept -nber2000. AdditenalIy, the Company forgave $20 mill ion of oonvi rti bla promissory notes; wtich wFre .oriainalIy i ssued to DigittansbytheCorripany in June2000.

Tangible aseatsacquired prin. pallyincluded cash arndcash equival'ents, .accounts receivableandpropertyandequipment. Liabilltiasasaanedprincipally included long-tern] debt, acoountappyableandaxmed.liabilities

The final yss of the expected future rash flow attributed-to a I existing technology resulted i .n a von of approxi .mafaf y $0.6rd ll ion for developedtechnology beat had reached technological feasi bility and :tF~erefore was cortali table .

In- process technology acqui red, valued at approximakely $5.0 mil lion ; oonr spri manly of additionsto Digitrans corete *ir logy, which was relatedto Digitrai planted development of new features A portion of the intended f xi ioniity of these newfoature wmsrot supported by Digtr .s'then-current technology . Intended newfeaturesir tided sysrsrnonclipsalutionsforDOCSISacidDVB/DAVICcable rt1odens During 2001, theCompany deeded not to pursue t as development efforts

TrueChat

On Dearnber22, 2Q00, the Company, aequi red TrueChat, p taunt to the termof an Agreement- acid Ran, of Merger and Reorganiza tion (TruCChatAgreement) . TrueCiat devel opsbo ni rah on systemsthat enable rnul ti Mad a teleconferenci ng and provi de increased control over teleconferencePam s

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NOTES TO CONSOL I DATED FI NANCIAL . STATEMENTS-(Continued)

In, acoordwoa W th the TrueChat Agreerrierrt , the Corriperly ( sstisd 534;487 eresof cormton: k and made a cash paym ®r* of $0.2 rri I l iota: Inaddition , the forrrier opfi on hol dare of Tr ueCkiat reoaved opti one to pun s 1 9;OBi tia es of the Ciiirpeny"s cormron stock. The ap€xoxi mate pcrdiaeapace wa~$2 .9 rr I I i on, based on the fair mal k e g val lie o f the Dompany ' s aarm~on sbd on tha days i s l yy preoedi n.g and fd local rp the dos rg date ofthe qui t nn ($ mi I I I on) and the vMue of the options w putt the Company ' s shal es isa~d to tha ulvasted oph'an hd tiers ($0 .5 million) . Deferredcompensation relating to theoptionsisair~rtiz&1 overtfie option kidders ' vetting paiod: :(ses '1otA 9):

A .strrur-y of thepurcham pri eeallocabonepertping totheabove aoquigtionsanddieariior zattonperiodsofthe . intar4fileasedsaau redisayfollows (in thou):

Tdegate ANE C'ornBcK IT Ultracun Mainaail Digitrane TrueChat

2OW Ac:qurytionsaA~prcmirrrtepuU-aZwPnce

P1t~ s prEoe $130,553 $Sa,477 $ B78A $62,265 $57 ;621 5166 .556: $15,511 $2,66 3Transact on and other direc t

acquisition costs 4;483 265 672 1, 486 598 2,641 116 21 0

$135,036 $83,742 $99,456 $63751 $ 21 $163,1.97: $01 :61737 $2,874

AIIocatianofp(gcf epioe;Hidoric,al net tarrgibioa is

ae~ired ($ $,580) $14,145 $ 2,309 1,118 15) >3C)6$Convert] bl e I oais 12,48 2

6,, 14,145 2,348 1 ;116 (i5) 3OB

Intarrdea isacquired:Cu8twr*r relationeNpor base 34,580 24DDQevelopedtecinologY 21,500 12,609 12,500 5,950 1,050 49,(00 550A99errbladworkforce 4,200 12,2170 11100 505 1,190 2,800. 1,106Trade mark 6l]0I n- process rash an d

do4omeet 7,500 750 8,000 2,560 1,80C1 5,000 4,950Gootivnll 65,382 44,047 60,444 54,751 53,927 107,692 9,131 2,390Deferred tit ! f b l ty (6,028) (4,896) (774 )Deferred conger s ti on 4,719 454

$135,098 $86,742 $99 .456 $63,751 $56,215 $169,196 $16,CC7 $2,814 : s:

Ar xtazatonperiod(inyews)Cuz crr -rel*onshiporbaee 3 5Deveiopedt%hnology 6 5 5 6 6 5 5Afrsnbiadworkforae 2 2 2 2 2 2 2Trademark 5

11 1C,poov ill 6 5 5 fi 6 5 5 5Deferred corrpensati on 1 .5 1 .5

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NOTES TO CONSOL I DATED FI NANCI AL . STATEMENTS - (Continued)

(media RadwIz

. . . . .. . .J996Aot{u{siions ! _ . .Approxin pWR'me price :

fkrd 89e price $106,347 $ 52,667orrandother dlrest a*atianraisaco

Costs 2,345 1,09

$108;69'Z $ 53,7x}

Allocation of pLr Bpnoe:Hi etori cal net taiti ble aearAs acxiu red ($ 355 $ 3,058Forgivenessof rate peyeble 1,000

6 3,0%

rtaV ki e assets aaqulred:Devdaped te&ridogy 27 €X J 29 ;85 0Aseerrtl ed workforce 2,500 2,800Tr ertark 4t)DD 1,15 0In-pro .re%wchaiddEVdoprT t 1I,0(JQ 3,600 . . . . .. . . .Goo M I I 63,547 24,293Detoured tax IiabiIity (10,098)

$100 92

•

$ 553,7,53

-Amortization period (in years) ,Developed tad rd ogy 6 6Assernbledworkforce 2 2TradaTerk 6 6Goodwill 6 6

Pro Forma Financial Results

The following selec ted unaudited pro formamntbinedremitsofoperationsfortheyear ended Aeo ber31,20(X)oftheCompany,Tel eg e, ComBox ,U I tracom, A N E, I nternet Tel6com , M ahSai I , Digitransand TrueChat have been p'ep0red ase mi ng that the acquisti ons ooatx"red at the begi nrr hg of theperiod presented , The fo! lowing selected unatJdIt& pro forma finandal informati on snot neoess nIy in dicative of the reaitsthat .would have ocxurred hadthe zx oat ons been comp {etedat the beg: rvti rig of the period i rtdi c ed nor i sit i ndicetive of fut re opera4 hg results (in tousands, ®ccept per lwe data) .

Year EndedDecember 31 ,

Reve~~aes $ 35 ;568Netlos~(1) $ (71,343Net loss per siare (1) $ (1:.16)Shares uaed in caFwlation of net Ioea pershare 61,343

(1) Net loss and net loss per share eRdudesapproximately $30 .5 n Ilionof in-proce research aid dwe.Iop neat diargesfor the year endedDeoernber 31, 2000.

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NOTES TO CO'NSOLIDATED FI NANCIAL .STATEM ENTS-(Qontinued )

15. Product Warranties

ThaCornpany providesfor estimated product warranty expenseswhen it sellstherelated products: Bello mV a mzfesaeforera stFiat are

based onth .bestwailableinformation-rr tyhistorid damsexperience--daims cogs may differ from amountsprovided An a nalyssofdwgesinthe I iabi Iity for product warrantiesfol Iowe (n thous r&) :

AdditionsBdartoget Chergai .to BalanoeetB hning Codsand End ofd iod Expenses Write-offs Period

Year ended: Clseefrt r 31, 2OWWarrn reserve $ 2 6$5 5,991 2, 751 $ 5,925

Yeas er~eKf .#3emmber 31, 2CC 1Watran . . re r e $ 5 925 7,956 5,513 $ 8,368

Year ffridAd ' 3'E, 2032Warrarttyreserve $8,368 2,73() 2,491 $8,607

16: Subsequent Events(Unaudited)

On FL-y26, 2003, the Company and Soleetron Corporation (Solectton) tared ihto .anagreerneitto settle ail o utsta dirg obligations under twomanufacturing agreements between the Company and Sol a Iron . Unde r th a termsof the eetderriant ~reernerd; the Coni wiy padSolec ron approxirnetel y$3.9 rnil l i on , and each party released any and al) der ms that it may have tract agai ns# the other party . Additionally Terayon reoei.ved eel eoted i rwent fromo ry5dectron . The Company previ out y apxued the $3,9 mill ion sett(e,nent as a vendor cancellation in the fou`tt1 otter of 2000 and the asoond quarter of2D01 .

On March 14, 2D03, theCorn yinitiatedawortdwidereduttioninforoeofapproxirmtely100errployeasior2f}pen ntofthe workforce, aind,tFted as,re of certain remote fad f ti es The Coman y expels to re ord total chwges in the range of approximately $4 nil lion to $5 million asaod aced wi th therealignment and trier writedown of certain related assetsi n the quarterendi ng March 31, 201)3.

17. Unaudited Quarterly Financi al Data

Summarized quaterly financial datafor 20.02and 2001 isasfollows(in hnusw wcept per fharedata) : .

Quarter

20~Z Fir9 --ecand Third Fourth

Told re .ernes $57,216 $22,467 $ 24475 $ 25:303CGrotsprofit oss) 25,491 (77) 296 2,69 4Ro*ucb.ring oo:#s and aE) eO vvrite-offt(2) - (3,972} (4,99 )Netloss(3) (4090) (3,6$5) (15,972) (20466)88dcand di Iuted n6t IGesper dire $ (A06) $ (0,Q6) $ (0.22) $ (028)

i p,2.

Table of .Contents

TERAYON COMM UNI CATI ON Zi.$TEM$, INC.

NOTES TO CONSOL I DATED FI NANCI AL . STATEMENTS-- (Continued)

Quarter

2001 Firm SEaaid Third FouEt h

Tat revenues 53,984 < f; X5, 33 $ X33 $Q 161Gr profit (Ions)R ri taste 9,dASsetwrite -offs 2)

(869)574744

(15,73 15 9

16,368 22,445(

Netirx~rr~e j3))

COQ )( d62504

(53U1 j3

(3,449)

l ie",:d f ui lccc a (IQW) per, 4)are $ (7.& )''( )

(0.93) ';. :1 0,82

$ o : IS(6,,2,4 )

s (acs)

(1) Ea'r i ngs per d'"e are computed i ndepahdenb y for each of theC{Uarters4resented . The sum of the: quarteri y earnrgr; pei' dvre i t 2 m and 2001 :doesnot equal the total computed for the year dueto th es i n shares outstandi ng end roux dng

(2) See Note 6 for an eepl artati on for restructuri ng and asset wd to-offs

(3) See Note 7 for an e(planaki on of this repurchaw of subordi nated convet bl a notes,

103

Exhibit C

Table of Contents

SECURITIESAND: EXCHANGE COMMISSION

Washington , D.C .20549

Form 10-K

(Mark One)Ef ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITI ES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2003

or

TRANSITION REPORT PURSUANT TO SECTI ON 13 OR 15(d) OF THE SECURITI ES EXCHANGE ACT OF 1934For the Transition Period from to

Commisson file number : 000-24647

Terayon Communication Systems, Inc.(Exact narre of registrant as spe&i ed i rt its charter )

Delaware(State or other jurisdiction ofincorporation or organization

4988 Great America Parkway

777(I RSeitployer

ideafifi .. ti on no .)

Santa Clara, California 95054(406) 235-5&

(Address including a p code, and telephone number , including area code,of the registrant ' sprindpal executiveoffioes)

Securities registered pursuant :to Section 12(b) of the Act :

Titled Each Class: Name of Each Exehangeon Which Registered ;

None

Securities registered pursuant to Section 12(g) of theAct :

Common Stock, par value $0001 per share(Title of Class)

None

Indicate by d-edc mark whether the regi strant (1) hasfi led 21I reports required to be filed by Se ction 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months ( or for aach short er peri od that the reyi 3trant was required to file such reports), and (2) has been sibj ed to such filingreGU retnents for the past 90 days Yes o No Q

Indicate by check mark ifdsdosureofdidirqimtfilamspirai ttoItem405ofRegula ti onS-Kisnotco tainedherein ,. adwiIIriotbeconhained,tothe bed of the registrant s knowledge, in definitive proxy or information by reference in Part III of th storm 10 -K or ,anyamendment to this Form 10-K . ❑

Indicate by deck mark why the registrant is an accelerated filer (asdelihed in Rule 12b-2 of the Act). Yes I No. ❑

The aggregate market value of the voting stock hd d by non-affil iatesof the rep strant , based upon the dosing sale ph ce of the common stock onJme 30, 2003 as reported on the Nasdaq Nat oral Market, was ap proximately $159,297, 437. Shares of mrrunon stook held by each offi aerand di rector andby each person known to the registrant who owns;5% or more of the outstand ng oo on stock have been excluded in that such peteonsmay be deemed tobe affiliates Thi sdeterrrination of affil iatestatu9 is hot riecessan I y a cord usive :deterH nation for other purposes

As of February 29, 2004 , the registrant had outstanding 75,536 ;192 shares of common stock.


INDEX

page No.

fi~FTLtam, 3,It 4,tLia! 5 .

HEZI terr M .Itom a.114L 24

Item 9A .

lt@M 1fair 1 .

ilkItdr, 14,

Item 15 .

SGNATUFAHIBIT 10,

BV4HIBIT 10.25FXHIBIJ 10.4

EXHIBIT 105

EX. BIT 23.1EX IBI 31 .1EXHIBIT

7IT .

PART I

s .s

1 0

90.93

100102103

103108'.

Table ,of Contents

Item 8, Financial Siatemenlsgrid &ipplerrwtaryData

TERAYON COMM UNICATI ON SYSTEMS; I NO .

I NDEX TO CON SO LI DATED FI NANCIAL STATEMENTS

p4p

Repc.t of Etr t Fo.trag L L E« xient Ac4 J tars 54,iUod Bo. at5oe t. eels 55

Ccxssoiftlaiedetaketrrer ►> of Op~r di . ; Sg '<trx~sniidatedStatgTmftofShxcchddms' Equity 57Cor l'id &I &a6a 3ettiEs.a> k [cntis 58Notesto Consolidated FnahciA Shaterrients 59

53

Table of Contents

REPORT OE ERNSt & YOUNG LLP, I NDEPENDENT AUDITORS

The Board of Directorsand Stockholders

Terayon ComnuiicationSysterrr% Irr-

We have audited the aocompaniyi ny :consolidated araoe streets ©f Terayon Wrin iNcadon Syst" 1 nc: asof Deceb 31, 2003 and 2002, and therelated consul icletedstatements of op~'atior stodchol dad. equity. and cash floyi for each of the tree years in the period ended Deceriber 31, 2003. Ourauditsal:sc>inductedthefinanoial staterrierrts ~elistedintheindatatItem15a){2) .Thesafinarsnial saterrientsaridsc edulgaretherespondbilltyofttheCornpaiy' smanagement . Our respohebi I ity isto express an opinion on these fi Harris el, soterrierisand a± dule based o n.air audits

We conducted our auditsi n as irdwee with audi ti rig etx rds gene I y . accepted in the United States Thom standards ; requi re that we plan andperform t hie audit to obtain reasonaBia as raiioe aboutwhathef the frrwidol. sll marts are free of matanal tnis~taterriei1t Anandt iHid atlaseKami ring, on atest basis, evidence agvi-drigtheamuritsaic sdosresinthefinancialstaterrantsAnaudit almincludes aaae ngtheaacatnting princi :piesusedan ds gnif i cant esti mafeslraie by nuvownent, eewell asswai uati ng the overol I fi na*dal statarreht rres®nfati on . V* bel ievelhat our audits provide areasonable bass for our opinion.

In our opinion, the consolidated financial dataietitsrefwredtoabove present fairly,inall material regectsfheoonsolidatedfinendal position ofTerayon Ganriuiication Systems, Inc. at December 31, ZXD3 and 200Z aid the oonsol idated resin tsof itsoperations and Its cats fl ows for each of the threeyears in the period ended Deoernbe 31 2003' in ebnforhrity with aaoountiho pri naplesgeieral ly accepted inthe Uriited States Alm, in our oplnion, .tkrerelated f nanoal siateni nt ¢hedule, when considered in relation to the beecfi nandal ststsnxentstaken as* whole, prow tsfairl y, in al I material respects,theirrforn 1onset.forththerein.

As di sauseed in Note 1 too the oorml i dated fi rm dal statementsi effective :1an+ y 1, 2002 the ConVwy adopted Statement Of Fi nandal A ooountirgStandards No 142, "Goodwill and Otherlr>tarrgi eAsset3'andStaterrlentofFinanaalAooo ►jitirg :$tarrdadsl1o.145 "Ra isaonofFASBSiaternentsNo. 4, 44 and 64, Amendment of FASB Statement No . 13, and Technical Correctiord (SFA .SNo .145).

!J ERNST & YOUNG LLP

Pal' o Alto, California

.bnuary 23, 2004

54

Table af .ContetstS

TERAYON COMM UNI CATI ON 19YSTEM 6, I NC .

CQNSOLIDATED BALANCE SHEETS

December 31 ,

20(Xi 2=

~ n thousands,e~ceQt sharedar ~

ASSET SCurrent assets

C dl and cash eojvA eats . 30,188 $ 117,079Stbrt-.term investr gents 108,452 89,42 4

Acmtult9~aCiv da,I 1Qw for doi.btLi as of$3,5&l a#~ S3 and $3 519 ire 2002 29,199 16,355

Acowntsrpmvablefrom rdatedparties 600 84 2

Otlrerctlteraelie eival7tes 3,662 ,~721

+ rtasaets 2, 883 8,263

Total arrent meets 191 , 348 . 242,81 7Propertyaiideq iipitient , net 11 :,871 1 !Abe,Re ictad spa::: 9,212 .. 9, _

'a awd~ipeneiYSand Wher<a , net 2808 5,#142

Total assets $ 215,240 $ 275,71 0

LIABIL1TIESANDSTOCKHOLDERS' EQUfTY

Current liabilitiesAcxountspayable $ 26,040 S 23,920AmruedpayrdI and relatedexpen5es 6,537 6,227Deferred revenues 3,423 497Warranty re ves 5,508 8,607A= ued ra trLdt Ing d ges 4500 6,754Accrued vendor ca'x Iation charges 2,869 13,8650tke A=uod3 i aU!Itea 5,036, 8,609I ntere9t pey a0aand c. tportion of Ipng-term debt 1,358 1,355currert port onof .c *tai [easeaUigatfons 124 154

Total c rrentfialtilitles 55,405 69,988Long-ti maWiga#iohs 3.3fs6 3,421Lor-term portionofc t4 Ieae3 obligatons - 78C nvrrnbn suborcinatednotes 65,061 6508 1Con"bnents and Conti r genci esStockholder equity .

Preferred stock, $0,001 per value :A uthotized fharss- 5,000000ssue,d and o u to d ng shares- none i n ZO03 and 20Q2 - -

Common stock, SD 001 par valueAuthorized Jres- 270,000,00 0Issued -75,031,,097 in 2063 and 73.240.054 i n 2002Qu[5andi ng - 74, 875088 in 2003 and 73,0B4,045 i n

2002 75 73Ack bof paid In capital 1,f182,036 1 ;078,144Acck r mated doicit (987, 560) (937,207)

e,wee carp or :D i(25Treemiry took, at c , 156, D09 shares I n 2003 and 2002 773

2773

Awsrxltetedotheioompr veloss ( , (34 70 ~

Total stockholders equity 91,388 137,142

Iota[ {taE11111es ISh khOldetS eaLAty $ 215,240 $ 275,71 0

Seeacmmpenying rotes,

55

Table of Contents


C©NSOLI DATED STATEMENTS OF OPERATJ.O,N. $

YaarsEndad Deoanb6r ,31 ,

2003 2002 200 1

F~BV iesO n thouwd3 0(cWt peg share data)

R odurt .tevar~+ $128,791 $120,306 $ 227,036Rdate;CGiftY Produd t8i 4,694 9,097 52,445

Total revenues 133,485 . . . 129,403 270,481(lost of goodseold :

Cast of p p.di{ct revenLBs 99,261 92,497 229.836Cod of reEat Patty product r va ues 1,773 . .. . . 8A5~ ! .. . . .: . 33,181

Total cost of goods sold 101 , 034 100,949 263,11 7

Groasprafit 32,451 28,454 16,364O rati ng -pa-s-

Reaegrth and dovd wnent 42,83 58,696 79,92x 'Selesaid mar" mg 26,781 35,704 55,70 1General and adn irr strab ve 12,127 14,716 31,309Goodwill .amortiza Qn - 2`x,41 0Restu~ctunng c sand aswelt vote-offs 2, 8tf3 8,922 557,149

Total operating expenses 84,550 118,037 779,496.

Loa.tromoperatorrs (5209} (89583) (763,132 )ncome 2,917 6838 18132

expa-ce (3,279) (6174) (15,224 )Other inopme (expo ) 2,424 (4,145) (2,864 )G inonear{yrah6klentddebt 49,08 186,327

Lo before tax (expense) benefit (5Q ,Q37) (43,975) (577 761 )ltltiatt>~ta (expat9e)benefit (316) (238) 13, 15

Net l oss $ ( 60,363) $ (44,213) $ (563,848)

Basc and t] net Io perrzh2rs $ (068) $ (061} $ (8.25)

Shares used in computi ng basic and diluted net loss per Grace 74212 72,863 68;33 1

See aocon parrying notes

.56

Table 3f Contents

TERAYON CO MM UNI CATI ON SYSTEMS, I NO .

CONSOLI DATED STATEMENTSOFSTOCKHOLDERS EQUITY

Treasury StuckAccumulated

Common Stock Additional 9odihotderd Other Tdel

Paid-in Acxititulated Deferred Notes C mpral on ve Srodthdda$

Share; Amqupt CatYitel D dt Compensation Reoeiyahle I naorne Sharps Amount Equity

A4ddrt rilst odeferredmmpensdion du e101.4 1,23423AJ(1

1c~01tftiEldICotrYtiop stkk fo rmvioesprovidsf 27&260 1237 1,237

{ ~anpe d commondock for Err o oybeStock PucbawRon 387,428 1,w 1,96 6

i statat oe of warwtsp~rt#s&10

awynonJock 1,187 1,187tic of CQnno n

stock f or h Mof fer 141,442 2,001 2,00 1

rsa3ticeofcomrr niOdc rof fel irdn org d '.of dept 1,464,359 1 1706 17.87 0

Cali proceeds frompuvmait ondodchotdws nc4 arrvile 3 3 . ..

incorne .lraeaeto unraiizad

rain on short-ter mirx (Amarls 208 208

tray l muJjin9~rtit~ (821) (621 )

NA tom (E53,8443) (567,846)

Corry tth v etoss Essa,zs~

SaianwalDe eryber31 , 2(01 71,943 ,930 73 1,074,203 (892 ,994) (468) - 248 127,839 (768) 18(Y,304

Baience al :DLWFFtier 3 F ,

20014lirotg3h tfattyatd) 71,943, 1) 73 1,074 X03 (892,%4) (458) 248, 127,639 (708) 180,304

Exercise of opticnsf orrash to purchagacgnymn Stock 422,073 1,721 1,72 1

Iiurcix rdumof aornnungod (1,068) 28,17.0 (5) (5)

Reim nat escrowehaesfro mT¢egeteacquisition (25,077)

t#twi of opf•IOtisto38

(3)Arrprtirdion ofdeferredeqmpensat ion 1 471 472

to trpsof re3rided6trrxrnit6tock fromOak gi1irii iiifor service*provided 205,001 290 290

Acceleration ofve$ing ofemploy ee st orkoprlonsand soc kprctecfion prima t 1

rasrdtiub(~urtnvci Iswck rOr Etiiployae51(xfc :PRrtfiaoo

Ran 539,186 1,8641 .804

I ~ el ofwara1topurchEw cofuT o nStock 26 26

Garrprel~wiveinoonna:

I rxreese to vrei i zedown on d1ort-terminvesUre dsQmu(ative

trasi4iona4ustment

Net I c

Comer tlensive

.. .. (519) (519)

(44,213)(2,799]

(4,213

an on mat-term

loss

BalanceDeowtw 31, 2002 73,084,045

Decanter 31,2002(tirougFilarvrertf) 73,084, 045

Exercise of opl ions forc - to purthcorn non stock 579,233-vd1J$[on oftoptlonstoirm-anply/~

Arrortiza[im ofdeferredcvrrpaiclirn

to aneof re¢ridedc«wrx n lock fromstock option planfor seviasprwidei 9,600

Isuanceof cornmo nsock for EmployeeStack PurchasePlan 1,2Q2 ,21 0

I Ss r of warrant topuroFae mrrrnonstock

CorT hrevv ei rmn

r~euseto urrEdize d

irrvelllsCumul at ive

translationadustm nt

Net tool

Comprehiensiv est

(47,53 1 )

73 1,078,144 (937,207) (25) - (3,07( 156, 009 (773) 137,142

73 1 ,078,144 (937,207) (25) - (3,070) 156,009 (773 ) 137,142

1 2,533 2,534

50 (50)

53 53

70 7 0

1 1 ,194 1,195

45 4 5

(470) (47[7

Balanoe~Dumber 31, 2003 74,875,088 S 75

(50,353)

$1,0a2,036 $ (987 .560) $ (22)

1,172 1,172(50,353)

(49,651)

S - $ (2,353) 156,009 $ (773) 91,388


57

Table of Contents

TERAYON COMM UNI CATI ON E'STEMS, INC .

CONSOLIDATED ST.ATEMENTSOF CASH FLOWS


200 2002 200 1

On1 o sand yCrier i ng W @vi assNet loss $ (50,353) $ (44213) $063,846 )Ad}ti hrt tsto teoo Ie net I Deist' r at castr used in oe"n9

a~cttvitiesSeal event of Net Servi ces account reoei vab e - 1,118 -Depredak on 9,369 11,572 15.726Write-off a 3amortizabon of int" biease ets - 3,972 619,157Ai Mart Wdn relayed to stock options `53 476 5,81 5C a n one ly r9prar t of debt - (4$,C ) (185,327 )Lowerstf s[ tlrtTt~[kef invwrtory provision 4 :b66 6 ;109

rrnsnf :of irn+es3nlentI TO - 4,5530 -Write-off of fixeda_ts 407 2967 1,600Cou Don aacpeisefor issuance of canyon stock 70, - 3,238Val ue of common and prdenred deck wairwft i sa,ed 46 26, 505

C t r a r w e i i n,operating assets a nd 1 iabi I itoActauntsrec vable " (12;844) 26,211 (5,614 )Aaountsreoeivablefromrdatedpartes 242 3,164 13,448fnvenio y (13,193} 4;065 71,108Other wets 7,251 443 16,506AcawisQeyabte 2,129 (18,901) (81,173)Accr payroll and related Wpenses 310 (3,214) (3,964) .Deferred ravarx*s 2,926 (3;673) (829)Warranty r%orves (3,,088 .239 2,443Acvued re~trudtring i organ (2,254

51,443 8,197

Aart~ed verkior carx 4I on charges (12,33 (3,426) (1,788)Otl ax u iliabilities (2,331) (6,725) 8,000Deferred taxes - - (18,6651ntereEt p%-dUe 3 (1,918) (7,6 )

Notcadh used in operating adivitias (68,397) (67,719) ( 102,481 )

Invest ng actvit e sPurchases of short-term invetrte is (243,652) (288,186 ) (402,653 )Ftoce®dsfromsafesardnbtuibesbf short-terminvestnents ?'.24,154 434,346 384,689Purchaeasof property and equipment (3,831) (7 ,186) (9,074 )

N et ca (used in) p ovlded by lnv ling activities (23,329) 138,974 (27,038 )

Finning tivite sPrinci psi payments on capital leases (66) (127) (130)Princi pal payments on debt - (16,835 )Paym®nte on repudhe of common stock ( 5) (685) < >Fri r ipal l Wments on pckhi der notes rec vabl e - - 3Rep 4iih aof corsfertble'sJbordnafed notes (57627) (113,428 )Proceedsfromisafan eof cornrnon stod< 3,729 3,872 14,464

Netc providedby ( usecfin) finandr)g activi ti es 3'M3 (53 ,887) (116,621 )Effect of gcct ige rate changes 1,172 (563) (Q0)

1Vet:.(t =e@Sa) i=eM in can and cash etauivafents (86 ;891) 16 ,865 (246 741 )cesh equvalentset beqi rr ng of year 117,079 100,274 347,01 5

Cashed i2 , e ivatertest W'd of yew $ 30,188 $ 117,079 $ 100,274

Sup i er )ental di sd osures of cash flow i nfom a ti on:Cash paidforir ineta(w $ 194 $ 714 $ 31Cash pat dforinterest $ 3,262 $ 8,387 $ 20,81 0

noncanh investinganditnanangacti vitiesC-Q(T l lwe* i saod for sOtl en nt of oonverti I l e debt $ - $ - $ 17,900t)d'e °redc np rsationreiating ba cor ocoon 4ockipiedto

rxin ernpfoyees $ 53 $ 38 $ 684Reducti on in det erred compersab on due to termi nation o f

employees $ - $ $ 1,234lsaiar*eof waiiantsinconnectioiwith pure of TrueChat $ - $ - $ 682

See: accompanying notes

58

Table of Contents

TERAYON C OMM UNI CATI ON SYSTEMS, INC .

NOTES TO CONSOLIDATED FINANCIAL STATEMENT S

1 . Organization and Summary of Significant Aooounting Policies

Desori pti on of Bus new.

Terayon Comn'KOcgti on 5 y s t e r r l s , Ino. .(Corrpany) w a s it rporated Utder the{awsof the S t a t e of California on . a n x 2Q 19 . l rn :June 1998, theCompany rei noorporated in the State of Delaware .

The Company dev®I oprh markets" sells equipment to broedhand sarvi o provi tiers who use the Company's products to deliver broadband voice,video and data servi c esto resident al and busnews subsaibars

Bassof Consolidatio n

The consolidated finen,ial staterrxritsinduclefhe accountsof the Company and itswhollyowried aid majority-owned s ibediafies All interoorr>pa'iybalances and transactions have been el I ni naiad .

Useof Estimates

The preparation of the consul i dated firwd al stAkerrierrts in conformi ty wi th general I y .aooe(Red 3ocourtng pli ncipl es in theUnited Statestequiresmanagement to make essti matesand ass mpti ons that affedthe amounts reported i n the oonsii i dated financial statements end ecoompenying note sEs i mates.are based on historica etpenenee, input from sourode of the Company, and other relevant facts" d rtalrrt taxes Actual resJlts coulddiffer from those estimates Areethatareparri vlarlysrg ficsrtincludetheC,orrgmny'srevenuere©©gNtionpolicy,thevaluationof itsar~o untsreceivapleand inverlory reserves the assesa~1e ~t of recoverability aid the rr xerr~ent of impairment of fixed seets, acid the reoognitron of restru *zi ng reserves,

Accounting Change

Effective the beginning of 2002, the Company adopted Stahement of Financial Accounting Staiifards (SFAS) No. 141, " Bus news Combinab ons" andSFAS No. 142, "GoodwiII and Other IrrtangihleAseets' As required by SFAS No . 142, the Company discontinued amortizing the remaining belanoesofgoodwill as of the beginning of fie f 2002. See Note 5 .

In April 2002, the Company adopted SFAS No .145, Ron of FASB Statements No, 4, 44 and 64, Amendment .of FA 88 Statement No. 13, andTeani ran Corrections" ($FAS Na. 145) . .SFAS No .145 al l ow* and y those ga ns srcil I os vn the Oct ngui shment of debt that meet the cri facia ofextraordinayitennis tobe .treatedassz hintheauntidated:finauialsratanentsAccordi:ngly,theCompanyisnow ngthegainfromratramentofConverti bl a Notes i n operating revlts Asa resrl t of adopting WAS No . 145, the Company redasd f Ied the $185 .3 mi l i on prep cowry recorded i n 2001 asextraordi curvy gal n as a component of opera i ng results.

Foreign Currency Translation

The Company records the e ff ect of foreign o . rrerwy translation in accordance with SFAS :No. 5Z "Foreign Currency Trandation ." For operationsouts de the United Statesthat prepare finarxial statements in ctxrend es other than the U . S. dollar, resits of operations and cashfI owsare trandatedatovee exchange rates duri rig the peri od, and assets and I i abi [it as we translated at end -of-period ezdiange rates Trard a ti on ustrnents are i ndtxled as aseparate component of ancurrxl aced other mrrpcehens ve loss i n Aocidhol dens equity . For the three years aided December 31, 2003, translation gar ns andI osseswere not sgnifi cant , Realized foreign currency trar sac ti on gains and Iosses are nd uded i n re3aits of operati ons as incurred, and ho ve not beensignifi cant to the Company's a perati ng resuitsi n any year presented.

59

Table of .Contents

TERAYON COMM UNICATI ON SYSTEMS ; INC .

NOTESTO CQNSOLI DATED Fl NANCIAL . STATEMENTS-( Continued )

Coneentrationsof Credit Risk, Customer s Suppliers and Product s

The Con'Wany performs ongoing a-editevaluetionsof ittoustomersa,d gener a lly requresno oolletsral .,Crash I.osmshavehisfm rically been withinrrranagerrerTsexpectations The Company rr iarnteinsares erve for potentially urvollediblea ntsreceivablehosedonaiae ssrertt ofW Ieetibi4ity .The Company asks ool lecti b lity based on a:rnmber of fachors i nqudi ng pad history, the rxrr per of dallsan arr oxar t Is pest dua .(4ased on InvoicedPedata ~ ccheingesincreditrat'rxgeofous4arnars,cxrrenteventsanddre~lrr >st rer rcN ng thr budnemoftheCorrpany' sclient` .swstomersandotherfactorsthat the Cornpany!relievesarsrd event .Chargesforunooflecti kilesmztsareIndrli dasa'componantofnetrevenueintheconsolidatedstatementofopbor At Dennber31 ;2003and2O2 ; there rve:farpoteriti al lyuncolIedibleaecauntswas53.6nil lion and$35miIlion, respectively . Arelabvelyat1a1I rxrnber of cudomers~toountfora :a grtifi coat pent geof the Company's revenues and accounts. receivable The Company ecpe ctsthe sal a of itsproducts t o a I i rni tad number of a.siomers 5nd Yawl Iersto Con ti ru a to acoourd:for a ,h gh percentage of revenues

The Company relieson a ngle source suppliers of rr aterialsand Ia iorforthe s griflcant majority of its product i nventory . Swill the Corrrpeny' scurrent srppl i ers not prod" and del fiver inventory for the Company to sal I on a tin y t ad $ . operating results may be. adversely i mpac#ed

TheCorrpany pl aces its:cashandc equival ants in several financial instituffonsardlirriitsihearvuntof credit exposure tt o ghdivers ri cation andby investing in only high-gradegoverrxrlent and commercial isaiwa

The Company i nvestsits .ecows cash in debt it rurnerts.af 0ovarmnent l egor i eq and oorporati onswith credt.ratirngs of AAIAA- or bstteror A1/PIor tom, respedi vety . The Company, hasaetabl. I d guidelinesrdativetadivafic lion and maturitiesthat attempt to meiintain suety and liquidity, TheCompany has not experienced any sgnifica t I asees on rtscash equival arts or St vrt-term i nvestrnent s

Revenue Recognition

The Company sal I sits productsdiredlyto broadband service providers ; and to a I esserextent rasellors Reienues related to product salerarerecogrvzed in aocordxne wish SEC Staff Accounting Bulletin No . 101, "Revenue.Ree9gn lion in Financial aterrxrrts (SAD 101) ; asanlerxied, when(1) pers.rasive evi dance U-0 an arrangement ex! 44 (2) delivery has ocwrrad or savi cos hale been rendered, (3) the sell et s pri oe to the buyer isfixed ordeterminable, and (4) col IectibiI ity i s reasonablyassured . A provis an is made for estimated product returns as product sii pments ate made . The Company' sexist rig agr is typically do not grant return nghts beyond those provided by the warranty .

9eterrni nation of criteria (4) is based on rnar riot's j udgments regarding the col lath iii l i ty of the Belling pri ca . Should there be clui torriariagernent sj udgrrents, revenue reoogni z e d far any report rig period ca! d be adversely affected .

Contracts and customer pr&a ordersare general ly used to di3termi ne the ex) stenos of an arraxgetnelt . .Shipping d=rna its and homer acceptance,when creek cable, Lire used to verify delivery . The Company asas whether the The is f ixed or dotertni nabl a based on the payment tertnsae9oa aced with thetransaction and whether tte salesprice issul~eek to adi us`ment The Company aaaeseescol I edibility based primarily on the aeditwor"neesofthe customerasd rninedbycreditchecksandanaly saswe1Jasthec n*rspaymentNitory .

Revenue arrangements wi th reseii :ers are gene a' l y recogi zed when product isshi Aped to : the reset I ers asthe Company general ly does not grant. returnrights beyond those provided by the warranty .

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TERAYON COMM FUNI CAYI ON SYSTEMS ; INC .

NOTES TO CONSOL I DATED Fl NANCI/ L . STATEMENTS- ( Continued )

Research and Development Expenses

Resewth acid devel opnie t expenses are B arged to expense as incurred,

Shipping and Hand ing Costs

Costsre[ated to shipping " tending are included in cast of goods sol d for all periods presented.

Advertising Expanses

The Company accounts foraivert [ angcoatsasecperminttte.penodinwNchtheyareincurred. Advertising wpe1 for the years ended DemTbff 31 .,, 2002and20D1 were$0 . 1 million, $0.4 million, and $23 .6 11 ion, respeotively .

In Deowber 2001, theCornpany entered into co-rnarke ti rig arr4vementswith Shaw Comma ricatiorn, Inc: (Steno) end Rogers Cornmuriications, Ina(Rogers) . The Company paid $7 .5 million to Shaw and $0.9 mil lion to Rogers, and reoordWthess amountsasot current a In July200Z theCompany began amorb ng tt ese prepei d ads and diargi ng them agai n revalues i n a xordanoe ti+ ith Emergi ng ! s6iies Task Force ( EI TFJ 01-D9;Accounting for Cone Benison g vin by a Vendof Ya a Cu tpnpr or Resal IeC in Cornadion with the ELI d oor Pron *on of the Verxior ' s Produc±s"

AmarrCschar egair~strwarxiesin20)3and2D2tot~ed :afoximat y $5 .6rriiiionand$28mill. ion,res ectveiy . TheCompanychargedtfieamnrtizakion o 3l1a easels againsf re reriuesttrou~s tfie sx quarters ericfed in Decersdrre 3f; i, the term of the rel aced a emert , at the rate of$1 .4 nil I I i on per q uarter. Seii Note 13.

Net Loss Per ar e

Historical basic and di [uted net l oss:per ire was corrputed using the wei ghtad ava3age mirnber of oorr non stock outs" rig. Opti ons warrants,restricted stock, preferred stock, and co nvertible debt were not in cl uded in the con putationof H stofical dil uted net loss pot share because the effect wouldbe antidi l live.

Shares used in the c alc cati on of bas a and diluted net loss per a areas foll owe (in except per share data):

Yams Endol Docanber 31,

2003 2002 200 1

Netloas $(5Q;353)w~rrr~r

$(44;213)~rr~~

$(563,8A6)rwu ..r■

Shares used in conW i ng bas o and diluted not I o per 4xr e 74,212 72 803 68,331

Raac a ddIuterinetIaeon'4- are:' $ ( %) $ :(0 :61) $ (625) : :.:

Optionsto pure 17,463;959, 14,635,025, and 20,007,886 of common stock were out tandi rig at Decembe` 31, 2003; 2002 and 2001 ,ree ivei y, and warra its :to par .200,00D; 2 ;325,593, and 2,406,300 dlaresof common etack were outstanding at December3l , =, 210"2 and 2D01,respectively, but were not i rxi uded in the computation of of I uted net loss pers1we, since the effect is an ti di I utive,

Derivative Financial Instrument s

The Company recognizesallderivativefinardal insh-un,eft sd, wforeign .a(cluVe contracts, intheconsoli dated financial statern ntsatfairvalueregardessof the purpose or the i ntent for hol ding the i nsirunlent Changes in the fair value of derivative financial i nstnmonts are either recogriizedpertodidly i n i ncorne or i n stockholders' equity as aconponeit ofcompre ve incomedepending onwhether thederivative f .nenoiW iriwunwntqualifies for hedgi ng am*unti ng, ax1 i f w, whether itquai ifies as a fat r value

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TERAYON COMM UNI CAtI ON SYSTEM S, I NO .

NOTES TO CONSOLIDATED FI NAN:CIAL . STATEMENTS- (Continued)

hedge or cam fl ow hedge. Generally, ctiiigas i n fair vfil ues of d erivat ves aaounted for asfair val ue mare recorded in i noome al ong with the por Pionsof thecF>r+ Vesinthefairvalussafthah Changesinfairvaluesofderivativeseauntedforascah'flowhedgesto the extent they are effective as hedges a re .reoorded i n oih& oompceF vein ne, net of deferredIces Changes i n fei r vel ue of derivatives used a she gesoftherietinvestmant in foreignoperatiorisarereportedinothereompreìensveincomeaspectofthec~imulativett idedonadjustr~ t . Changes in

far val ue of derivatives r of quali fying as hedgeaare repor%din I noorre .

The Cornpany had, no Jeri vati vefi hard al i nstrurrients outstondi ng as of Dege 31, 2003 or 2002 .

Cash E quivalentsand Short-Term Investments

TteCompany Irrvestsits excessc iinmoneymarketaccountsanddebt i netrui eritsoldoorsdersalIIvg IYIiquiddebt.instrun ttspurchasedwithanoriginal maturity of three months or Iass tiesashequivalantsIrxestrnentswithanori gi rxal maturity atthe ti n ofpucdiasaofavert eemonthsare

assi fled as short-term invedments regardless of maturity, date asaflinve tsareciasefiedasavailable-for-saleandcanbereadilylig uidatedtonroetcurrent operati onal needs

The Co' npeny determi nee i rnpairment related t o i t s egtii ty i nvestments in aooordahesvritft SFAS 115, " Account 'rig for Certai n I rwe stments In Debt andEquity Securities" , and Se uribesard Exd a lge Conm on (SEC) Aozouriting gulletin (SAR)59, "Ao zxnt ng for Noncurrent Marketable EquitySeca riff eel' , which provide gui da ca on determining when an investment i sothi3r-then-iemporari I y impaired. Aing this guidance requi r e s judgmett I nmaking thisiudgment , the Company evduates , among other favors, the duration and e>dent to wtvchthe fai r value of an i ivesum t i s lessthan. itsm , thefi nand al health of and busnassou tl ookforthe investee, InciudIVfactorssuchas i ndustry . andsectorperfor , thangesintechnology, andoperationaland firtand hg cash flow, arvaiIablef1nandal information ,, widtheConipany sintentandebilitytoholdtheinveWrOn t

The Company's short-term Inves entA which con" pri Mari ly of cerrrnerdal pacer, U .S, governinent:and U .S. .govemn>ent agency obligadonsaidfixed incomecorporatesammities,areclassified asavailsols-for-sale " are carried attfairmarket vatue Realizatgains andlosessenddedinesinvaluejudged to be other-than-temporary onavaila6l .e-for-sal a ssaa itiesare i rd Wed in interest Ino". The cost of securities sol d is based on the sped fieidentification method . The Company had no nrataial i nvetlsin thort-term equity secxuitiesat 4ecsrr1ber31, 2003 or 2402 .

Dun ng the t1 rd quarter of 2002, the Company rieoeived approximately 35 .9 mill ion.> ra5of Net Sarviooside Comunic~c~oSA (Net Se vioos), acustomer, valued at approximately $2.5 rni ll ion assetUenvnt; for al I outstardi ng acvouita reoeivaWes duefrom Net Servicoa The tiaesof Net Servicos aretraded on the Sao Paulo Stock Exchange . AI I reverua and theoost of sales relating to these receivables had been deferred due to edended payment tertr *offered in the original salesagrearner .TheCompanyrimedaloseonthessttlementoftiieNetServioosreotiivblesof$0 .9nrllion,whichwaschargedto cod of goods sold i n the th rd qua-ter of 2032.

The Company Iigiidated 32.9 mi I lion of tlxvsetharesvalued at $23 million in the fourth quarter of 2002 The Company liquidated 1 .2niiIlion of thesediaresvd ued at $b.1 million in thefi rst quarter of 2003. T O Company recorded revenue and the related cost of goodssol d as tlia tiaree were sol d and cashwas received . Add tiorally, i nthe first quarter of 2003, I .8 mill ion diaresof Net Servicos were paid to a con;sultant :i n Brazil who provided marketi rig andsales ssrvi oesto the Company . As of December 31., 20133, the Company no longer- owns any shares of Net Servicos

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TERAYONCOMMUNICATION&' $TEM8, INC.

NOTES TO CONSOL I DATED .FI NANCIAL . STATEMENTS.- (Continued )

Reatri ded Cash

Restricted cash at Dece +rber 31 , 2003" 2002 pri rr i l y rei sled . to approxi matd y $7 .5 million and $9. Q million, rdapectively to secure an;aircrattlease, aswdl as $0.7miIlion at Decertta: 31,2003 to sea.reareel estatelease

Inventory

Inventory i s stated at the lower of cost (first-in, first-out) or marker The :eomponenCs of i nventoryare as follows (in thousands):

Decarrber 31 ,

2003 2002

R Nn EhW goats $14,254 $ 5,91 5Work-i rf ProQeer, U30 769F''aw motenal s 1,440 1,5t3

$16,364 $8,257

The CompanyrecordsloasesoncommitnlmtstoptrcF inventoryinaceordancewith5taterniert10ofChapter44ofAooountingReleaseBi1IadnNo .-03.TheCompeny'spolicyforvaluationofinventoryaidcomn tT5lentstopurchaseInventory Inducing thedete~rr~ationofobectete :orexcessinventory, requi ies it to perform a data l ed asee rent of inventory at each bel ante sheet d teWhic i71 ncl udes a review of, among other factors ; an estimateof future. demand forproductswithin ofie neharizons'generally axmonthsorlassas'wellasproductlifacydeandproductdeveloprentplansGive ;itherapid dwV&inthetedxiologyandcon,, sieationsequiprnentindustriesmWeli assignificart,unpreddailediaingesihcapital *end npbythe.Company°scustomers~theCompany believesthat asseed..ngthevalueofinventory usinggenerallyasixmonthti mehonzonisappropnate . .

TheesimatesoffuturedemandthattheCompenyusesinthevaliationof_i,nventoyare :thebedsforthereiienueforsax. Based ontftisardysstheCompany reduces :the cost of inventory that it sped fical ty i de tifi esaridconsders obsolete or excessi ve to fil f I I future sal es esti codes The Companydefines excess. inventory as i nventory that will no longer be used in the nexufact ri ng process Excessinventory iagenerally defined asi nventory in e camof projected use, end i s deter i ned using the Cat Zany' s best estirriafe of future demand at the time, bowd upon information then available, See Note 3.

Cost of goods sol d for the years ended December 31, 2003 and 2f3o7 i nd uded rev ersal s of $10.9 million and $15 . 3 mi Won, respect vel y, of specialcharges on gi real l y recorded in 2001 and 2=for vendor car-odlart on dhargesand inventory considered to beeccess and obenI ate The Corry was able :toreverse the provi si ons in 230)3 and 2DOZ, asitwasable 1o selI inventoryonginall ycansde-edt beexcess~and obsolete . In:eddition , the Colnfmywasableto nepot ate downward certain vendor cancel I ad on daims to terms more favorable to the Company . Cost of goods Ed d for the year ended Decerber 31,2001 i nd uded $33.5 mill ion of qieoial dlarger for vendor cancellation and inventory considered to be ® roess and obsd eta

Add ti oral I y„drri ng 2403 and , the Company recorded inventory charges of $4.1 million a-0 $6. f million, respecti vely, to reduce some of itsinventory due to excess and obeol emerge and to reduce the inventory to the Iowa of cod or market value In 2002 as ASPsfel l bd ow the out of theseproducts end to record dwgeefor rues and obsolete inventory . No changes to reduce inventories to the lower of cost or market were recorded i n 2003 .

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TERAYON COMM UNI CATI ON &'YSTEW .., .I NO .

NOTES TO CONSOL I DATED FI NANCIAL . STATEMENTS . (Continued)

Ether Current Receivables

As of December 31, 2Qai and 3002, other axrent receivables are prln>a.rily composad :of interest, taxes, and non-trade receivables, and includedapproxi rnatel y $1 .8 million and $l .4 million, respectively, due fromcontract manufacturersfor rare materials purchased from the Company .

Property and Equipment

Propertyand equipment are .carri ed at cost Iee;azxmulateddeprac ation andamiortization. :Propertyandequipment aredepreciatedforfinancialreportingpurpc~aesusing thedraigit-line method overthee$imated useful live4 Generally three to seven years Leaehdfd improvemarrtserearrortizedu9ng the atrai g it-I i ne met od over the iorter of tkie useful I ivesof the a~chs or the terms of tFie l ewes The re~vverabi l iity of tfie carryi r1g arnourd ofpropertyand equ prrlert i sa5ees~ed b std on estirr 1 future urKiiazunted c h flows and_if an imps1 rme it exist ths :c#iarge to operat ons fsmea .red asthe exca~s of the csl ryi ng a ioi nt over.the fait val ue of the 2ssats Bgsed upon tali s rtt! ltatl of asE ng recavelahi I i ty, fdt the years ended Deoerttber 31,20tXi aril 2002, the Compeiiy recorded $D ;5 n i l I i on and $1 .3 rri l I ion, respeo6vsly i n aeaet i mpai rrrierits pri magi l y Tel ated to Te ring ac8vi ti s s

Property and equiprnentareasfollows(In that rids) :

Dacernbi 31 ,

2OD3 2002

s 0ftwa'.e and GArnputers 23,273 .$ 25 ,5 1Furltiture and eel upment 23,816 31,D92Leasei,6 d improv is 4,935 5,01 8Automobiles 16 1 6

R'bp6rty andequipmert 52,D40: 61,657Aoamlulateidepredati on and ambrtization (40,169) (43,751 )

Property and aqu prr rd $ 11871 . $ 17,9©6

Goodwill and Other I ntangibleAssets

Goodwill is the excess of the purchase price over the fai r value of i dentifi ad a net asaeI acqui red in business combinab ons aooourited for as purd es.During 2002 and 2001 , the Corr~r~y recordedirnpeirrnentd- rgesforgoodwill , abedworkforce; aidouterirttargibfe assets (see Note s) AtD ecember 31, 2003, ell goodwill had either been amortized or written-off the Company' s books Consequently; no goodwi li was i riduded in theCornpar y'soonde r~ead consolidated Ba[erxe 5heefsat December 31, 20X3#

Goodwill eventssuch asproduddisoondruaioe, plaitdosures productcos ti ons or other d arges i n o rcun xm3 i ndi Gated that the Garry ing amount may not have be recoverable: Wm ai .eve'its aacurred, the Companycompared the carryi ng arnount of the assets t o unci aeoun ed ®cpected f u t u r e cash flaws I f thi s co npari son ird cated that twowas an i mpa mrant , theamount of the impai relent was typi call y calal ated using discounted ecpa t d future cam flows The discount rate appti ed to these cash fl owswas based onthe C.om eny ' sweighted aver2na cost of capita( , which rerresented the bl ended codsof debta,d eouity .

Warranty Reserves

The Company provi des a staridard warranty for most of i is prod,jce, generally Iasi rg orie to five years from the date of purGxnse . The Companyprovidesfortheestimtedcost of product werrartiesatth time revenue isreoogHzed . TheCornparty'swarranprobligation isaffected by product falurerates melee al usage 64

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TERAYON COMM UNI OATI ON SYSTEMS, INC .

NOTES TO CQNSOLI,DATED .FI NANCIAl- . STATEMENTS-( ContiPW )

and =vice delivery coda incurred in correct rig a product fai l uro . Reserve esti mites are based an hi stori cal eoepoiance and expectation of future cord b onsSee Note 14 .


The Company aooountsfor itserooyee stock plansi n aooordar> o6 with Ao=unting Pri apples Board Opinion No. .25,"Accounting for Stock I saved toEmployees" (APB Opi ni an No . 25), and indudesthe disclosure-only provisonssas rsgui rod under SFAS No , 123, "AixouiY rg for Stock - Bsased

(SFAS No . 123) . The Con iy provIdes additional pro fottn dacl osurowes req.i rsd under SFAS No. 123 and, SFAS No. 148,'Accounting for Stock-Based Compensation , Transition and Disclosure" in Notes.

For purposasof pro forma disclosure the esb:moted fair valve of the optowgrarted and ESRPureat" be .issaed isar io tZW toexpense .over theirrespedive :vesti ng parlods Had eornpen on cod .for the Company's hack-based corrw, on plans been determined based onthe fair vat ue at the graftdat asfor awards under thowpl ans aorta scent with the method of SFAS No . 123, the CompaW s riot loee eppIt c ki a to conxnon oto¢dhwldersand net I oasper share appl i cable to oonrran stoddtoI dens u+txi d have been . increased to the pro forma an uifs i ridcated below (am Note:9)(i n thoueands,: a cept pershare data) :

Years Ended De rbe31 ,

2O 2002 2001

Nit tom $ (50;353) $ -04,213 $( 563,8 6Stock option plans (72,212 03718) (126,72161>pln rsfocklxactgseplan ('t,V1Z (1,990) (22212

Fro forma net Ions $(74,275) $(79,921) $(192,779)

Proformabaseand dihrtednot loss.* eh2re $ (1.>OR) $ (11II) $ (614)

The pro forma i mpact .of opti ons gwitod and urea from the empl ogee stock purdiaae plan to be issued for the years ended DeoerrA r .31, 2003, 202and 2001 is not representative of the effects on net income(loss) for future yeaasfuhireyears willind lette continued .effectsofoptionsvestingaswall Ias the impact of nuiti pi a years of stock option grants .

Equityir trumentsgrantedtonon-erTooyaesareaccountedforunderthefarvaluemethod,inaccordancewithSFASNo.123andEITFNo .96-18,"Acmuntirig for Equity I ristrume^tsThat Ara Issued to Other Thai Employees for Acquit ng, at in Conjunction with Selling, Goods or Se'vi ces," us rig theBieck-SO) asoptionpdangmodalandarerecordedinthe .equityset#ionoftheGarpany"scor lidatedbalatesheetasc erredconlpens3tion,Thes ei nstrumentsare sibject to periodic reval uatlons over tha r vestin8'terms The ekpm is recognized as the instruments vest

Accumulated Other Comprehensive Loss

Axwulatedother comprehensiveloss presentedintheaooonipanyingconeolidatedbalancestieetsandccnsolidatedstate iesofstoe*holdsesequttyconsists of net unreal i zed gin on short-term i nve&me Its and aaountul ated net foreign ardency translation los is.

65

Table of Contents .

TERAYON COMM UNI EATI ON SYSTEMS I NO .

NOTES TO CONSOL I DATED FI NANCI AL . SrATEM ENTS - (Continued )

The following arethe conVoner tsof acct `nulated ottier compret>e( ve Ions (in thousa'ids) :

YewrsEndedDecember 31 ,

2003 2002

CuTgA atrvetranla iUna4 rshTwts $42 40) $(3,572)Unr®eli zed gaiN (loss) on available-for- einvesti its 32 502

Total aou"ated a ffi6rcorrpranert fvelo ${Z 68) ` $(3,O70

Redas4 icatio n

CErtainamounts reported i n previousyearshwe been reclassified to conform to 20M presentation. Such redasrificationshad no effect on previot yreported results of operations total asmets o r. aoairnul ated d i.dt.

Impact of Recently Is ued Accoun ti ng Standards

In May 2)O3 , the . Fi nw6al A ccounting Standards Bp.wd (FA E6$) ieated 5taternenhof Fi nancial Accounting Standads (SFAS) Np. 15(1, 'AccountingFor Certain FinancialInErumeftwithperar;Wsisof Both Llal~'Iibesend Equi " wtctteslabli s_forhowaniso*.offiremalirarurmntsdassfiasandmeas~rescertanfinanaalinsrurmntswithdar"aderistcsofbothI i abi,li sand equity . It requiresthatanisduerda fyafi nand alirutUn&itt that iswithinits scope asaIialility(oran asset insinedrbtrrrtar s ) if,atincep ti on, themmetaryvalueoftheabliOationis based solelyorpredominartyona fixedmonetaryaT untknownatincepion , variatoresinsorr i1ngotherthanthefarvalusoftheiseer ' sequity aesorYariatonsinvesdyrel atedtochangesinthefairvalueoftheiss .ier's equity shares SFASNo. 150 i seffedi ve for fi na-6W ins&uments entered intoormodfiad AfterMay 31 ,20 Q3 and otF wiseiseffedive at the beginning .of the fir intrarim peri od beginning a fter Am 15, M The adoption of SFASNo . 150 did nothavea material inp ct on the Company 's finangtil posi tion w rrsalteof operations

vities' SFAS No . 149In Apri 12003, the FASB Issued SFAS No. 149, "Anieniirrlent of Statemrnt 133 on Derivative I nstnunel is and Hedging Actiarriends and darifi esfi mend al accounting" reporting for derive i ve i rstrutrse its inducing certain derivative i nstnunentsenbedded in other- contracts(collectively referred to asderivetives)ax forhecigingactivitiestrlderSFASNo .133,"AoonunbngforDerivativeIrntrurrwntsandH ngAotivities"Thi ssl rnent is effective for oonb- s:entered into or moth fled after June 30, 2(703, and did not have a material i rr act on the Company s financi stposit onor resUltsof operati ons

In ,lanmry 2033, the FASB is red l nterpr ta5on No . 46, " CortaJli dation of Variable I ntered,Er tie " whi dt was ratised .i n DeceMber2tB3.nterpretati .onNo.4gasrevis3d,darifiestheapplicationofAcoounting .Researd,BulletinNo 51 andapplies.irrmedi2kdytoanyvariable irteredentities

created after January 31, 2DD3 and to v riabi a interest entities i n which an interest i s obtai rii d afterthat date . Thi s I r teipretsti on Isappl icable i n the q "tei-endingMarch31,2004, for interestsaoquredin variableinterest e titiespnontoFebruary . 1, :2003. This Interpretationrequiresvaiableirderedertitestobe oonsol i dated if the equ ty i nvesbner t at risk is not s ffi sent to permit an entity to finance its aetivit es without st pport from other peruse or the equityinvestosladespecified draracteriscsThe adoption of InterpretationNo .46,asrevised,isnotexpectedtohaveameterisl impact ontheCompany'sfinancial position or restitsof operations

In NoverrO r 2002, the EITF reached a con ,ws .on . Iswe No. 00-21, "Rev erweArrangementswith Multiple Deliverables' . El TF Isms No . 00-21provi des gnu deuce on how to aooourt for cFrtsi n arrangements that involve the de i very or patormarx>e of rnitiple products sa vi oss andtor ri ghtsto useassets The provisi one o f El TF I ssae No- 00-21 wi l I appl y to revenue arrangementse' tered i nm in f i s r a l periods begi nni ng after bne 15, 2003 Theadoption of EI TF Issue No . 00-21 did not have any s0 ficant impact on the Cotrp'any'sfinanCial positi on or resit is of operation s

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TERAYON COMM UNICATI ON SYSTEMS, I NC.

NOTES TOCONSOLIDATED .FINANCIAL STATEMENTS.-(Continued)

In,Uy 20OZ the Financial Account ng Standards.B oard issued Staterra t of Financial Ao,aouiti ng: Standard No, 146, A ocounti ng for C sA ssoeiatsdwith Exit or Disposal A ctivities FAS 1 4 ) .FAB146aidre thefiriandalaoxunting aril ~ ngforcostsaseocaated with exit ordI o adivitle;and s~ersedes Emerging I T t Force Issue `No . 94-3, Llat Iity : rwtion for Geriain pyeeTa rt lon Renefitsand Other Coststo Exit anA ivity, irldudir>gCeitftiC fslnaaredInaRs ructtxrr>g.,(EITFS4 3 AS f46r riresCanperuestorecpgrr po s aociatad with exit orrfgasal.actvitieswhentl, aYareirwvrredradhertiiariattlie .dataofaoonvntrneiittvan ti :tofci alplat I naddition FASNo . 146establishestflat#arvafubistheobjec veforintlalmeaexrerr~erttoftl~aliabil ity :.FAS?4 iseffectivefor~scitorcfl os1a~vitiesIrtiatee (att&Desriber31 ;2002, The .adopsonofFAS 1d6 did not have any a gnifit~nt i ri ~1ad on tt >e Comariy 'sfinartdal po~ti on or resultsof operatiiins

In June 2001, theFASBissued :SFASNo. 142,"Goodwill and Other IntangitleAs s' (SFAS No . 142). SFAS No.142prohbitstheamo ti rationof

goodwill andintw iblea swithindefiniteU ullivesSFASNo . 142requiresthettf~9seassetsbereviewedforimpi3irrneitatlealain II y.. I ntargibieassetswith definite liveswdl corrtinuetobearrort dovertheirestimateduseful IivesAd di ti onal ( y, SFAS No . 142ra iresthatgoocMlII indudedirfthecarry! rg value of equity method i nvestmertts no I anger be an )orti zed

TheCompa(iy adopted SFASNo .142on .J yii ry 1, 2002, I .denti fiaUeintangide s with Indefiniteliveewerere Iasafied;:asdefiriedbySFASNo . 142, to goodwi I I at the dateof "on.on. The:Company :tested goodwill for i mpaimlent usi ng the two-step process presen bed i n SFAS No . 142 . Thefirsfaepisa screen forpotential impaiorient, whiiethesecond step rn irestheamountoftheimpeirmert , ifany. SeeNote5.

The fol I owi ng pro forma i nfomaati on refl ects i rnpect on net I oss and basic and di I uted nett oss per share sawn i rig the adopti on of SFAS No, 142had occurred on January 1, 2001 (in thousands) :

Yewsended December 31 .

2003 2002 2001

(Pro farina)Repoftednetloss $:(SQ363) 5(44,213) (55.1;m)

Amarb ation of goodMu and intargble a~a~with indefinite lives - - 53,846 .Ftoforrnanetloss $(50,353) $(44,213) $(510.ElElO )B c and d I uAed r*t I o_% Per share

'ReFOited net loss : $ (0.6e) ' Eo.61)$ ' $ (825 )Adju n' it reisuedto amortization of goodwill and intan tea Cs

with it Winiteljves - - 0,79Pro forma badc and d' i l uei net toss per stare (0.68) $ (0.61) $ (7 46)

In July 2002, the Finanoiat Acting Standards, B card issued Staterrw t of Financial Ao n© Standard No . 146, Ac ountingfor Costs Aseodatedwith Exit or Disposal Activities ( FAS146) . FAS146addressesthefir'e al amourttingandrepottingforcodsaseodatadwithexitordisposaladivitle4andsupesedmEmergingIssiesTmkForceISamNo . 94-3, LiabilityRecogni ti onforG in EmployeeTerniinationSenatitsendOtherCoststo Exit anActivity, indt rg ; Ga'tain Costsl.nourredinaRestncturirg(EITF94-3).FAB146reo. rescompenlesto , 2o costsaseocidted with exit orcis)oedactivi ties when they areincurredratherttianatthe date ofacon ritrr 1ttoanpctordisio91 plan.Ina±fi ASNo.146establishesthAfairvalueisthe ogje~ive for i r ti al rneas rerrieln of the l lab l ty, FAS 146 is effective for exit or dial activiti es initiated after Decerriber31 ,217) The adoption ofFAS 146 did not have any sgnificait i mpact on the Corrpmy'sfina-Cal pos ti on or real tsof operations

GI

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TERAYON COMMUNICATION &YSTEM6 ; INC .

NOTESTO CONSOL I DATED FINANCIAL. STAT EMENTS, (Continued )

Fair Val us of Financial Instruments

The amounts reported as c ash and .cas1 equivel entsi accounts receivabl e accounts payable mid aCQUed I iatii l ities t iprvxi nee faj r vW ue due to theirshort-term rnatuiti es The fair value for the Company's irwastrnents in marketabie :debt and equi ty seaarities is estimated bayed on quoted market prices

The fair value of short-term and long--te"capital Ieweanddebt obligationsisestin tedba9edonexurentinterestratesavailabietousfordebtit run tswithsimilarterms,ilegeesofrisk,andremainngmeturitier. The carrying valuesof these obi i9stions, as of each period preserted approximatethe r raq7&tive far val UeS.

The foIIowi N esd mated fai r vat ue amounts We been deterrrr nod us ng avai table market i riformaton . Howevef, aonsderab1 e j udgmed is requi red i ninterpreting market data to develop the .e ntates.of fat r vat ue

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TERAYON COMM UNI CATI ON 6Y STEMS, I NC .

NOTES TO CONSOLI DATED FINANCIAL . STATEMENTS-(Continued )

Accordingly, the esti mates Presented herein are riot neoeasdri ly irk cative of the 2rriouitsthat the Company could realize in a cxirrerit ma ket -change.

Deoernbar 31,.2003

Grow Gross.Amortized Uittealized UhfeeII i E stimate d

hat- term invesrnaits cost G 10Ys. Lo at Fair Value:

Q n thousands)I by rads n- to i rig in les&than 1 y r:Cor m,eraal . paw $ 38939 $ - $ (11) $ 38,928Fi xed income arxporate amurites 2,223 1 2,224Govarnrnerrtagwxy oUigations 7,918 1 - 7,91 9

Tote) 49,680 2 {11)' 49;071Investrr d maturingin1-2year sfike is~cotriao5rpowat9 nGes 1,333 - - 1 ,333Goverrmentagencyobligations 58,006 68 (2S) 58,04 8

Total '' x,339 68 { 59,381

Total $ 108,4191 $ 70 $(37) $108,452

December 31,2002

Gross Gross Est imatedAmortized Unrealized Unrealized Fai r

Short-tam investments Cod Gains Losses Valu e

(I n thousands)lnve tsn-6turinginfesethan I yearCommercial paper $16030 $ - $ (26) $15,974Fixed ir~co ne oprparateseariti 12 920 196 13,116Government agency ab(igabaris 10;300 260 - 1.8560CorporateegLAy. wearities 202 151 - 353

Tot4 47,422 607 (28) 48,003Jnv trrmtsrr tu•tngin1-2yearsFixed ir 1i corporatesqa ribes 2,0017 145 2,145Government agency nbligaBons : 39,000 276 - 39,276

Total 41000 421 - 41,421

Total $88,422 $1,028 $(26) $89,424

Realized gai nand losses were insignifi cant for each of the years in the period ended December 31, 20003 .

3. Commitments

Lease,

The Company IeatItsfadlitiesaid certainegUPn-entunderoperating Ieases Theoperating Iease.fortheCarnpay acorporate headquarters expi resin 2009 . The operating lease for the Company' s I s-aet headquarters acp resin 2005. The Company's other ope'at rig I eases empire at various tunes though2606. Rent expwAowasappraxirutaly $7.1 million, $7 .9 million, and $7 .2 million, for the years ended Dec6mbsr 31., 2003, 2702, and 2001, respectively .The Company subl ease s a portion of itsfao] itiesto thi rd acmes I n

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TERAYON COMM UNI EATI ON SYSTEMS, INC .

NOTES TO CQNSQLIDATED FINANCIAL . $TATEM .ENTS- ( $ontihued )

con' ionwiththerestrut rir~ pl, annourced Jahuary27,204 the Company isseekingtostl easeproximars)y56;4D0squarefeatofitsSanta ClaCaliforniafanility. See .Nota16 . TheCorrpony' ssibleaserm l inmmewaseppNoxirr>ately$1 1 Wallin; W,4 million , and $0.1 millionforthe

yserserKW December 31, 20 3,2002, and 22001 respeoflvely .

The Company I eee certain equip i'eit under norxance[ Iabl e lam agreernents.tftat are ac suited fix as capital leases. Equ prnent tnderc apital loamarray ments i nd ilded i n property a ►id equipmentagg egated $0 3 m I I i on and $0:7 million at December 31, 20M and 2002, respectively . Related9=mxiiated amort zkon was$0.3 mi Ilion and $0.6 mi I lion at Daoarber 31, 2003 aid 7XD2, rs *ztivaly . Arnor1izdb on a( related to asa6ts undercapital .l eases is [nd tided in deprecl ation expense. The capital 1 eoeesare sewed byte related egtapmenk and ft. Corripa ny i sr.. qWred to main th liabilityand property dame i nsrance.

In 2002, the Company entered i nto an opera i ng I ease arrartgernent to I ease a oorporate ai rcraft Thi s I atrarlgerr nt .was secured bye $9.0 millionI etter of credit at December 31, 2002 The letter of credit wasreckedto $7 .5 rri Ilion in February 2003. The ]ew e commitment forthe ai edaft isineluded inthe table blow .

Future minimum I ease payments under nonaricela a operating Dees and capital leases as of Decerrber31,2003 are as fol lows (in thousands) :

Ope g C,

2004 4.,a'68 11262005 7,188 -2OW2007 3,1652W8 3,445Therdefter 2,537 -

Total nirirnii* yrt is $ 853 126

Less anountrepresa tinginterest 2

Total currerkporlidn $124

There are no future nii ni mum subl ease payments to be received under noicarx d abl a s.i leases

Purchase ObligationsandSpecial Charges

The Company traspurettaseodigationstocertain of itssupplierstt s :ipporttheCorrpany`sabilitytoma ufactireitsprod..vtaTheobligationsconsist. of purchase orders pI aced with vendorsfor goods and savi ces a d roqui re the Company to~purchase rrr:rti mum quan4B es of the s ippl iers productsat aspe ifiedprice.AsofDece~rmber31,20D3,$54.4mlllionofprc a oblig2Norswereotk~ating.AsaresaltofdedinesinforeoW,theCompanyhascanceled certain Urc :hase orderswith itsmntra t nlerwfacturersthat had exiAn5 inventor yforec~ts

. Cop on band or on order ih anticipation of the Company' seerlierrmequentl y,theCompanyaccruedforvendorcancelIationchargesinanoiints,whichrepreeantedn gaiiert'seetimateofUisCompany's

exposure to verxiorsfor its itwentory commitments At December 31, 2003, accrued vendor carxel lab on charges were $ZS m Iii .on and the recant Nng$51 .5 million attributable to open vi-clime orders The rerrei ruing obl igabons are expected to .become payabi a et vane ioustimesthrougtaut 2004. .

On February 26, 2003, the . Company entered irib an agreement with SDI ectron Ccrpoiati on (Solectron) to settle all outstand rig obligations under threemanufactun ng agreements between ft Company and 56 eetron . Under the terms of the with racy t a e€ma,t, the Company pad Sol edron approxi rrad y

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NOTES TO CONSOL I DATED FINANCIAL . SfATEMENTS- (Continued)

S3 9:mill ion, and each party released any and al l daims.that it may bone had oqai nst ltie other petty. Adci ti orlai l y, thoCompany received eel acted inventoryfrom Sol ~eetron . The Company preoi oudy a aued:$6 C mi ll ion towardthe seal a mnt of the Sol edron matter asa v eidor l atiori charge in the fourthquarter of 'Z)00 and the seoond .quarter of M . I n :20Q3, in connection with the Sol ectron settlement ; the Corrpany reversed $~ 1 million of the accruedvendor cancel I ation dhryes ind uded in cost of goods Bold .

On September 29, 20D3, the Company entered into an a0reementwith FIextronics(Isad) Ltd ., an Israeli company (Flextronic , to ptrcirwaitory

from Flo?ctroriooandsendsall outdaidngdain batweontheCompanyandPIectronce, .UriderthetarrnsoftheseWwrier>t;areemar the Company paidFleictronlosepprox rhately$1 .5nvllion•totieappliedtowardtheputhaseoffutureinventoryfromF(ectroricgifany .Additionally,eachpartyreleaseda 'and all dai msthati it may have had agairte the other party . The Q.on.~peny previ curly a xzue l $2.0 million toward the settlement of the Fl xtronics nester asa vendor anneal lation diage in thes9oorxi qubrteof 2001 . In 20Q3, in co nwtion wi th ttlb Flextrorr issettl enierrt, the Company reversed $0 .5 rri I lion of theaccrued vendor cancellationdrargesihduded in cost of goodssoid :

Lettersof Credit

As of December 31, 2(1)3,1heCompany .t $92million in unused out taiclirig lettersof credit primarily required to sipportoperating ledger., whichecpire at various dates through 2009,

Royalties

TheCompany'stotalaccrued obligation forroyalties ofDecenbe 31,2003 and 2002,was$1 .3million and $0.9 million, reppectively ,

The Company has purd rased, through Itsaoqu sbori of Radwiz Ltd (Radwiz), certain techriology that utilized funding provided by the Israeli ChiefScientist of the Ministl'y of Industry and Trade . The Company haseomrritted to pay royaltiesto the .Govemment of Israel on procoodsfromsales .ofproducts based on thistechnol ogy at ratesof 3%-5% per sale, SRI as of products us ng this to rwlogy are i ninaterial .

Additionally,theCompanyhasvariousroyaltyarrangements,whithrequireittopaynominalarnountstovarious iersfori s usageof licensedproperty .

Guarantees

The Com oany from timeto ti me enters i nto certain type-.of oontradsthak contingently require the Company to i nderYriify parties jai net third partydams Thesa obl i Qati ons pri marl I y relate to certain agreerrientswi th the Company's offi cers directors and arnpl oyeeSunder which the Corr aiy may berequired to inde nifyschpeâonsfor Iiabilitfesaner9outofther employment relations hi p.

Thetermeofsuch obligationsvay. Generally, amaci.mum obligation ienot explicitly stated . Beau the :abligatedamounlsofthecatypesofagreanarts often are not explicitly stated, the overal l maximum arrant of the. obli cgati one carrot be reasonably estimated. Hi storfcal l y ; the Company hasnot bean obligatedtomakeany payrnentsfor these obllgatior and no liabilitieshave been recordedfortheseobliga ti onsohitsoona idatedbalancebeetsas of De cember 31, 2003.

4. Accrued Severance Pay

Several of the Company's sdjsdiarias are subject to Isaeli I aw and labor agreements, under which they ere requi red to make, severance payments todismissed employees and enployeeslea✓ ingitmern loymentincrtainotherdrarntanoesTheaubsdicried severance payIiabilitytoitse' oyeeswhich i s calculated on the bas sof the salary of each anpl oyes for the lost month of the repotted year multiplied by the years of such employed sernployrner t is included in the Company's coned i dated balance shiasts on the accrual basis; and is

Exhibit C

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TERAYON COMMUNICATION SY STEMS, INC .

NOTESTOCONSOLIDATED .FINANCIAL STATEMENTS -(Continued )

partially funded b r a pircha of ina~tarxie p6liaesinthe sb5i dia ied tiaras. At De mbar 31, 2(303, $1 .8 nti(l ion foraocrued severance pay Was includedin long-term obligations In aocordairtce with EI TF No . 86Deterrrrnadion of Vexed Benefit Obligadonfor a Defined Benefit feia on Plan theGorr~enyinduded$1 .3miIli .onrelatingtotheamQtnifsfundedbythe iurcha9eofinsurarxe :policiesfortheIsraeliseveranceliabilityinitscmsalidatedbalance s)eets as other aseetsat Datember 31, 20M ,

Restru ct uring Chargesand Asset Write-offs

Restructuring

2003 Restructuring

During tha fi rft quarter of 2003, the Company's Board of Di rectors approved a restructuring plan to conform the Col ipany'sekpalees to its revenuel eael s and to better pos 6 on the Company for future growth . and eventual. profitability. The Conj. y i Warred restructuring diargesi n the amount of$27 mill ion related to employee tamination oosfs es part .of the 2(% 3 restructuxi ng. As of Deoramber 31 ; 2003, 881 .employees were terminated throughoutthe Cody, and the Company pad $Z7 million i n termi nation costs I n the second quarter of 2003, the Company reversed $86,000 of prenrioud yaxniedtent i nation cods due to a cha' e i n es i mate . At Dec en tser 31, 20, no restructuring diargesrerrmi ned accrued .

.A summary of the 2003accrued reatniduri ngchargesisasfolIows(in thousands):

nvoluntaryTerminations

Total charge V-1,745Recovery of charge (ICast' P*Melts (2,W)

Balance at Decanter 31, 2003

2002 Re ructun ng

Duri ng the third quart er of 2002, the Company ' s Board of Di redorsapprroved a restructuring pl an to conform the Company ' s e►Cpenses to its re✓enuee✓el s and to better pos ti on the Company for future growth and eventual profitability-. The Company incurred res tru Cturi ng tharges: in the amount of

access [eased facilities AtDecember 31,2003, re ruoturingchargesof $1 .2millionminedaccrued . AsofDecember31, 003, 1S3erriployeeswe~tettt~inatedthrougbaAthecompany aspartofthe2002restrucring, "theCompanypaid$2 .2miIlioninterrrir at ioncoalsand$0. 2millionineioa5sfai Iitycos.During20C)2,theCornpenyrodasd fi ed $0.1ml Ilion of exces stermina0onoa stoleasedfaditi esduetoaorangeinsellmate . TheCompanyantdpatestheremainingre3rudiring aocrr~el , pri marily relati ng to excess leased tad lilies, will be utilized for servicing op&W' ng lease payments or negot aced buyout of operatingease oornrri tments, through 2005 .

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TERAYON COMM UNI GATI ON SYSTEMS, I NG .

NOTES TO CONSOLI DATED FI NANCIAL . STATEM ENTS-( Continued )

The followi rig t b1 a summed zest* costs" activities rel ate i to the 2002 resirugtudrig ( in t1*A. rit4:

Fxcessi easedFaeilitiesand

Involuntary CancelledTarminatlons Cuntrads Total

Total rhargein. . . .. . _ _

$ 2,31. .. . . . . . .. _

1,3 y 3641Gash payments (2,131 )Reidaeafieaf on (100) 100?alanteat Decerttber 31, 2002 88 1,422 1,51 0G 1 Pay>1x its . {88) (219). (307}

Bal anoe, at December 31, 2003 3 - $1,203 $ 1 .203

2001 Re ructun ng

During2001 , theCompany ' sBoerdofDireetorsap rover ructudngplantostreamlinetheCompgnsorgarrizaiionalsruaturewoddwide.TheCompany incurred restructuring chargesintheanountof$12 :7 million in fisc-alyear2001 of wl•ioh$3,3miI lion rernaned :a at December 31, 2003.Of the total re*udtuir g dlargesteoordedduringfisCal year 2001, 53;2miIliortretatedto employee tempradoncostsU oughbuttheCompaany,atdtherema ding $9.5 mill ion related. pn ~tarilyto costs for oe ss leased feciIhiesDuring2QQ3theCompanyworsed .$0, millionofpreviougyamruedtermi nation wets due t o a dmrW in estl m a t e. The Corrpany antis pates uti l i a ng the remaining resat ton ng accrual , whi dt rei atess to sern c rig op eratingIease payments or negotiated buyout of opetati rig lease oommitrrtrhts, through 2005 .

The following We sumrrari zesthe costs and wtivi ties reiated to the 2001 restructurirg (in thousands) :

Exom laasedFacilit iw and

Involuntary Cancelle dTerminations Contrails Tota l

Total dr gesin2001 ' $,3,168 $ 9,501 $12869Cam payments (11891) (2,530) (4,471 )Balar atDeoemLer31 , 2001 1,277 6,521 5198Cash payrrWs ( (2,855) ( 2Ri~daficaton f 1

Balarlce at December 31, 2002 - 5,243 5,243Re mery of cfia[g (2$1) (261 )C.ashpaymats - (1,685) (1,685 )

B>ei'anrx akL3eoen 3.1, 2003 $ 3 ;397 $ 3 .297

Asset Wtite-offs

Primarily as a resit of rash uoturi ng adivities .i n 2003, the Company wrote off $0 .4 rtii l l i on of fixed meets in 2003, which were detami ned to have norema ni ng useful life Asa resrlt of restruoturi rty .a t vities in 2002 and 2001 , ado rapid deli ne in demand for Awes Network El edronics (ANE)godud* Cart n property end eq i pram were daterminod to have no rerra ni ng useful I ife, Dun rig 2 00; $1 .3 mil lion of fixed assets were wri tten-off .

unng2001 ,$1 .6millionrelatedtofixedaseets aoquI' redfromANEweredeterminedtohavenoremalrr useful life and werewntten - off .Theirnpairedfixed assets in each pe ri od represent the rot boob val ue of idle manufaduri ng equipment IsasaWd , and office eo pment:

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NOTESTQ CONSOL I DATED FI NAfNCRI . STATEM ENTS-(Continued )

From Septet 1E99 throwgh December 20W the COT aoqured ten corrpc~n'a% In M arcft:30(31, the Company eval t tdtgd .the carry) ttg value ofoertan long-lived assetsaid aafuired intarigible~ cbr~sGng p1nTar1ly of goodwill recorded on itsaon lidatetl balatetieet. PtxsJa1tb.acoounling rulesapplic 4eatthatUme,dude!gthefirstq{iartaof2001,imansbleassetstr, ltng$1 .63,1 .miIlion,refa6adtrscerta[n eb4rsw~edeem . totieimpairedwith no f utu a value and were wnttenôff. Fu tha the aorei aitioned dw'nturnsi n tha Ixi rx i pal marketsi n wtYCh the Corrg aiy co rise tq operate,remelted i n a .writs-down of these i ntangi ~f e a is rel aced tb both the Cable and Tel atom segn> tS of $408 .7 mi I li on i n the t1 rst nI ne months of 2001 . Thecaamourrts were i nd uc~ed i n amt write-offs in the Cc?n iy's :o4nsol idated staEem nt of opaati ons In 2001 .

The Company adopted SFAS No . 1 12 on January 1, .2Q02 . The Company reclassified $1,3milinof ailed workfpro neto# accumulatedamortizaadon, with an indeflHitelife; to goodwill atthedate:ofadoption. The Companyte sgoodwill :forimpaiinventu ng'thehero-stepprocesspres~ibedin SFAS No . 142 . The first step isa sae€n for poterlti al impel rrnent, whi l e the second step ti res the amount of the impairment, if any . The impairmentteEtswerecompletedduringtthesecondquarts of 2(X12 and indc ednoimpairment. Dustoadiffiodt.ezsrtiottfcenvironrnentavidheightenedpriceoomiAtion in the modern " telecom burn ses during thethree m©nftended the 30,20M, the-Con y eKpw i ced a s gni fi caret drop in its marke t

determined that the oL* .mre of this test reflected thatthe rernaini ng good vil I of which $9 .D mill ion in 2002this write-off, the .Company had no 1 ntangi bl s ass s,

use of tan itscalryi ng amoirit . The Cai n a non-okh charge of $4.0 n1ias related to the Tel acorn eagmer

During 20Q1, the Company recorded a deferred tai at of approxi nx#eiy $4 .0 nil I ion and. correspording redudi an of goodwil I, for the tax batofforeign net operating l oss c a Tyforwards .related to a previ ousacqui etion. Due to fhe i mpai rment write-off, the deferred tax ass*, and remai ping netdeferred tax I iabiIity were also written-off .

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TERAYON COMM UNI CATI ON SYSTEMS, I NC .

NOTESTO CONSOLI DATED FINANCIAL STATEM ENTS- (Dontirtued)

The fol l owi rig We desci'i besthe i nta igi bI o aesetswritten off duh ng 2001 :

Del daped Cudcnier Custrxw Asaeglbled.Goody ll Tachndoyy Tradernack Relations BOW Workforce Tout

„(Un tha.tpridslCOUaSecyT tUltrapom $ 46,2 $ 0. 9 $ - $ - $ - $0 .3 $ 47 .4OomBbx 65 .3' 16.0 0,2 75.5Irnedia 472 20,0 29 - - 0,3 70, 4Digitrtns'' 8 .2 0.5'i 0.3 8, 0Tel agate 52.8 17.0 - 20 .2 - 0 .8 90 .8Int # Telecom 39 .1! 5.0 :'> - - 0 .1 44 .2TrueChat - - - - - - -

Total Cabte £egn ,t $258 .8 $ 514 $ 2.9 $202 $ 0 .0 . '! $ 20 $337: 3

Tslemrr Segn rt~lainSail 97 :0 44.1 06 141 7AN E 33 .5 10.3 0.5 - 22.0 4.5 50. 8Radwi z 1,87 23 .1 0.2 0.3 43. 0

Total Telecom Segment $149 .2 $ 77:5 $1 .4 $ 010 $ 2 .0 $ :5 :4 $2335: 5

Total Cable and Tdebcm $408,0 $130 .9 $4S $20.2 $ 24 $ 7.4 $572 8 . : .

Thefoll owi rg tabl a desri besthe intaigible.a~ets written off dud ng 2002

Aft"bledGoodwill Workforce Tc*

(I n LhoU nds) ,Cable segrtxntUltraco mCQmBox 01 0 1C)iqitrans 0.2 - 0.21 ntemet Teleoom 0.1 0 . 1Trt.ieChat 2 .5 - 2.5

Total Cabie SeTr nt $27 $ 0.3 $3 .0Telecmn SegT-"t .Mainsail 0.5 0 .5ANE - 0.5 0 .5

Total Td.=m Sogm t $ - $1,0 $1 .0

Total Cable "Tel ecom $27 $1.3 $4. 0

6 . I mpai rment of Long-Term Investmen t

The Company's I ong- I i ved asa is i nd ude long-tempi equity invests During 2002 the Company deterrni ned that die such equity i nvestment i n aprivately-held company wasinmpaire3, The I nvestee sforecastswere not met and market cordtionssgnificantly d0tedorated and accordingly, theCompany recorded an i rrpai rment chwge of $4 :5 million.

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TERAYON COMM UNI GATT ON &YSTEM$, I NC .

NOTESTO CONSOLI DATED FINANCIAL . STATEM ENTS:-.(Continued )

Convertible Subordinated Notes

In Jody 2000, to Company isaaed $500 .million of 5% Converti ble Suborci noted Notes ( Notes) due in August 2007 res.4tir g i rt net prooeedsto tfieCompany of approximately $484 . 4 million . The Notes are .the Company' sgeneral .uneacured obligation and are subordinated in right: of payment to al Iecisti rig and future senior i ndebledneasand to all of the liabi litl es of the Company ' s s t d ari es The Notes are corwerti bl a Into shares of the Company'scommon stock at a conve rsion puce of $84.01 per share at any time on'or after October 24, , IOOttTough maturity urleseprev iouly redeemed orrepurchased The Company cold have rsideen'iod sorn ee or al I of the Notes at anytime on or after October 24 , 2004 and before August 7.2003 at;arederrpti on p.n ce of $1 ,000 per $1 ,g00. prind pal arriautt of the Notes ; pi us accrued w d unpaid interest, if any, if the:alos ng price of the Company ' s stockecceeded 180% of the convert on pre ce , or $1201 for at least 20 trade rxd days withi n a pon od of 30 consecutive trade rV days and rig on thetred rig dayprior to the doe of mail irg of t[ie' redemption noti ce. The Corrpa ' would Aso make an additi onal payment of $193.55 per $1,000 prfno pal amount of theNotes, Iassthe amount of any interea actwally ' d on the Notes beWorethedateof .redemption . TheCompany m .y redeernthe Notes at any time on or afterAugust 7, 2003 at epedfied oricesplusa andu n paidinterea .: Interest ispayableen-aVVAIy. Debt iesuancecostsrolatedtotheNotesw ereapproxirratdy$15.6miIlionandareamortizedoversevenyeasAtDecanter31,2003 , amortizati on of deli[ isimanceco stataled$14 .5million.

In 20)2, the Company repi.rchaaeiiapproximatdy$109.1 Mill ion of ft Notes for $57.6mill ion incasi,rawlti ngin again of2pproxistately$49.1 million, net of rd ated u ran ortl zed iaeionoe costs of $24 mil I ion. In 2001, the Company repu'c1 1 approximatel y . $325.9 mil lion of the Notes for$113.4 mill ionini and $ 17.0mi Ilion in stock, resti ngina0nofapproxi motel y$185.3 mil lion, net of related unarnbrtred tostsof$9.3 mil I ion . The Company did not repucc}asa any N otesdu ri ng 3

In April 2002, the CornpMy adopted ',VAS No. 145 and determi ned that the .exti rgui sfvrient of Its debt did not meet the criteria of an extraordi nary itemasset forth in SFAS No . 145. Accordingly, in 21702, the Company began reporting thega n .from retirement of the Notes inoperating rasilts Asa reaA tofadopting SFASNo: 145, the Company red as6figd`the$185. trill Iionpreviously recorded in 20W aswelreorclinery gainasaoomporwritof operatirgres.lts

Approxi mataly $65.1 million of the Noteswere ou&arxli ng at December 31, 2003

8. Contingences

Litigation

Begi nni ng i n April ZO), several plaintiffsfil ed d a%action 1 awa its in federal court ago nst the Company and cert2in of its off oersand dire tors Laterthat year, thecases were consolidated in :the United States District Court, Northern Disirictof CaliforniaasIn re Terayon Corrrnnicati on syaerre, lno39aritiesLiti gation .TheCoutthenappointedleadplaintiffsVwhoflledan'arnerdedoompla" .In2001,theCourt grarttedinpart end denied in par tdefe dants' motionto dare ss; and.paintffsf[fedaneweomplaint.In2002,theCourtderileddefendants motion to risn[ tf-iatcomplaint,which, like theearlier tnnplairts, alleges that the defendantsviolated thefaderal eaa nt es laws by issuing natei al I y false and rrisl eec6 ng statements and fa I ing todispose material information regarding our technology . On February 24,2003, the Court certified a plaintiff daseconssting of those who purdiased orotherwisoaWu red our securities, between November 15,1999 and Apri111, 2000.

On September 8, 2003, the Court head defendants motion to disqualify two of the lead piai ntiffsand to mdfy tho definition of the pl ai stiff class OnSeptember 10, 2003, the Court [sated an order vacali ng the heari rig date for the pat es' summary j adgrnent moti ons and, on September 2Z 2003, the Courti hued another order staying all ciscovery until further notice and ves frog the tri al date, which had been November 4, 2003 . See Note 16 for subsequentactivities related tothisiriatter.

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TERAYON C OMM UNI CATI ON ia'YSTEM S, INC .

NOTES TO CONSOLIDATED FI NANCIAL . STAT EM .ENTS - ( Contln> ed )

On October 16, 2000, a lawsuitwasfi led againdthe Company and the irdvidual clefendants(Zaki Rakib, Salim Rakib and Rays Fritz) in theCAIforr aS for Court, San Luis Obispo County., This Iawsuit isti Uad 6erttarnv. Tera n ConnJnicatonsB, 1 Ino . The factual alIegati onsintheBertram oornpialnt were s rnlarto those I n the federal d ass a31 on , but the Bertram complaint sought reined asunder state law. Defexlants removed theBertram c a s e t o the Oni ter Slafas D l s t r f. 0 Court, C e n t r a l District o f Califomi a, which. d smiaeed t h e compfwnt a n d t r 2 n s wed the c ow to the United StatesDi Court, Northern Disttiot of California That Court e,+entUdly Issued an order dismiad g the case. Rai stiffs have appeal ad this older, and theirappeal has been set for oral argument on Apri116, 20Q4,

The Company bel fi vas that the of I ega ti onsI n both.the da acfi on and the Bertram caw are without merit,.and it i ntends t, contest U-ee mattersvigorously . These rr>atter however , ootA d prove costly and time owsurd rlg to de fend, and there can be no assurances about the euent outcome .

On Jbnuary 19, 2003, Omni bend Group Limited, a RuWan company , or Orr ri band, filed a request for arbitration with the Zurich Ciraimbor ofCommerce, d aiming danid~es i n an amount of $2 094 ;971) al le d:y ~aus9d by tFie Cornpaity ' s breech of an 8g~ eetYient to sell to Ornnibend 'iertainequipment pursuant to an-agreement between Ornhiherid and Radwi z Ltd ., one of the Co : y swhel ly-owned subs r ar es On Decenber 18, 2003, thepanel of arbi terswith the Zuni ch Chan er of Commerce al I owed the arbtrati on proceeding to sonti nue aga nst RWM z. The CotrWy het ievesthat tthedIegati onsare withoutmerit and 1nterxlstopresentavigor defense in the arbitration pceedings.

The Company, aswell asitsa oniarqbasreo¢ivedldtersfromthirdpertiesdaimingthettheConpany's .tedxiotogyandproductsinfnngearithethird partief patents The Cavrlpany hasconsjlted with its-patent counsel and isin theprotessof reviewing theallega lonsrr e .by such third parties TheCon-pany does .not know whether the third part as wi 11 pursue thei r dai ms of patent i nfri ngemart I n court, and If U- y do, whether the Company would befound to infringe thethird partied patai If the Cornpeny isfourilto hate infringed such third party the Con ar r could be sutajecttosuf rtialdamages wdor an injunction preventing it from ad I ing its products and conducti hg our business A ti onal l y, such t

.WV.ird parti eland additional third pates

could assertinfringatientdaimsageir ttheCompanyinthefuture .Any dairh of patent infririgeme t,whethermeritori ousornot,cooldbe.ti rre conaimi ng, result i n mil y I iti :gati on, cause product shi prnent delays or require the Cornpony to enter into royalty or I i care ng agreannerits Suchroyalty or I is nsng agreerrents may not be wdlabl a on termsaxep*a61 a to the Company or at all ,

The Company I sairrently a party to various other legal proceed ngs, ) n adds lion to those noted above, and may become Involved from time to ti me j nother l egal proceed ngs in thefutwm. Mhi I a the Company currently belloves thet the u l ti p r a t e outcomeof these o t h e r proceed ngs, ind vi duall Iy and in th ea agate wilt not have a material adverse effect on the Comp2rty'sfi.nahcrai p tikn or overall n altsof tsper2kionS I itigation issbjed to i nhe.rent.uncertainties, Were an unfavorabi a rul i ng to acxur in any of the Company's legal proceedings there mil ststhe pose bi l ify of a material adverse i roped onthe company, sresrltsofoperativr fortheperiodinwhichthenilingcoc orsTheestimateofthepotentialimpactontheCompany'sfirraneialpositionoroverall results of operationsfor any of theaboveIegal proceedr :couldcha'igeinthefutre .

9 . Stockholders Equit y


I nooryunction witha1 998preferredsaxi<financing , the Company ieaied Shaw awarrant (AM-Di luton Warfa to purchae.eanindetermi notenumber of shares of Common stock . The And- Dilution Warrantwsseuerdsabla at the option of Shaw during the period that Shaw owned equi ty in the .C o m f y and i n the evert t h e Compe ! issued n e w equity asouritasa t l ow the current mar ket price defined in the A nti -Di l utjon warrant Th 9@Q gregateexerase price was$0.50. The Company issued certai n equity securi ti es that, asof Decanter 31, 2M3,2002, and 2001, reO red the Company to issue anadd 6 opal 37,283, 17.293, and 35,982

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TERAYON COM M UNI EATI ON SYSTEMS, I NO .

NOTES TO CQNSOLI DATED Fl NANCIAL STATEM ENTS-(Continued)

warrants, respectively, to purdmae Jwesof common dock pursuant to thsAnti-Dilution Warrant The .Company recorded expHnsesof approximate(y$45,000, $26,000 and $0.2 million retaking to the iaarance of warrw tspurswarlt to the Anti-Dilution Warrant, . in 7003, ZQ2 and 2001, respe~ .

. vely, Theeaceruewasc6lciliated by rr)QI VPIYin9lhe amtializedfairmarket valveoftheCompanystockby tfies4ieredlutionattrftxdabfetotheAnti-DilutinWarrant In February 200;3, Shank-arvtorreditsownersh .ptoatHrdparty andtheAn -DiluionVlialrait expireduntmerd odAsofDecenb 31,2DM,the Anti-Dil ud on Warrant had expired aid wasndt exercised

In October 1999, a a atorrier of the Cvnlpany entered into an arc reement with Tdeg2i a Ltd.; an Israeli company (Tel agate), . whi eh was negoti ati rig W fhthe Company to be acquired by the Company

' mppany, whereby the customer committed to an invests i n Tel spate i n connection with the acqui stn on of al I . the

oultard rg shares of Tetegate by tfie Coany . The a+slomer committed to provide thi s i:nodment in the avant itiat the aw is tion of Tel sga"a by the,Company did not dose I n Jwuta y 2700, the Co . issued the a stonier a warrant to purchass ~,0CO,tXX) Vices aft Cornpany's common stock at apriceof $30.75 per share; the d oeng price oft err's oomrnon A D& on the date the warrant vrasisa led The WW at wasful I Y Vested ,non-forfeitable, and i mrne iately exereimb! eend has a term of three years Ttie fair value of the warrant, datemti ned asapproxi mate .y $34 .6 n~i Ilion. usingthe El adc Schof es rrrode! , vans ind udedi n the Tel agate purchase pn ce and wasaasod, eruct with.the vat ua of 1h0oustotm~ar rdati or>eip. Thevad ue of thewarrant recited in anon-caih dhargeto cost of .goodsaoI dto b6 amortized over thethree- year term of thewarrarrt In the first quarter of 2001, theCompany wrote-off the i ntaigible assets relad rig to the purchase of Tel, egate (see, Note5). For the yea smiled Dec~rrlber 26QC3 .an ZQ02, the Conp~anyi ncurred no amortization a perw related to the ;warrant. For the year ended December 31 2001 the Company incurred appnozi~ y $2 .9 milli on inemortization expense related to thewarrant The Telegate warrantexpired in .limy 2003 unexerd sect .

In February 2001, the Company issued a warrantto purchaM 200,000 shares of the Company'soom n stodc :at a price of $5.4375 per share; theclosing price of the Company'smmrnon .stadc on the date the werrant:wasissued, in aomee#ion with the December 2000 acquistia1 :of TrueChat, I ►x(TrueChat) . .Under tenT sof the warrant 100,000 mares are vested and exercisable immediately drat the rerr~airii ng .1lX],000 sMaresVest aril becomeexerdsabl a at ft rate of 1124th, per month, beginning Jarx dry 31, 2001 . The fair val ue of the warrant of approx m td y $0 .7 million was calal .ated 4s ng theB l add-Sdiol es method and wesrecorded as additional coven dera6 on relating to the purchase of TrueCfiat . As of DeceMber 31 2X)3, the TrueChat warrantwas exercisable for an aggregateof 200,000 sharesof the Company'sobntmon stock. The Tr ueOhd warrant expired uneterdsed In February 2004 .

Stockholder Rights Plan

In February 2001, the Company's Board of Di rectors approved theaciopti on of a Stockholder Rights Ran under which A I stocldiol ders of record as ofFebruary 20, 2001 received ri gluts to purchase shares of a new spriesof preferred stock . The rights were, distributed as a pion-tenable dividend aid wi I Iex pi re i n ten years from the record date. The n tits wi I I be sine, cisabl a or y if a person or group aeq i red 15% or more of the Compeny'soorni on stock orannounces a tender offer, for 15% or more of the Coipany's common stock . I f a pepsin or group acquires 15% or more of the Company's wniron stools,all rights hot dams except the buyer wi I l be entitledto aoqui re the Company's conwrion stockat a di scout . The Board may terminate the Rights Ran at anyti me or redeem the rights prior to the ti me a person or group atgui resmore tim 15% of the Company's common stock;

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TERAYON COMM UNI CATION SYSTEMS, I NC.

NOTESTO CONSOLI DATED Fl NANCIALSfATEMENTS-(Contihued)


Common stock reserved for iasuanee. isasfollows

Dcu,n 31,

Cora stock o , M.-OCornrnRn 9tOck W TanLs:. ,1 . .F~ployeesf~k°purd`plan _ 2,400,152

28;545,71 1

Stock Option and Stock Purchase Plans

1995 Pla n

I n Mach 1995, the Company's Board of Di rectorsapproved a stock option plan (19 05 Ran) that a cthon ed dwesfor futt re isawce to be granted asoptoristopurohaae acesoftheCompany'soorrtlonstook . tofDeoember31,20D3atotalof4,229,494. areshavebt3enauthorizedforis-usncerelatedto the1995 Ran

1997 PI an

In March 1997, the Company's Board of Directorsapxoyed an equity incentive pan (1997 Plan) that authotized 1,6001000 aresfor fuhre is ar>Ceto be granted as options to purchase shares of the Co pany'soom on stock . In 199& ZOO) and 2)03 the Company's Board of Directors amended the 1997Ran, i naea3 ng theaggregate number ofsha esauthori zed for iaarxe tinder the'1 g97 R an to a total of 15,516,732 s#rares as of December 31,2003 .

1998 Ra n

I n Am 1998, the Company' s Board of Directors authorized the adooon of the 1998 Non -Employee D1 rectors Stock Opti on Plan (1908 Ran),.pursuant to which 400, 000 sh ares of the Company`soormmn stock have been re. ved for future i canoe to non-employee di rectors of the Company . In2002, the Company' s Board of Di rectorsarnended the 1998 Ran to i rxreathe slaves a ithodzed for issuahceby 400,(W additi oral shares As ofDecember 31, 2003, a total of 800, 000 shares have been a ifhorized for issuance t elated to. the 1998 Ran.

The 1998 Ran provides for norr-discretionary n equal ified stock aprons to be issued to nor--employee di rectors of tthe Company automatically asOfthe effective date of the r election to the Board of Directorsarxf annually following each armual stockholder wresting. Pricesfor norq,al ified options maynot be loasthan 100%of the fair market valued thecommonstodcat thedateof grant . Optionsganerally vet and beoomaPxercisabla over a period not toexmed three years from the date of grant. Uneocerasec optsonsacpi re tan years afterthe date of grant .

199 Pla n

n September 1999 the Company's Board of Di rectors aErtfpn zed the adopt on of the 1 999 Non-Offi oers Equi ty I ncent vePlan (1999 Ran), Pursuantto which 6,000,000 sharesof the Company'st omrnon dock have bean reservedtfor future isarino6 to non-offi oer employees of the Corrtparrji . The p an hasbeen arnerxied by the Board of Diredorsto nereaeethearnount of authorized sharesavailalleto atatal of 14,737,826 sharesasof December 31, 2003 .

Al

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TERAYON COMMUNICATION SYSTEMS, I N C

NOTES TO CONSOL I DATED FINANCIAL . STATEM ENTS- (Continued )

Thp 1995arid.1897 Plansprovldefor ingentiic+ stockopponsor nohqu4ified stockoptionrfo be issued toerr0gyees directorsi arxlt mltarrtsof theCompany . Prices for i noentive dodo coons rmay not be law than the fa x rnarketvA ue of the oonrnai st<xic at fl a date of grant. Noss, for nongual i fiedstock options may not be.leett i 86% of the fairmarket value of the ppmrnon dock at the dates f gra,t Optionsae i mner3atei y e?cerdsableand vest ovEa pen od not to exceed five years from the state of grant . Any !guess ed stock issued is sub wi to repa-ettesa Icy the Company et the on gi nal isao priceupon terry nab on of the option hol da'semployment Unecerased options expi re ten years after the datecf Want.

The 1999 Ran provi lesfor nonqual i fi ed at o k . op i o n s t o bs is ed t o n o n - o f f i oar air pl oyecs and consultants of the (onVany : Pri oes for nonqua i fledstock option may not be I:: than 85% of the fa rmarksk vas ue of the >xx n stock at the date.of the gra 1t Options general I y vestand become exa'd sableaver a peri od not to eceeed five years from the date of grant . Unexerdsed opt] ons expire ten years after date of grant .

Dun ng the yeas ended Debeirriber .31, 2002 and 2001, tie Company recorded a ggregate deferred mmpensa i on of approxi rrntely $38,000 a id 535;000,re eetively, represarttirg the cifferex between the grant pri :oe and the deemed fai r vaiu® of the Corrpany' sodrnu stock options 9anted duns ng thepen od During the Y ear ended December 31 .2003, the Coripaiy rfi d not record any a~ditrcr defe red oorr~psisat~ on . The amorb zap on bf deFerreda~n- een bon is be rg die ged to oper<#ior sa d i sbei rig am tized ova; 1}1e :veaing period of the opppns which istypc Iy. .five years I n each sub equantrepor{trig pe~9od ( though the vesting period) the terra ni ng tl9ferred compensation wi I I be remeastired. For the, yearsend J Date it 31, 2003, 2002, and2001, the a rc tirati on etperue was approxi metal y $53 ;000, $a.5 rr I l i:on, and $D. 5 m I l tort, reseed vet y .

Dun rig 2002, the Company id 20,000 nornquelifiedstook optionsof common stock to a r nester of'its Board of Adviabrswho isajsc a Ali re torondChef Executive Offs oar of one.of Itsa etomer$ and recorded $38,000 i n related oanper l on a periee. The compensation expense was calculated usingthe d od ng price of the Comp®ny's common stock on the daft the stock was iswed of $1 :96 peralwo

During 2002, the Company issuad 200,000 Shares of common $ock to a cunsaltant and h orded $280,000 in retested tmmper"on ®cpaisa. Thecompenseti on expense was call out akedusing the d oa ng price of the Company's common stock on ttie date the soOkwas I saved of $1 .45 per share.

n Juie2001, the Company ias .ed 16D,000 sees of the Company' s common stock to members of its Boafd of Advi sots and recorded $0.6 mill ion inrelated corrpersation ecpense. The compensation ecperm was calculated using the closing price of the Company's con rt stock on the date the stock wasiseued at $3.72 per thee.

During 2001, the Company issued 115,250 sharesof common stock to i is empl oyees and recorded $0 .6 mi I I i oh i n related compensation expense: Thecompeisati on expense was cal cut ated usi ng the d as ng pri ceof the Company' scortrrion stock on the date the stock wasisaied at $5 .57 per share

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TERAYON COMM UNI GATT ON SYSTEMS, INC .

NOTES TO CONSOL I DATED FINANCIAL. STATEMENTS- ( Continued )

Thefol lowi rtq is.a same ry of > d iitional i nformati on with re> to the 1995 Plan, the 1997 Ron, the 1998 Plan, the 1999 Flan, outstand ng optionsasurnedby ft Corrpenyin oaijuiiti onwithiislx inese.aogwiAti olsadopti ongra,t made muW detheplari5 (ifany) ;

OptionsOgiitandingoptic s

Available(or Number of Waghted-AvarVeGrant shares ExedeePrwe

al atlce at aeWtlt» 31, 20C~(i < 8r84f)0 21,489,536 $ :39.27Optonsaittbri zed 13, 000,QMOptivnsgwted (22, 925565) 22, 925,565 :Opbonseceroaed Z 24224) $ 4 .59Opborsraneeied 2 .9,4&3,1:41 ( 1,483,141) $ X93

Balance at December 31, 2001 20, 397,6 24 Q47,686 $ 975Ciptons a ri zed 3, 40 3,I7~1Options grated (1,734,40D) 1 ]34.400 .- $ 540Cboiismceraaed {7."~1) $ 3 .95Optionscancded 6,849, 540 (6, 849,540 ) $ 12 .66

Baia wat 0 azernt 31, 2002 28,912,8tJt3 i4635,fl25 $ 8 .05

Opti ons awRitori zed 3,0 0,,000 -OptioFis reduced (20,EYY1,009) -ODd ons9rantecf (7,153,320) 7,153,320 $ 3.05Optior,secercised f 272 $ 4.20Opbonscancded ,3,722114 (3,722,114)3 $ 7.58

84womat Decerribe 31 , 2003 ' 84$1 ,5W 17 d63, gE9 '' $ 62)

In addition, the foll owi ngiabl ea rixnari.zes i nfonna ti on about stook opti onsthat wereoutstandi ng ahd exercisable at Deo nbe' 31, =:

Options OutstandingOptions Exercisabl e

Number of Averag eWeighted Number Remaining Weighted Average Exercisable W ei ghted Averag eRange dExercisn Prices Out st anding Contractual Life Exercise Price Options ExerasePrice

$0 .01-S 245 5,480,406 s.'', $ 234 201 .017 $ 1,22$2 .46 - $ 4.26 1,599,731 805 $ 3.77 . . 532214 $ 3.51$438.-$ 6 .50 2,819,153 7.86 $ 570 1,197,386 $'' 566$6,52 - $ 8,39 6,483.914 7.23 $ 6.85 5,15Z720 $ 6.82$8,51 - $123.50 1,080,756 242 $ 26.86 684,176 $ 27.56

Total 17,463,969 7.98 $ 6.20 7,967, 513 $ 8.58.

At Dscernbr 31, 2093, tFiere were no shares of the Company' s common stocks jet to re{xrdrase by the CGmpany .

Employee Stock Purchase Plan

In Jr*u1998, the Board of Di rectorstapproved, and the Company adopted, the 1998 Enployee.Stock Purchase Plan (ESPP),'which is dedgned to allowel igi bleer oyeesoftho.Conipanytoptrchasemaresofcommon stock atwmi-annual intetval5throughperi odicpayroll IdeductionsIn2002,the ESPPwas amended

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TERAYON COMMUNICATION &YSTEMS,INC .

NOTES TO QON SOL I DAT ED FINANCIAL , suTATEM ENTS - ( Continued )

to add an addi ti onal 3 OOOOpR shunt:t o tsle ESPP. An ay agate of 4;400,W O stares of tin stockers rsearved forth* ESPP , d1,$48eheat i sa cl tfvough Deoetl4ier 31, i>The ESPF i s irrplerinented i n a seii es of arbpemve offerjrtg pen de; esct with a maxi murri durati on of 24 moat is

dai~tedthatcan lae ±~aesf to {xrd~aae sharesof theao>rimort stock on specafie dates determinedEfigible.errployeescan hsvaup to 15%of tltietr lase salaryby the Board of Directors (up to a n iii nxsri of .$25,000 per .year based upon the fair market value .of the sf>aftat the beginri ng date_.of the offeri ng) . Theprice of c>xrrfion stock purl asa 1 uhde.r ie ESPPwI I be equal t o 85% of the I pwar of thefalr morketi :val ue of the common stock on the oorm et nd a t e of each offeri rig period or the spitted purdi asa date. I n November 2002 the Company ' s Board of Di redorsaiended the ESRP after the currentoffering period a pi res{rya l ater tft7ii July 31, 2004) ..

Tha .Company haseleoted to follow APB Opinion No . 25 and related interprdatior inaooountirtg for its employee stock plans because, as ds0.~edbelow, the altema've fai r vat us aaoountirig provi ded for urxier SEAS No, 123 regal resthe use of vai uadon modelsthat were not developect for use invaluing employee stock i ns7wnet1ts Under A PB Opinion No . .25, when Ahs .ecerdse price of .the Company's employee stock opti orisequal s the maket priceof the under) yi ng dock on he dale of grant, no compensation expense is recaognized .

Pro forma information regarding net I ossisrequi red under SFAS No . 123:arid iscaipulate+d as if the Company had aooouited for itsempfoyee stockoptionsgranteddiringthe y.earsendedDecerrtaer31,201 2002, and 2001 and for itsESPPdiarestobeissued L derthefairvaluemethadofSEAS N< 123 . The, fai r valuefor employee stock options granted and ESPP shareswas es(i matted at the data of grant based on the Black-S0iofes modalus ng the fd I owi ng wei ghted average assumptions

Ric Free Risk Free Risk FreeInt steel Rate IntatestRate IntrreetRate

20i3 :20M 2001

Stock option plans 2 .67% 4.22%Emil, oyes stock pischase pi an 2.88% 4.366%

Dividend Yield Volatility Factor Volatility FactorAll Years 2003 2D02

Stock opti on plans 0 .0 0,87 1 :.50Employee stock purchase plan 0 .0 1 .54 1 .50

Weighted Aver age WeightedAveregleExpe 6ed Life Expected Life

4:50°,4.14%

Volatility Factor2001

1 .501 .50

Weighted AverageExpected Life

2001

Stock option plans 5.0 5.0 5.0Employee.stockpurda plan 05 0 5 0 .5

As disaied above, theval u2ti on models used under SFAS No . 123 were devel oped for use in esti n~atf ng the fai r vat of traded opti or s tt have novesting restri lions and are fullytransferable. I:naddition, valuation modelsrequi re the input of N ghN y "jedive assumptions;inducing tfie expected life oftheoption Boom mtheCorrpany'sennaloyeestock opti onshave ctnrsglaisyessignificant ydifferentfrom thoeeoftraded onsandbecause d xgesinthe eubj ecti veri nput assumptiono can materially affect the fair vat us estimate, in rr art2gement's opi rii on, the exi sting modal snot necessarily provide areli a61e sngl a meaaie of the fai r vat ueof itsemployee .stock ir>sstnxnenta

The options' weighted average grand date fair value, which i s the val us asagried to the options under SFAS No .. 123, was$2.14, $4.98, and $5 .83, foroptions granted dud ng 2003, 2002, and 2001,re * ivel y . The weighted average grant date fai r value of ESPP shares to be i ssied was $1 .00.$2.25, and$3.99 for the years ended December 31, 2003, 2002 a d 2001, req,ec tivel y .

Table of Contents

TERAYON0OMMUNICATIONi ?STEMS, INC .

NOTES TO CONSOLIDATED Fl NANCIAL . STATEMENTS- (Continues{)

10 . I noome Taxes

For tth years eryded D rnf 31, 23 ; 2 and 20p1, the Conpany hod an i moats tax expe yse of $0.3 riii I I ion,'$0,2 mi I I oft, and an i noorretaxbenefit of $13.9 trillion, regeetiv y.

Yeer$;End iDeoer 31,

2DU3 2DO2 200 i

On thousnd qCurrent

Federal $ - $ -_ _ _ -`State 20,Foreign 316 218 831

Tote! Ghent 316 238 831Deferred - - -

FaJeralState - -

"Foreig (14,746)

Total deferred - (14 ,746)

Total $r31fi . . . . . . . 238 5 {.f3~1s) . : ,

Therecondliationofi>cometaxbwditattributabletenetJossapplicableto comm sfodihddersconi ufedat U .S.federelstabitory ratestDinoornetoc benefit (in thou ) ;

YearsEnded Decenba 31 ,

2003 2002 2001

Ta< benefit at U .S. statuto ry rie $ (t7,624) $ (15;391) $ 19T 346)Goodwil l 'rrtization - - 2,849L(A for fi'&rxi ,tatbenditisciTerttyremgitizabie 17;538 15,391 179,338Other, net 404 238 1,244

5 316 b 238 (13 91'5)

83

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NOTES TO CONSOLIDATED FINANCIAL . STATEM ENTS -(Cohtinued )

y fferenops nreerthecertyingamaurits ofaeaetsarxl liabititiesfor firmrxaal reportingDeferred incolnetamreflectthenottateeec tamporarpu ses"theaipunfsusedforIhoonte.taxpurposesSgrifirantconponentsoftheCompaq'sdeferredta(asa®tsandliabiIitiesasofDecember 31,

and2D02areasfallows(inthous :

December 31 ,

2003 2002

Deferred tax as itsNot owati g l carryforwards $ 149,82 $ 118,021Tat credit carryforwards t9,5C~5 14 16

Resaves and aogvals 9,949 96,428Captaiized!rGWW0h dda dope l 9,761 4,372Intangiblesamo rt ization 38,8&4 2.61 6Ott er, iei 12130 8,430 i ;

Groasd Fared tax asp is 239~07i 2.44,8(?3uaEuauSFia1tovtarce 03907'f) (244,ea3)

Tow deferred lac ate . $ - $ -

Reelizationofdeferredtaxassettsisdependeltonfutureearninge,ifany thetiMingandtheamountofwhichareuncertain.Acoordiingly,avaluadionA Iowans. has been edta l i shed to reflect %ne urce tainti as as of Decanter 31, 2003 and 2002 The chars . i n tha val uati .on al lowence wasa net dacrearof $5.7 rniIIion and a net increase of approximately $28.4 million and $867 million for the years ended December 31,200 B,, 20 OZ and 21)01, respectively,Approximately $44.2 rri Ilion of the vel uati on allowance wil I be credited to equity when realized :

As of December 31, 2003, the Company had fed" , Cal ifornia and foreign net oper ating Iosscarryforwer'dsofepproximatery $340 . 0 milI ion,$129;0mill ionand$107. 0 million, reepecbvd y .lireCompany also had federal and California tax creditcarryforwardsof approxirrmately $9-0 million and$16.0 million, respectivef y,. Tiiefederal: and California net operating f oes and aad t earryforwards wi l l expire at various dales begi nni ng in the years2004th ro ugh 2028, if not utilized . The forei gn net operati ng Ioswshave :an unlimited carryover period.

Utilization of net operAi rig Ioasand tax credit canyforwatds may be subjec t to a auf uyti al .annual limitation due to the owne rship c harxg e I imitati onsprovided by the i ntemal Reierwe Code of 1986, as amended, and smil arsate provisions The annual limitation may re sult in the ration of net operatingloss and tax creditcarryforwa-ds before full utilization .

Defined Contribution Plan

During 1995, the Company adopted a 401(k) Profit Sharing Plan and Trust that allows digibleemployeesto make co ntribubonseibjectto certainlimitations TheCor any may make discretionary contributions based on profitability asdetermined by the Board of Directors Noamountwascontributedby the Company to the plan during the yea ended Deoerriber 31, 200'3, ZQ02, and 2D01-

12 . Segmentsof an Enterpriaeand Related Informatio n

5nce l ate 2000, the woridwide telecom and tel Iite irdudirie3 have experienced severe ddwnttmsthat have resulted in a gnificantly reduced purd>msof new broadband equf prnent . 6ecauseof this overal I drop in demand, the Company has rdocused :i is effortson the cabe i ncl ry, and has s gni firxnl}yreduced its i nvestment i n the to ecom and satelf rte businesses Consequently, beginning in 2003, the C.ornpar y's Previousl y

84

Table of .Conterits

TERAYON COMM UNI CATI ON &YSTEM$, I NC .

NOTES TO CONSOL I DATED FINANCIAL . STATEMENTS - (Qontinued )

reporteclTelecom segrr t no longer meetsthe .quarititattve threshold for diadosi re and the:Con ny naw opetatesas onetxus riessaegrri t . Tf afore,operating itcdedosureforElieyearendedDeoerib 31,2QD3isnotprovided .

Ri or to D e r bar 31, 2002 ; the Compai t opted pri nian l y i n two principal operating aVma t Cagle Broatlfiand A ocessSysterrss (C le) andTel eoom Carrier Arxms S}jstw-6 (Telecarr ). The Cabl e.segrrent cXifl sted pri n ril y of TeraConlrn Sy i,, TJ I i ne of DOCSI Stahl a tltodet* BI ueuvaveI ine of DOCS S CMTS. and theCherryRcker fernily of Digital Video M ana rent S~rstemsthat a e Id prinYrily to c~bleoperatorsfor the dq oym rt of .data, video, and voice eervioes overttieexisting able i nfradzuc ure . The Teteoom segrvnkcora steel p1 marl ly of MiniAex DS, Systems, I PTL OonvergeclVoice and Data Service 5ysèrn .and Maim= products, which are sold to providersof broadband services for the deploymenttof voi .coarxf data.servicesoverthe existi ng copper wire I nfrastu8ture . The Con ey do1wrninod thew repoittl a operating gPgTwftba%c1 in how-the neseeswere rna rged andoperated .

Inforrrotion on reportabie seg mentsis:asfdlows (inthouswds'

Y rsEnded Decamber 31 .

2002 20Ct1

Cable Broadband AOOe%%gnw .tRevewes

TersComii system $ 68,753 $ 192,757TJ DOC51S cable moderns 23,059 25,069Video products 20833 16,363Other 6,284 11,639

Total Gabler ve noes $1118,929 $ 245,828Depreciaton acpense $ 10 ,347 $ 12,02$Operetrngloe. $ (75,731) $(466,435)

Tel worn Broadh nd Acce%Segment :Rees

MiriRex, DS. . Systans $ 8,366 $ 23,41 7cow 2108 10,236

Total Telecornrevenues $ 10,474 $. 33,EDepreaabonexpe- $ 1,225 $ 3,7UGC>perakirg Io $ (10,852) $(297697)

Total rare iu $129,403 $ 279,481Total depreciati on e(pense $ 11,572 $ 15 .728OpGr4k ng lases

Operate r g I oas by reportabl a segn-ierds $ (69,583) $ (763,132)Urvilocated arrountsIoter and other income(expor +e),r et (3,481) 44Ga n an ea lyi eti rerr itof debt 45,089 165,327Ino metax (Eu pense) t enefit (238) 13,91 5

Netjgw $ (44,213)..

$(5Li8 )r

85

Table of Contents

YearsEnded December 31 .

2063 2002 2061

United states $ : .74,341, 5 31,15q . . .. 5Q 29 1Car,da 3,145 . . .. 17,247 . :_ . 113,300_

_, Europe,' 17,695 '' 11,381 34,952IsaEl 7,038 8,283 16,528 . . .. .Japan 21,183 36,214 37,721Asa, exd ud r ,lawn 9,575 11,845 24,( 4South Aroei$cd 563 :! 3283 2, i

Tom $133,485 $ 129,403 $279,481

0 anba 31,2002

AssatsCad e Broadberxl Aare Segment $ 217,531T@feoom BrtafAcesmt 58,1 T8

Total aseets

Long- 1 ived asGets

$,275 ;71 0

Decanber 31, Dewnbet 31,2003 2002

United States $ 19,630 $ 28,169Carl" 810 787Europe 175 1701 sael 3,104 3,442Asa 17,3 207South Amanca - ' ; 11 8

Total I o rg-l i ved omAs 23 , 892 3289 3Total currert ase;ts 191 ,348 :! 242,81 7

Total assets $215,240 $275;71 0

Ttree o. omes; Adel phis, Cross Beam Networks, as ibsd Ury of Sunrotomo, and Cor<reE accounted for more than 10% of tatal rever u for theyearailed Decd 31, 2003 (22% 1666, and 13%): One customer, related to the CaW a sVr exit, Cross Bearn Networks accounted for more *mm 10% of totalrevenues for the yea eticled De~anber 31,2002: (28%). Two armor a~ 5 aid Gloss 6eatn N etworks both rd ated to the Gaol a segn a it aczount& for10% or snore of total revenues (33% aid 13%) :for the yea ended Deoernber 31, 7001 . Two a~ston 5 acopwited for 10% or more of total accountsreoei~abl a for the year ended Dec +tlber 31,2003 24% and 20%) . One at omen .related to the Cabl a saga f, accouultted tar 10° or mote of total acmtmtsreceiuable for the year erxie~ Dec~erriber 31, 2002 : 24%).

TERAYON COM M U N I CATI ON SYSTEMS, I NC .

NOTES TO CONSOLI DATED Fl NANCIAL . STATEMENTS-(Continued)

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TERAYON COMM UNI GATI ON SYSTEMS, I NO .

NOTES TO CONSOL I DATED FI NANCI .AL. STATEMENTS -(Contihued )

13 . Related Party Transaction s

Dun ng the yeas ended December 31,'20X3 , 2002 and 2001, the Company recognized revenue of $4.7 mid lion, $9.1 m+11 ion , and $524 Hil l ion,resp sdivel y in connec ti on with product shipments made to related parties Prior to the third quarter of 2001, both Share and Rogers, each bf which . had. onerepres tati veonthe ~per~y sBoardofDirsdorswere signiflc3t* AadchddersadwererelatedpatesBegirdrtglntttethirdquarterof 2001, Shawwas no longer a s gnifi t stoc ho1 der bs SI a no I onger cacerq sad vo ti ng ri ghts over i is straresl n the Con atiy , and the board mernber from 5tk vresi gned . Accorth gly , S iaw was no longer considered a related party. Revanuesfrom Shaw have not been in cl uded asreve uesfrorn related parties afterthe saoond quarter of 2001 , when Shaw cawed to bea related party. In 2001 , the Company recognized $31 .4 mi l li on .of related party revenues in connectionwith product shi proft to Shaw, riot of arnorti on of co-marked ng expense .

Alek Kr34ic, a meter of the Conlpeny '.sBoard of Dire ctors wasthe Senior Vice Pi dent of I ntern tIveServioes, Salesatd Product Developmentfor Rog ers until tanuary 2D O3., Beginning April 1 .X003, the Cam ny no longer recd . reverwesrelated to Rog ersasrelated party revawesasRogerswas no longer con sidered to ba a related party . For the year ended 41X, 20)2 and Z01, the Company recognized $15 :mil l ion, $8.0 million, an d$21 .0 mi Ilion, respectively of related party re✓erxxas i n connection with product sH pnrw ts to Rogers, het of amortization of oo -marke i rig a per>se .

Lewi s Sol onion, a member of the Company's Board of Di rectors and Chad rnian of the CotY parry' s Audi tCormi ttee isal so a member of the Board .ofDirectors of Harmoni o, Inc . (Harmonic) anrarwfacturerandsetterofbroadband products InApnI ZXf2,the .Corrpanyentered intoaresaileragreementwith Harmonic tos41 certain oftheConpAny'sproducts The agreement appointsHammgnicasanauthorized, n n-acdusvereadlerofcert+ainof theCornpaly'svideo products For the yearsended December 31, 2C03and 2002, revaiuesfrom Harm icof $32 rrxllion and $1 .1 million, reqoectivefy weincluded ;weverwesfrorn related parties

Cost ofreletedpastyproductrevenuesintheCompany'sconsolidateddaterratsofoperaxlonsoortes of di red and Indirect product costaAoorsreceivabl a from Rogers:and Harmonic totaled approxin tdy $O6 f i II i on and $0.8 m II i onat December 31, 2003 and :2002, respectively . None of therd aced-parties is a,g-#V 1 er to the Company .

InDecurbar2001, the Company entered into co-merketlng arrarxfarneitswith Shaw and Rogers The Co-ripany pad $7,5rniIIion to Shavi and$13.9 million to Rogersi and recorded tt se arno ntsas other o xrent meets The Company eared into tt arrarxde rarts wi th Shaer and Rogersto promotethe Company ' s brand and iden ti fy i is produc15IIn July 2002, the Company began aniorti n ng thesis prepaid aseelsand charging them agai gat Cable revenuesin aooordalxewith EITF D1 -09, ° Accounting for Consi deration gives by a Vendor to a Customer or Rescuer in Corwmedion with the i3ac or Promotionof the Vandoe s Rnduce The Company charged $1 .4 mill ion of amore zati onof these meets ~a net revenues i n each quarter beginning i n the third t terof 2002 through the .fourth gi : nrW of 20073. Amourie diarged against revemies i n .2003 and 2002 total ed appro d rnatei y $5 .6 mi Ilion add$2.8 million, .respectively . Of the co-markati ng amortizvi on dtarged to total revenue, approximately $0.15 million and $0.3 million were charged to related part yrevenues i n the year ended 2003 and 2002 , resliecti vel y.

In October 2002, the Company Inarredamarket]ngexpenseof $150,CO) for Team Honor, anorganization that supports aprofs or Bailingteam.One of the Company's Board membersAleksnderKrstajicisthefounderandFiresdentofTeam .Honor.

14. Product Warranties

The Company provides for esti mated productwarranty expenses when it sells the related products, Because warranty eeti matesare forecasts that arebased on the bed available information - mostly historical

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TERAYON COMM t1NI CATI ON SYSTEMS, I NC .

NOTESTO CONSOL I DATED FINANCIAL. STATEMENTS -(Continued)

dalmsecperiepee-daims costsmadydifferfroni arnountsprovided. Anw4yssofc gesintheliabil ityfor productwarrantiesisasfollows(inthousads) :

Additims.8alanceatB~ nnfngof Period

Charged toCabisandExp- s write-Offs

Salarweat En dof Per iod

Y%rendad DeDarber 31, 200 1V rty reserve $5,925 7,956,_ (5,513) $ 8,368

Year ended Dwernber 31, 2702Warra,ty reserve

Year endec60OQent r 31, 2003$ 8368 Z730 (,491) $ 8,60 7

Warranty reserve $ 8,807 2;287 (5,385) $ 5,509

Guaranteas~ Including Indirect Guaranteesof Indebtedness of Other s

In additi on to product warranties, the Cantpainy, from ti rne to time, i n the normal court of business, indemnifies other partieswith whom it emirs into :contractualreiadori ips,indudrig .c rho lessors,aridpa'tie$todN1etttartsadonswithft.ConVWy,'With re tocatnMatteMTheCompanyhasagreed to holdftother party iwmiar lessaainst fi od loss such asthoee and rig from a breech of repreeeritati ansor mvwmnts, third party d ai msthat to Teayon'sproductswhen ueedfor twit intended purpo*s) infringe the Intdl actual property rightsof eutFi third party or othef dams madeagairistdertai n parties I t is not pond bIe to determine the nwim.rn potential m urtt of I i abi I ity under these i ndeimifietation o6l igatiansdue to the I i nrted history ofprior Indemnificahondaimsandtheuniquefactsaxlofr that weIikelytobeeinrolvedin each perti4uisirdsfm. Histoncall Iy, peyrnentsmadebythe Company under these obligabonswere notmaimal axJnoIia libeshavebeenrecordedfort .obligafonsonthebaianciesheetsasofDecxnber31,2003 or 2002.

15. Sala of Certain Assets

I n July 2003, t h e Company entered into an e Q r e w r f f d with VeriIink Corporation (VeriIink) to W certain asaetsto Vedlinkfor lip to a maxi murn of$0.9 rni 11 ion . The Cotrrany received $0.45 rni I I ion inJul y 2fb3 and wi I I recei ve adciti oral payments totaling up to $0.15 mil 11 on.tFro h December 31,2004 . The assets were ongi nal I y acqui red through the Company' s acqu%sti on of A.coes; Network 9 ac troni cs (A N E) i n February 2000. Add ti end I y,Vq-il ink ag reed to purer at I ead $2.1 mil 11 on of related inventory from the Company on or bef ore Decernlier 31, 2004 , A sof Decemba- 31 20M,Verilink had purchased $0.7 nuilion.of this .inventory .

As part of thisgreemait, Vetilink agreed to assume all warranty obligationsrelated to ANE pradi ctssold prior to, on . orafter .Uy 2003. TheCompany agreed to reimburse Veal ink :for up to $24 trillion of cerfainwarranty obliga6onsfor ANE productssgld priorto Ay 2003. Further, Verilinkassumed the obligation for one of the Contpeny`s operati ng l eat previously accreted as redruoturi rig, resulting in a recovery of restruduri ng _doges of$03 million in 2003.

16. Subsequent Events (Unaudited )

In the fi rat quarter of 2004 , the Company initiated a Worldwide red )c#i on in force of approxi nr tely 70 eirci oyeec or 17% of the workforce,consolidati on of ce tai nfacilities, , and reduction or eli nil nati on of certain discretionry aosteand programs . In connection with this restructuring,: theCompany will seek to sub1 mseap{xoxi mately 5& , k00 squarefset of i is Septa Clara , Cafi form afaa l i ty . The Company apels to record tatal diarges i n therange of approximatel y $ 5.0 mill ion to $7. 0 mi l l ion associated with tftis red gnment in the quarter ending Mard-i 31, 2004 .

88

Table of Contents

TERAYON COMM UNI GATT ON SYSTEMS, I NO .

NOTES TO CQNL I DATED FINANCIAL STATEMENTS- (Continued )

On Febrtary23,2004 , the United Distri ct Court, Northern Pisttict:ofCalifornigisa,►ed8nordercisgimlifyingttooftheleadplain ti ffsintheda:$acti onlawwits aga rrt theCorrpany . The.orderaiso thatplairttiffs' a o u n s eI n &provideeataininforrrra ti ontotheCoxrtatioiicoun5d'srelati on ►ipwiththede.qualifi edleadpl ai naffs;and. it provides fiatdof thtsmayserveperWnaddiaanaldi .sove ry.

17, Unaudited Quarterly Financial Dat a

&rrwnarizedquarterl y fi nanaal data for 200 and 2 O2 i s:asfoll ows(in thousands accept per sharedata) :

Quarter

2003 Fire Smand Third Fourth

tci revex*S $71268 $ 36599 37, 8 . $0.299 0Gro$profit (10 1 2,675 6,863 10,104 1.271 91~e9ruetunn3 oasts (rmovery) and t write-off i) (3162) 116 244 _Net loss (23,8889 (13,139) (7,210) (0,015)$r Eandci► i&edt► et to per sEtare

,$ (Q33 $ (am) $ (Ql0) .$ ttl }

Quarter

2002 First Sawnd Third Fourth

Total re er s $57,218 $22407'' $24,475 $25,3MCross profit(Ioss) 25,491 (27) 29$ 2,69 4Re&t, kut rn ea is and abetwrite Off 1) - 3,972)

((4,950) -

Net 10*2) (4,090) 3685) (15,972) (20,466)B agic arid d,IutedwImper 1we $ (0<tl6) $ (0.05) $ (0.22} 5 <•f0 . )

Earn ngsper share are comp<ked ndeQendentl y for each of the quarters presented, The sum of the quarter) y eani ngs per share, in 2003 and 232 does notnecessari ly equal the total oarnputed for the yaw due to changes in shares owfatanodi ng and roundi rig .

(1) See Note.5 for an et pl anti on for redrvduring and aseet write-offs

(2) See Note 7 for an ecplarti on of the gains on repurdme of subord rated Convertible Notes in the saoond quarter ($33,276) and third quarter($15,813) .

89

Exhibit D

Table of Contents

SECURITIES AND EXCHANGE COM MI SSI ONWashington, D .C . 20549

Form 10-K

(Mark one)0 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE $ECURI TI ES EXCHANGE

ACT OF 1934

FOR THE FI 9CAL YEAR ENDED DECEMBER 31,2004

OR

❑ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE:SECURITIESEXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMM ISSION Fl LE NUMBER : OW-24647

TERAYON COM M UNI CATI ON SYSTEMS, I NC .(EXACT NAME OF IEC,IS[RANT .AS EOFIEDIN 1 7SCHARTEM

DELAWARE 77-03 29433(STATE OR OTHER JURE ICTfONOF IRSEMPLOIERNCORPORA7I ON OR ORGANIZATION I D~NTI FI CATI ON NO, )

4%8 GR EAT AMERI CA PARKWAYSANTA CLARA, CALIFORNIA WIJ54

40 M-IN(ADDIiE$ , I NCLUDING7JP GORE, fND 7E EL PHOrE IBM INCLUDING NFiEA CODE, C TFI EWGIStR*M3PRNCtPAL EXECVT1VE UFFICE 4

SECURITI ES R EGI STER ED PURSUANT TO SECTION 12(b) OF THE ACT :

Title of Each Class . Name of Each Exchange on Which Registered :

None None

SECURI TI ES~REGI STEREO PURSUANT TO SECTION 12(9) OF THE ACT :COMMON STOCK, par value.$0.001 per there:

(TITLE OF CLA$S)I ndirateby check mark whether the regi strant ( 1) half it ed 2II reports required to be filed by Section 13 or 15(d) .of the 5eairiti es ExdiaigeAct of 1934

during t h e prec r xg. 1 2 m o n t h s (or for s u c h shorter 'hod that the registrant was required t o fi[e such reports), and (2) hasbeen subject to each fi I I rigrequirement for the past 90 days . Yes ; No O

I nc6 site by dieQk mark if rli sdosre of dd inquent filers pursuant to Item 405 of Regulation $-K i s not contained herein, and will not be contained, tothe .bedofregi ifsknowledge , indefinitiveproxyoriMbrrna[ionsta birzorporatsdby reference in PartIll of thisForm 10-Kor any arrendrnentto this Form 10-K. ❑

Inrirsteby check n*arkwhelherthore.9 strut isanooWerabod .ffiler (asdafinedin Rule12b-2ofthAct ) . Yes® No ❑The aggregate market val ue of thevod ng dock held by non a ffi I iatesof the registrant was approximate) y $140,449,OW on June 30, 2004. For purposes

of thf a cadoul ation only, the repstra t has excluded stook benefi dal ly owned by directors and off hoer By doing so, the reg. strsnt does not admi t t[-at suchpersons are affi l iateswttlii n the meaning of Rule 405 u the Seariti es Ad of 1933.orfor any othw purpose-

Indicate the nintsw of sfiaresout stand ng of each of the registrant 's dasesofcoirrnon stock , as of the I shed practicable date Common Stock,$0.001 per value, 76,786,521 sharesoutstard ngasof February 28, 2005.

DOCUMENTSI NCORPORATED BY REFERENCELIST HEREUNDER THE DOCUMENTS FROM WHICH PARTS THEREOF HAVE BEEN INCORPORATED BY REFERENCE AND THE

PART OF THE FORM 10-K INTO WiI CH SUCH INFORMATION IS INCORPORATED :

spat Part I I Comtuii cati on Systems, Inc definitive Proxy Statement , to be filed not. [ ater than 120 days after the end of the fiscal year covered by thi s

INDEXTERAYON COMMUNICATION SYSTEMS, INC .

Page:No .

t 1 5l) NESS ~~ 3It~xn PRO .R1 fES 11Item 3. 11I tan 4. E I P :F I 13

4QN E U I,r EtMARK E,TF~ REGISTRANT'S rx 'y R 8TEJZ9 IsHOLD EliMA TTERiAN i JER S F t TY TI - 13

16

Item 7

Itern 7A .Item 8 .i

Item 5A .lts„s6.

[tar 10,Item 11 ..Item 12.

Item 13,Item 14 :

URES

1o:TEx I' 10:

BIT 10HI7 1 1

E)C IT23 ;1EXHIB T31 .1

175456

93

95

9595

068698

96100

IT1FX JTEX

EXHIBITS. FINANCIAL SfATEM NT SCHEDULES

Table . f .Contents

Item 8 . Financial Slatemenlsarid SLpplemotary Da ta.TERAYON COMMUNICATION SYSTEMS ; I NC,

INOE) TOCON8oL1DATED FINANCIALETATEMENTs

Page

ReficrtS Ern & ` ou,gL .Iiiriepelx t i~wod #?iikifi~sAc ou1ingRrtnGata1i da~ec~Balar, Sfieeta:: &Q.CorisnE~F aJSt eYiit~rtst 6pr » . .; ?i :' E1<>Gal lsoli si enl~tlf Rf Stc kt~plslet . .~q.. ,i;or+so[i B etMi~ttsof• Stt F~ st9: " 6 6Nobesto Consdidatef.Finandal Saerr wts 6 5

56

Table of Contents

Report Of Ernst & Young LL P, I ndependent RsgisterodPublicAocounti ng Firm

The Board of Directors and Stockholder sTaayon Communication Systems, Inc .

We have a4ted th& aooonrpanyin9 consolidat e d balance shedsof Terayon Corntruni cation System Inc. as of December 31, 2004 and 2003 and therel ated wnsoli cfa tad statements of operatiorA .tocki'd er ty and cash flowsfor eedi of the lx~e years in the period ended December. 31, 2DO4. Qurauditsaiso included thefinordal SWernentsdtiecl~ia li sèdi i tnd®c at Item 1.5(a)(2) . Thee- fi nancial statemeMsxndsfledutewethe responsibility of theConpany's Our responsibility isto ecpreas an opir on .oh thasefinandai si rientsarad schedule based on our audits

Weowduded our axitsi:naFaoardarrosvvifhthes#ansiar sof 1hofkblicCor npenyi4 ountir g Oversight Board (UniheiStates) . Those fa dardsrequirethat we plan aid perform the .autl'it to obtain rea ®onaWe .assuranoe about wt dher thefinenc ial stetements are freer of materiel fl aternent An auci tindudesexatriiring, onatestbes $ evid~xasuportingtheaniautsaidc 5do5ireeinthefii~haalsfatarr~erstgAnatiltalsoindudesaeaessngthe .ax untirr princi 4es.u d arx! 4gnifis t esb matesmade .by m vQwient, ;a swe I asevalua ting theoverall financial stlterientpresentati on. We believethat our auditsprovide aresswabie i sfor ouropinion.

I n our opinion , the cor kol i dated f i hanaal statements r erred to above present fa rl y, I nail material req3 6dsj theciinsol i dated financial positl on OfTerayon Gornrmac tion $yster m Inc at Dec err er 31, 2004 and ZQ . and the . i t®d results of its aperationsand its cash fl ows for each of the threeyears in the period ended De enter 31,2004 , in conforMty with U-S. generally accepted amount rig pri nciples Also, I n our opt nionL the related f ina *dal$tatwrratsdw"e, asawhde,praenntfa lrly,inoflmaterialr Sth6inforrnedonsat forth therein:

We also have audited , inacxcdarxs'with thestwdwdsaf thePu61icDo eriy AccourtingOveraghtBoard(UNted }, the effec#iveness:ofT rayon GonvntrvcationSystems Ino sirternel mr d overfir~naal r 4g asof gec~rr>b 31 , :3404, ba y. don criteriee~bfi erlin Int~na lControi - I rrtegrated Framework i sated by the Co mti flee of Sponaori OrganrAationsvffhe Tre way Gammi sson and our report dated March 1 d, 2095~cpres

,

d an ungi~alifiedopriion on rrrarr r ner~t' sasaesay~errt aid an ace opinion on the effediver~ess .of interrml control over 6ranaaf reporting ,

ls' Erns t& Young LLPRaloAlto, Californi aMarch 14, 2005

57.

Table : f Contents

Report of I ndeFendent Registered Pubti oAcoounti ng Firm on! nternal Control over Fi Handal ReportingThe: Board of Directorsand 9har®fiotderso fTerayon Communications Systems, I n o

We have audiited rr~arr rr~erat'sa rrterrt, included in Mar and t`s Report on internal Control Over Financial Reporting in It, 9a, that TerayonErorr ication Sys f ne Terayarr ) drd ridt mai stain effective irderr~al adntrd over fi nmaal reporti asof December 31, 2004 bera;iss of the effectof the rziateri al weakr deembed i n rnatape ► r~ar~t sasseser~ent, based on cri#eris e~tabI Weed i n Irrterrtai I - Integrated Frarnewrork f eared by theCcarrrritteeof onsorirg €fryani7ationsof tpeTreadway ommiasioii (the"CDSE7' aiterisj . Tarayon smartapemc rt isresponsble for maintasingeffedtve i rtternal tnn7d over fi r~anaai report ng and for i is assess~~etit of the effec3ivenees i riterti~ control over fi Nrd al repo ti ng : Our rsspons bil ity isto a press at opi nion on managar~ent s aaae~srriart and a~ opi rr on on the dfe venessof the company's i nt area control over fi nand al reporting based onour audit.

We-conducted our audit in accordance with the standardsofthe Public Gotr yr Accounting 6versgFt Board (Uni :ted States). Those standards requrethat we plan andperfpnntfieaudittoobtain reasonableaeeJra about whether tectiveinterrlalcontrol overfinonaalreporting was mainteinedin al la erial re~eds xa tindudedobtarifr~ asunder ng ofiritert~ Conboi over financial rnepofi evelLOUngri rata`s rent, testingaid evafuattng the deign end opda~ ng 6ffec#i va Bess of Intq gal can7ol., . Arid petfomti ngstidt .other proceduires as we oalsde ed necemy in thed rccrr>starwes We bel is elhat qur :atrdit providesareasonable baas.for atr on,

A r ort~pany's intamai control over fi nand al reportfiny isa procesade<igned to provide real twd ea5sararice regardng the reliabi lity of finanaalreporti ng end tF preperatign of fi nanciai stad~rner>fs for a ternel grposes in aecordanoe with general ty accepted accounti n9 Pri r M as A t Y sinternal cor~tro1 .overfir~ertaal reportir indudesttx3sepoliciesandprooedurestFiai(t)portal nto .fhemaintermnceof recardsthat, inre~onahladetaal,aocuratel y and fai rty reflectthe t r y ors ai d dGr{~osL©risof the as~lsof t h e Compmy; (2) provide r Hold a a smx a r ee Ou t ftisactionsam recorded asneo~ealy to perrrut prepersbtsn of ii no dal sfata-traits i n €±coordartoa with goner l l y eot d acco~r icing pri ncipl q s, and that rood pts and :expen liturbe ofthe mrrpa y xa balsa marle.only in acoordanoewithauthorizationsof management and di

peerectorsoaf tliaenrrip". ; and (3) provide nae~riade: assus[xe

reBa n'Pg prevention or tirnely dateetion of unauthorized a cluistion, use or disposition of the company 's aseetsthat cold hale a mat erial effect on thefinancial statenmm.

RecaAeof itsinherent limitation internal oontral over finanaal reporting may notprevent .or detect missdkanenIs, Also, projections of any :evaluati.onof effectiveness to future periods are abject to to risk that control smay become inadequate been of cta iges in cord ti ons4 or that the degree ofeompiiaicewith the proceduresrrtey deteriorate

A material weakness is a control clef ciency, or Gombi nab on of control def iai ones, that results i n more than a r mota I i kell hood that a materialrnisstadetnent of the aYwal or inteim firancia[ statementswi I I not be presented or detected . The fol l owing material weakriessesheve been identifieclaridincluded in mar>ag ernent'sassessment :

Ma agerrient identified a material weakne dueto insufficient arntrofsrelated to the identification, eapttre, and timely oofl inicaton offi nand al I y ~gnificartt information between certain parts of the organi nation and the f i nonce c artment to erg ble tha .fi nonce dspa went: to account fortransgcti ons i n a compl ate and ti rnel y manner . Asa res iltof thisr teri al weakness na ement recorded an adjushnent i n the queter endedSeptember 30, 2004 tC record tannin on behefits .paidio a.former ezeafive..

Mar erneintalsoidentifiadarratedWweakr sforinaAfidaritcontrolsrelatedtothepreparationadreviewoftheannualconsolidsfiracialstatements and: a❑compeny fngfoatr&e der I o6urm The i naffiaeiit control s ind ude a l act of siffident persurid with techni cal =Mnti ng a perti Us ei n the fi nonce departrrierit avid inadequate revi ewand approval procedures to preperaeeacterraal financial statements in aocordanxe with -generallyaccepted accounting princiiples (CAA P) . Asa rewlt of :this

58

Table of .Conten:U

rrmterafweakness,monegeriehtmades ntialrevleionetoits anradoonoal)datedfinareel arnieritsaridfootnote disioairesbeforetheywere ise:ad .

Thew m tMjai were ccnsidared in determining the mature, ti rri ng , and Wtart of wdt tees wp ied in our ad t of the 2004 cvrnIi datedfinancial etate rientt and this report doesnot affect our report dated March 14, 2006 on thoea fi nand al a >ts

In ow .opinion, manigernent s! nart tat Terayoi CormiuriradonS staN inc . did not maintain aftediveinternal control over fira-id al reportingas of December 31, .2©041sfady stated, i n al I ;material respects, fused on the C©9Q control criteria Also, i nouropi nion, became of the effect of thematerial weaknessesdeeriihed 2bove ;anfheachwarnentoftheobjeCtiiesofthecontrol mriterie,Ta yonCo rt nivitionSysWms, Inc. hasnot.maintainedeffedive.inte-real control over fihand A reporti it as of December 31, 2004, based on theCOSO cdrftd oiiteria .

W Ernst & LLPPaloAlto, CaliforniaM arch 14, 2005

S9

Table of Contents

TERAYON COMM UNI GATI ON &'$TEMS ; ! NG .CONSOLIDATED BALANCE SHEETS

December 31 ,

20D4 20M

(I n thousand4eKKc t sharedataj

CI.lT amtsGe aid cash O*iV lasts $

. . . . ... x13218

. . . .. .0188

Short-term inveWwA 54 ~i7 106,452 ,, . . .Rtaorit~CBf~oeivab [ e le~3al E tt #dt ftiE 8wt~ittlt of i,264i n 2M4 and $3 5M .46

AccotXrtst" vaf 4 e from related pa rd 3106 , 60D(st)eel a ~i3srrt :c®i~ivable~ '> s . .. <: . . . 3 x2I nva, ry nek .. . 17144 . . . . 16 .364

Total as-rest s 174 . 191,348Rl op~ tY ?rr1• pr - r, et 5,?B(l : : 9.1,871 . . .Re6trieted cash a,827 %21,2Oth , not 2809

Total assets $ 153,734 $ 215,240

LkA81 .Ll:TfE.uSJ&DSTQCKHQLD S EQUfT YCurrent I sal A Oties

A tspayable $ 7,845 $ 4048AcCtuW payroJI, and r@late~i eJ t9as 4,1a1 6,537i~~farrad reveneiea 2579 3 423Accrued warranty ex pens 3 ,870 5,509Aczr ;eil .re~trudzxi q a~, executive sa eraix e 3,502 2,847 .A crrued vendor cancel lab on charQes 521 2,869Accrued other I sahib d 317 : 5284Interest payable 1,356 1,35$CuTont port on of caps U I msc oU rgabons 124

Tat4 caw r€nt I i abi Ii Ges 28,571 53,60 0Lang termobEigaflon 2,077 3,118,Aomied restruc uri .r►q and exeakve s v erance 1,084 1,553Colvet ble s ibotdir dnotes 65,061 fi8,081Canntm~ntsaidcx ir>iaes5t6ckhofcies rgity:

Preferred stock'. $0 001 par Val u aAuthaiz saw- :3,=000I saved and outstand ng shares - none in 2004 and 2DC)3 -

Cmnnvn stock, E1001 parvaEueAuthorized saes- 700'000000Issued -» 76, 454,16 in 2004 arid 76,031097 i n 2033Qukst~irg - 76,29B,l 52 i n 20(}4 aid 74,875 088 in 2003 76 75

Additional padirir a1 1,083 .711 i .{7~LCff3 8

I(1,024.091 (987 . x)

o nT rea%ry stock, at cost 156 QW 4-wres i n 2004 and 2003

264 3388)Ac L"ledott~ct wwpreheh vetoce ( (

Total oAudJIQft ~; equity 56,341 91,38&

Total liab+ltnesand~prdhoEtiefs' egety $ 16871 $ 215„240


68

Table af,Contents

TERAYON COMM UNI CATI ON 'STEMS, INC .CONSOLIDATED STATEMENTSOF OPERATI O'NS

Years Ended December 31,

2004 .220():3 2002

(I n thous~nd~ a~(C~Pf p tar..e ta)

FYockpt reyotit $ 14Q 6 :: $ 128,791 . .. $ 10.306 . . .'Retef d party product reveF es 9,J16 ; 4,69A .: 9,097 `

T,ptai r 'etn+es 1SQa38 . 133,485 1284fKiA€ g00ds8LlidGet gt ptvdtx .r~v~+n s 101,15 ?

770399,26 1

} 7792 497 . .$tot t 1~t9d:# tty t >ot reverr~e ,

Testa cod of goods 9Ad 106;920 101,034 100,949

Gtoa9prtotit 43,618 : 3 ;151 $454 .

Re rch and clwdwnerd 33, A 42 9 ~L3.695 . > : :Sal ee.and t wXe i ng 24,145 6,7b 1 35704C,¢caAlal aKf act n ra~r~rive 11216 12,127 14,718 ::Resh'OCttringc rg (net),exartiveseveranceandasset wnto-offs 11,159 2,803 8,922

Total,o k ng ex{a 90,479 94,%0 116,037

Lt sfrom 0per3hons (3@861) (52,099) (89,583)Er7f~iertillcAre 2;917 5,838 <' . . . .I.rtterest expet~e . . (3,294) (3,279) (6,174£3tt~eCtrooi tae(mcPEine) 1,566 .: X24 (4,145CO non esi1yreffremait of debt - - 49,Q89

Lo ietoretac (exr ) benefit (3Fi,~(17} {217} (43,97Incometat (epee) benefit 76 (31.6) (238)

Not tom $ (W,531) (4213)

Basic anddluterinetloasperire $ (0.48) $ (D.6$) $ (0 .61 )

Sf~arasueed i n ~ngxznrtg bags and tGtt ®d net I e per art 75,861 ` 74,212 72,$01

See 2anpanying notes.

Table of Contents

TERAYON COMM UNI GATI ON WSTEMS, INC .CONSOLIDATEDSTATEMENTSOF STOCKHOLDERS EQUIT Y

Apournulated

Common sock Additional C Other

omOtheri~ve Tr®flurySto* Ti*61Paid-in Accumulated Deferred Income Stodcholdere

Shares Amount Capital Del1d1 Compenselion (L bit.) Shares Amount Equity

iIn thwsands ~oept sharearnount9~T# f.Cje~eftY~At'3E; 248:. '12711 >'I .. ..18Q3045X+: 9 5 $. . . , .;.~ . .,.'

Exw u, of oUtior k rashtoppcchowour tut

o k < 4;1 .< .. . ., ;: _xa,«iv

ati staresAeacquatim (25,077)#ionsto noq 8 Cam)

d dderred

Payment 1 . . . . 1

ePur x,186 1,884 86 lImmoeoiwarranl to

f (rrn n flockp sr2 6litkti

I ncr to urt[ed LZWlges on mat-tamnveef ?~erlls. (S t 9) (5191 .

~m~a (2:799) (2,?98j <Net low 14k213) (44,213)

CorrehasYelas~ (4753fj

Balance 4 Deoe i ba 31 ,2002 73,084,045 73 1,078,144 (937 ,207) (25) (3,070) 156,009: (773) 137,142

~xau6eataptiatsl~ c~h-1o purctir"~e c7 rc nun '

hod 579 233 t 2,533 253 tR-valuation c~( oplior to

rlorrd!nFJv~' 50 (50)ArjpkY?iianof t1r'Iatng j

M"PIMioh 53 S3 r <I au artceof residded

oornrrm Hoek fromdock option plan forsett rns~rv ufed s.5R0 70 70

i$R Got signorsdoc kfor Csnqq~eesto4AurctS~eRa t :202,210 1 1,194 i,t9d

pprd1RY cQmrM(1 3tPG)C 45 45~'.OrT~Jf Ptl ©f 114 Y o l09fi

I nEr e Io inrBf1cz i

Ic on 9iort-ta mirivve~rreds (470) (470).L~mtili~iveltl~dion

a i mai 1 .172 1,172Ne! lass (50,353) (50,35

`c:orrQteha[iavelass ; I' _ _ ? (89;651j' ;

Balaxaa a Dtwrtba 31 ,2003 74,875,088 75 1,082,038 (987.560) (22) (2368) 156.000 (173) 91,388

Exp'cssR.o£t~p(ict~Lf9r cae~tG;Y~ra~e~ttttott=

225 .645 a a9bArr tiz4ionof dEl€rred

jxA Q0 17, 1 7illw)Wof unvedczt

I" VtkyzIsRR>alce of common dock

for Employes Stoc kPtxchaw Plan 1,197,419 1 1 , 190 1,191

62

Tabie a# Contents

Accu mulatedOther

Common Sock Addltlonal C .anprehmsive Treasury Stick TotalPaid-in Accumulated Worrell (now* $OdchddQi;

Shares Amount Capital Deficit Compensation (LOGO Shares Amount Equity

:::•. :;,, .. . . :.. . . O Rthous@nds acct >fiare tmount5l . . ..: .. .

See woompanyirg notes

63

Table at Contents

TERAYON COMMUNICATION SY`STEMS, INC .CONSOLIDATED STATEM ENTSOF CASH FLOWS

Yours Ended Do,anba.31 ,

X00 s 20txi 2b02

On th .PPS~t1 dflparETlll~g acUvfties ;f 14t 14SS . . $ X6531 ) $ ( 353) $ . ., (44,213)Ad/tt~Mr19f119Sa4 Utlchlfit lds6thtti t?> 1t up9if.telapeY2lingaliVilie~ :- '. ::' . . . :~ '. -.

Seftl@►perACC Sept~saC4ou11tRP~ty e -`

111 8l7egtr~iAi~ift. andsitwsciE?~tidh <:. .. . . . &'416 969 '' 11,572:: >Wn19 dt>ilifalll?rbz2ArPhd. .i ibleaisAlflciliir~ticxt aE ilJai.• d m 13 s3

3,872 .476

Gpn m.e f6fjta e~ of 4{E~1 - - (49,089)1rnerlcrYQtQViI9Tiiti 11,9BQ 4,08$ $,9C8 .

lnpa!fflKMO ( it ►!65ifF - 4500 .,t[JFf~e t(# dfi itel S ?,363 497 3.967 . >

ISwvn atRwe for imja>w o(mrm1on 4Q(* 70V'ueift~t#k[+cirfjid'G+efetred~odsvsaraftarasuad d5 2 8

Net 7es an=taslsadliztahfiesE246 (12 844) 2621 1

AccNosrweivebfefrom rd~Aedpwies ~(~ 5,f,1~) 24212 3

3,1644 Ofi6I» anttlcy ( 13 78Ctj ( ,

argr as9ets 5131 7,20j_AwxrEapyutie

d dd~y'

$~

Z130 0 G1 .~ete expetwsAcxrLe

Dderraf~ rarerMi ® r

.

672A cQUed v✓drarAY erAa~9es CIA 2Amued i alruduriiv .charg- E, fx .. f 313Arxritrl v,~rdC( cP!1c l0irn (t-bther~ acvued f iah li(J'es

,3¢Q) (12,-

3

interest P" e 3 (1,918

N61 ra h u6E in opwing "vide (39,55(}] 8 7} (67,7 1

Irv~lt g aFtIvitie~P, FAitsAf 88L-t~en irrv ~trrc r+ts (~i4,537) (243,6 (2$8.98E~ IPrgoa giro 1 Sales,-,d r7 uritissc8 f aj to i r e ltr~ds 107,931 224,154 434,34$ESrd aaea~t r* x t f2,668} (3.821) (7,1k)

Net cash provided by (us31in)irNestirig adivities 50,716 (23,329) 138,974.

~7SRIQnB-a.11Yk1~66 _ _ _ _Pri[tapaf .p~tmaA&r~n cagtai ies (124) (e~ (12 . . .frna+ttltttf~pftac~zYrrnai.odcRetx+tsaof~vrnrxtibleaabortl~naie~irafes - (57,627)E sfrorita»tiend~d.cmrtf~li udc ;. . .. ffi81 7~9 . . . ..: . 3,872

ng a ivitiescashy.Prgv

rwided.

4W.W

d irr~ Ln ndNq

1,5 7 3,60 (53,887)L~ifstiift ..g yr lecfiaayy 3(17 1,17$ (583) :

Nd (tlever mc!•• . in cash ald.cas . egn(vefads (?3,030) (86,891) 16,80 6Cad' h ygtyV eill~a{ b JlfSting o( Y" 30188 117,079 100,274Crh and cash equvalealsd ad of year $ 43,218 6 30,188 Y 117,079

&joerr a aai dia4oen esof cash flow i MDrm(ictrCae1 Pad for ncomelaces $ 138 $ 194 $ 71 4coiif pdidfor $ 3,263 $ 3261 $ $38 73u WiIc+T~ntalnircashirw ir~adfir~drga3wit~estX~dra3 colt peri iwn rafz#ttYlto:ipirm~ti 6tock :isarecl to K[q%q s $ 6 53 $ 38 £

See a=rnpanying notes.

64

Table of Contents

TERAYON COMM UNI CATI ON Sf'STEM$,1 NO .NOTESTO:CONuOL1 DATED E1 NANCIAL .STATEMENTS

1 . OrganizationDesvip ti on ,of Bus nest.

Terayon Communication Systems, Inc- (Company) wasfnoorporsted under the lawsof the Stateof California on January 20,1983. In Jule 1988, theCompany reincorporated in the State of Deiaaware.

The.Con pang develops, marketsand sd IsegLu pma,tto broadband servi ce provi derswha use tkie ConVany 's produdsto deliver broadband voice,digital video solutions(DVS)and:dataservices,toreedenball and Ix;siness subscribers2 Si mmar y of Significant Aoonun ti ng Polio

Bassof Con idationThe consolidated financial statements i nd ude the axz nts of the Company and I is whol l y owned suhsic9a*ies All Intercompany Warms"

trans#ionS have been el minted.Use of E i rmates

The preparpti on of the cons it i dated fi nand al skaterr >@nts in conformi ty with .United S Wm general I y accepted aocounti r princi pl as requires marrapanaitto makeeeinatesaidassun ptionsthataffectthearicxflexsportedintheoonWidaCedfinenoa l statementsanda ompanyir jg notesFtCn>atesare.6asedon historic ipoi eve, inputfrom soureesoiada eoftheCbtnpiany, .andotherrelevant fadsandarcumslances . Ad reoutswulddifferfrom thosead names Areasthat are port cularl y s yrr ficant i nd ude the Company ' s revenue recbgni ti on purl cy , the val uati on of its accourrtsreo@ivabie and inventory ,the assestrnent of recoverstii lity a nd the rneasrement of impeirmON of fixed a5eft .and the recognilean of reBtrudur ng I iabiliti ee.

Foreign Currency Trand ati oiThe . Company records theaffect offoreigncurrencytranslati oninaocordaneewithStatementofFinancialAcw,lntStanclards (SEAS) N.p 52,"Foreign

Currency Trangation." For opertionsoutsde 'the United 5tatiesthatprspare financial satemer s in a :in'ecrfaes other ttlan the U , S, dollar rest ts.ofoper*Aons" cash flowsaretran slatedatavrsicescdt igeratesdwirgtro w iad,and .assetsandliabiliti esambarrlatedatend of-period ®cdwxjerates Translation adjodmantsareindudedasaaeperatego iponantofaoamuCakedott~eroomwehensivelosslnstodchoIders eguity . Forthe three yearsended December 31 , 2[X)4, trxWadongainsand Ioms were lwt significant Realized foreign currency transaction gai.nsand losses are.induded in resul.tsnfoperati arts as i ncurred , and have riot: beeh slgnlficantto ftCompany ' s operating read to i n envy year prated.

Conoentrationsof Credit Risk, Customers, Suppliers and Produ ctsThe Company performs ongoi ng credit evol cati ons of its artomers and generally rec lu i res no col lateral . Credit l osses l a e hi anon call y been within

management' sexpedbations The Cam p", rrmai ntai ns an all owance .forPotefrtiall y uxol I ettible accounts receivable based on an assessrtient of col Iec li bi Iity .The Company a scol lectihi City lased on a nurri. L. of factors, i ndudirg past history,, the nurnber of days an anount i sprit due (based on invoice duedate), dh anges i n credit rati ngs of camas, c start events and of rcum noesre d ng the hus nessof the Car pany'sdl ant's w nmers and other factorsthat the Cornpany bd i eves ate rs1 eìant At DowTit er 31, 2004 and 2003 ; theal lowence for potentially uncol Iecti bl a aooountsWas $ 1.3 mi l I i on and$3 .6 mi ICion, re~activdy . In 2034, we expec erxed batter than .escpected ooi I eclionsof $21 nil lion offset by w6te-offsof'$201,000 A relatively mallnumber of cr ornersaecowtfor a sigrrfi cart

65

TERAYONCOMMUNIGATTON &1'STEM.INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)

purl eof ]heCorr any'sretenuesanda untureoava4le. TheCompay :ettpectsftsde~ofits.produsastoa,Iinvitedrwib of a..aten sadreseIIersto continue, to amt for a high porcetit2ee of revenues

TheCortartyreliesonsnglesancasuppiiersofrrratanalsandlaborforthe .sgni ficantm orityofitsproductinven ttory . SibuliffheCompany "sarrarcsu pq i Ersrbt produce" deliver inyerory for the. Company to ad I, gnat rn ely lxasA operating results may be adversely invaded:

The Company places its cash and rash equiwal entsi n s everal fi rend l i nstitutions and Ii mite the amount of :audit expos xe t}vowgh c versfi cati on andby Investing in only high- gradogovi rnment aid commer ci al issuers

TheCompanyinvestsitsecewca sh indebtin -uii ntsof governmental agenaesiandcorporationewith credit ratingsof AA/AA- or better orA11PIor better, respectively . The<Lònpany hose . i €hedgiidelinserds6veto diver0fii"ation" matt~ritieethatatiatnpt to maintain edety , and liquidity. TheC0tr any has riot etperiencied anyagliificant Iosasson its cash equivalents or short-term inve to to

Rev¢nueRecowitionThe Comperry reco~nizasrevenue i n a zordancawith SEC Sfa[f Accourrtirlg Bulletin (S 8) No. 104 " Revue Re cogrtitton" (." SA B 104" ) . SAB 10 4

requirestl fourlasicaiterianxlstberr lieforereveweearlbereoosni~ed : ~1)perwasve evvi denceofan:arr errant exists, (2) del ivory hasocarredors~rvioeswerererxiered ;( 3}tF~setIinglxiceisfixedurdetermir > abl~and (4) boIIectibiiityisreasonablyasaed.

Conti ads and customer purchase of ders .are u®d to dete~lni ne 1tie .soii once of an arrangement. Delivery ocars:when product is del i vered to a commoncarrier. 'Certai n of cur produce re deli vexed on an . FOB d nati on basis The Cornper defers rever ue asexi crud with these fransicti onsu tii the.del ivoryi oocutad to the.c toreiers prernisea The Gompariy ass swiieth& the fee is fixed or determinable based on the payment terrnsamciatai with thetra ion and wi Ma thesal es pnoe i ssrbject to adJ u i~ent . The Cortipa y scot I eo6 bi I ity basest pri man I y on the cred 'itwort) nessof the aiatomeragdaferrr ned by : rsdt c iecics and analy~ as well a~stbe custom s payment hisfiory .

Should there tie d r a r to man '!sjWWWft revenue reool;In zed for any report ng peri od could be adverse) y affected.The Cornpeny 's servi ce reverxk wlveh i s ,l s etely from Foa= I I nes represantsapproxi mately 2.4% and 1 .S% of revenue for trio years exiled

Decerrber 31, 20D4 aril 2000 , respecti vely . It is generated from m ce aran ;Ipments for product support, whidi i srec s >nized ratably over the term of thearragement, typically one year . Product s ortind Was internet accessto tedr ical content , software ipgrades., as well as internet and tee ephone .accesstotechnical support personnel .

Research .and Deveiopi ant ExpensesResearch and clmiopi *lt expenses are d rged to expenseas i ne rted .Shipping and Handling Costs

Cofsrid ated to sH Peing and handling are included in coat of goodssold for all peiodsprew tad .Advert ng. Expen ses .

The Company aeco ntsfor 2dverti a nq oostsas expense in the period in wh di they are i na.rred . Advertising expense for the yaers cited Deow bur 31,2x04, 2003and2CE12were$0.1million ,$0.1 mill ion, and $0:4rmilion,respectively .

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TERAYON COMM UNI EATI ON SYSTEMS, I NC .NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-( Cbntinu .ed )

I nI7eflanba 2001, theC Xe taedintoco-marketi.rxl :arrangerrEaits with SrwCwrrnunicatio In¢ (Straw) aid RogersCorrrrnnications,Itic .(Rogersj., TheCompariyp~d rrillion to Shawaid$09rr IIiontoRogers and reoocdeclthese amourdsasothercurrent assets InJuly '2000 theCornpan began anuxUzr ng tfiese preps d asesl~s 9nd d~arging lhern agai r revenuesi n acecr ce with the Fi r~arkial Rooizunti ng . Sat>dards Board(FASB) . ng I Take Force (EITF) Nq . 01 Og, "i4acourra r far Cor deration glyen by a Ve~cior to a Cu3omer or Reeeiler i n Connedion with theRrchaseor Promotion of the Vettthr 's f'radu s:" . Amoutts .c a~jed agair>st ieueni ,i n .2W3 atd 2002 h~tal .ed apptoxi nmately 15.6 mi l l ion aril$28 rni I I ion, re~vel y, and none i n X004 . Tha,Gomp 3► y d mrged tl ie an»rtizati on of tHese aeaetsagai rat raieixies tFvougFi the sx quartets ended i nDearr>ba 31 , 2(03, theterm of the related arra, rrr 1t, at3he rateof $ 1 .A million per qua br . See.l ote 14 .

Net LosaPer ShareBasic anddIutednetfosspershare .wsiscorrputeiusingtheweightedareragenumberofoxrrnonstraresout anding, .Options,warrants,restricted

stock, and corverti bl a de4t were not nei tided i n the oon utsd on of di I elect rot loss per share because the effect wouEd k anti =d IwGv eSues used i n the cal oul edon of basic aril di I uteri nett oss par share are asfol Iowa(i n tt+omrxl$ accept per share data) :

YearsEnded December 31 ,

2004 2003 2002

ttdt[a & (53t} $ (50,363). . ; '; S (t433~? : `'

Sbsresused inrnmptt ngbascarddi lutednot loi~s p Prshare 75,861 74,212 T2,803

B~ic2n~fYilEUt~liletlosapei !stt~re $ <(Q+B} 1 Q68} " (Q5Ij

Optiorsto pur,d rase 16,$ ,838, .17,463,969 and 14 ,635;025 aresof cormmn stock were outsfardi. ng A OecantD er31 , 200!4, 2003 and 2002;resp erti vel y, and warrants to purdiase 200,000 and . 2 ,325,593 s1a of :corrrnonstock were out ng at Decernber :31, 2003 and 2002, resp ecfi vel y, andnone in 2004 {xbut were not nd tided in the computation of dl uteri net loss per share, s nos the effect is aiiti--d I u ive .

Cash , Oath Equivafentsand Short-Term Inve pealsThe . Company investsits excess cash in money . market accountsanddeatinstrurr ttsaidoonsidersalIhighlyfigt d debt instn :ments.purd sdwithan

original mat x i ty of three rmnlhs or l ass to be task equivalents I rivets wi than original rr r tt r at the ti rase of purc hawof over three months ared assfied as short-term i nvestments regardf em of rrturity date as-WI i nvestrnents are dasdfied as avai labl a-for-sale and can be read I y I i qui .dated to meetcurrent operAi oral needs

The Com pany deterrr i nes i mpa m-ient related to its debt and equity i nvestments i n accorda-ce wi th SFAS No. 116, 'A ceounti ng for Certain I nveatrn erksin Debt and Equity Seanti ee , and SA B 59, ' A pcounti ng for No ice rent M aricetabl a Equity Seotriti es' , whi eh provide guidance on determining when ani rwestrne 1t is other--tharterrp xari I y i mpa red. Applying this gufdariae raqui resj ucJgment I n making thsjudgi* , the Co wipany evai uate among otherfartorttheduratonand Went towhich1hefairvalueofanIrive tisIessthanitscost,thefinar4al health ofandbusnessoutlookfortheitwee,indudi ng factorsaxfiasindustryandeectorperforn~ance , inter#urology ; andop~ecationalaidfinacingcathflaw , available#inarxialinformation,and th Company ' s intact ahd abi lily to hoid the irnestna7t : Tl~e Gatipany also rel ies upon gui dartoe from EI TF 03-01 'The Meartirig ofO t h er - e Than-Temporary I nipei m g t and I i s A ppl i c a k i on f o Carta n f nvestrrient~' i n deterrni ni rig po e 3 bl e i n per rmait as it relatesto i tsdebt investments I n2004, the Company re rde i approximately $0 .5 trillion in unrealized Ia~wson rove nertts i n Othe r

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TERAYON COMM UNI CATI O1V SYSTEMS, i NO.NOT ES TO CONSOLIDATED FI NANCIAL STATEMENTS- ( Continued )

Cornprehaaave Loss on the GorW i dat<ed Sal tinge Sheet . T he areal ized I asses telah ing.to:i rive is i n federal agency eeo n ties we re caused by interestrate increass The Company purchased tow sw riti esat par, aid the contractual cai i flows of them inveeitsare guaranteed by anagency of theU .S. gciverrment: A obarck l y , it is eotpected oxt tfia sa u .ti eawou(d not bests ed at a pride l owthan ftatatized st of the Catpany ' s i rivegmentSeca i the des) ne in market value i satinbutebl .e to ci vnges in i ntaest rates and not credit quality adnbecase the Company hmtheabi I i ty and i relent tohold ttiesa investrneiiks anti l a recovery of fair value, wt dl may beat matu ri ty , the Con ipeny does not con irfertheae i rivestrrrattsto beother-than-temporarily impaired at Dena ter31 , 2004 . Further ftCorripaiy hasa histo ry of he kIng thes etypeson irivestmentsto nietlyity andas9~ssesthis i 9sue quarterly.

The Company' s short-term inyadm e itq which consist pri nuil.y of oonxtieraal paper. U.1 govem rient: and U . & goverrvnent erger~cy obligati on andfixed moon a corporate secu itiesare dasafied as oval Fable-for -sal &aid are carried at fir trarket value. Realized gal no and Ioi~ti2sard dec31 Fries in vel uejutedto be other n-te;nporary on available-for-sales c ritiesare included in interest in oprr .Theoostof sewn ti as sold isbaesd on the specifi ci semi ficad on method. The Gorrpany had no materi al i nvesttY~h i n dot-term equity sea riti es at . Det~ert#~er 31 , 2 4. or M.

Other Current ReceivablesAsof Decarnber 31, 2004 and 2003, other current recekvabiesare p ri manly .composed of interea, taxeq and non trade.reoevabias, and included

approximately $0.2nillionand$1 .8million,respectively,dusfrom manufadi emforrawmaterialspurchasedfromtheCorripany .Inventory

I nventory isstated at the lower of coat (first-in, first-out) or market The components of inventory are aefdIowa (i n thousarids) :

December 31 ,

2004 2003

Fi nidgoods : < :3783 $! :. . . ."l4 ,2E'v4.Work-i n.ptoaess 650,kaff 'J'aw

17,144 $ 16,354

The Company records losomon oorrmnitm*nfsto purchase inventory in s nogvii th Statement 10 of Chapter 4 of Accounting Release Buileti n No .43 . The Company's poi icy for valuation of inventory aid cornritments to ptrdvase i rive itory, including the determination of obsolete or a cesi nw . itory,requi res i t to perform a detail ed aeseoanQnt of inventory at each bal arx~e > hW date, which i rid Was a re n + of, among other factors, an esti mate of future .demand for products withi n epeafic timehoriaon§, gen efal I y ax moritheor I essaswe[I es product I I fecyd e and product development pi aria Given the rapiddwngeinthetedindogyandoomrriuriicationsegwpmantindustriesasvreil as9gnificxnt wnpreoictaMediangesinc tai spending bytheCompany'stins, the Company believes that rg the van ue of inventory using ger>b'ral I y a .a x month time horizon i s appropriate.

The a timatesof fuhxedemand that theCorp" usesi n the vaiuab on of i nvenwry are the basisforthe reven ueforecast . Based on this anal ys s, theCompany redo the at ofinventorythat ital ifirallyidentifesandconsdersobsoleteorexoessivetofuifiII fuktiresalesemimatesFxceasirwe tory isgeneral I y def ned a s inventory in accessof projected u s a g e , and i .sdete r-m red i rig the C o m p a n y ' s bed e s t i r : r r a t e o f future demand at the ti tr . bead uponinformation then arai Iabie. See Note 4.

68

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TERAYQN COMM uNI CATI ON SYSTEMS; INC .NOTES TO CONSOLI DATED FINANCIAL STATEMENTS-( Coritinued )

Colt of goods sold for the yEersended Da ar>ber '31, 2004 and i 'rnduded reversaisof $3.3 mi Ili on ($0,04 per shae) aid $10A rni Ilion ($0,13: permare), re~ec tivel y, of sd al r angel ort na11X Boarded' i n 2 D1 atxl DOD f or vendoC cw ei lah on dsarges and irnQrtrxy oonsi dared to be exoew andobsd eta The Con pent' dtianged itspre~riouses4 matesar~d was ak~ll atii reNeiseltle pravi sail i n 2, aid 2003, as it wasable to sal l inventory orig nal It'mnd der& tobe exo axi oltepl.ete .I n add ti on, the Company wasable tD negotiatedowruand cetain .vendorcanodlati on daimstoterms more favorabl e

Din y , 2 XX aid 2002, the Cdrnpanj! r& riled i riventory die►ges of $120 m l l i on, $d:1 rni l l ion ar'id $6.1 mil lion , re Ctively , to witte down sineof i is ..... ry due ba exw®sad oba l essence and to reduce the i nvenfory to the l over of oo4 or n ket val ue in aswerage sal ling prices fell belowthe cost of thew products w id to record chergesfor exce and obsbl ate invento ry.

Property and EquipmentProperty ax!'ec~iFxr~ent are carried at oostlessa~cxtmutated depregaGon and a sorb atipn . Prop" and equi pmerit are depreciartesl forfiraznciaf

reporting ptxposesusng the straight-line method Doer t s .s in#ed useful Iives gene ally three to seven years Leasehold improverientsare a m tizeduang fhe straipiit~ft ne method war it~e forte of {he useful I ices of the amts ar t11e taiu,sof the leases The reCoveabi l ity of the carryi ng amount ofprctpetty.a id equiptY~ent is d be ed on estirtt~acl fut eundIecounted t h flows, and If an impoirrnent adg .o the charge to boeratlonsierrte¢a .iced asthe ~coess of the ea yi rtg amount over the fai r val ue of theagae is & d .upon .thi s method of aa ®wsrig recoverahi I ity, for the yearsended December 31,2DO4, 2CC3 aril 20(?'2 the Gorrtparry recorded $2 S n"i II ion, $0 5 Trillion . and $i 3 million, respectively in weed impeirrn ri s pri merily related to restructuringactivities.

Property and equipment are asfol laws (n thousands):

December 31 ,

2004 2003

8ottware:anct con tars $. 21 , 41S $ 7273Frrnh(eandequipnwnt 21,523 23,816 ,I d imprroveitients 54 21 d,633iAutonobi I es 16 1 6

P opertY arxf equfM t ? tT75 52040 < . :_ .Ao rr"a[ed depreci ation and Amortization (42315) (40,169)

*and equtptnf , n6t. : :< '$

Depreciationefcperm was:$5 .9milliort .aid$8 .9millionforthetwetvemonthsendedDeoert 31,2C04anal2003,rie ecxively .Ainorrizatlonexpenseforthe twelve me hs ended Deownber 31, 2004 and 20003 were both $0 .5 ml I lion.

Reetri cted GashRestricted cash at both Deaf rW 31, 2004 and 2DD3prrrmri ly relaled to approximately $7 .5 million to secure an aircraft lease aswd I as$1 .3 Mil lion

and $1 .7 million, r e s p e c t i v e l y , , to secure reel estate leasesGoodwill and Other I ritangibleAsert s

GoodwilI is the access of thepurcttiaseprica . over thefairvalueofIdentifia le netaseetsacquiredinbusirresconibinabonsaoo untedforaspurchases .During2W2, theCompainyrecorded ig*rrnantdi®rgesforgoodwilI,asseii ledworkforce, and other in bles(GNote6). At Deeerb r31,2DQ4 and 21X3, all goodwill had either been amorti zed or written-off the Company's book s

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TERAYON .COMM UNI CATI ON SYSTEMS; INC .NOTESTO CONSOLI DATED FINANCIAL STATEM ENTS-( Continued )

Goodwill and other long-lived as9etswerereviewedfor irrparmentwhenevereverrtssxiiasproclu tdapntnuanwplantdonxes productdi epos tionsor other in d7ourn {ncficated that.ft ca"j .ng amour t may nottlave ba recoverable . When such events ooa ared, the Cornparcompared the car yi rgeninunt o f the aseef s to unc scounted: expected future cash flows I f ttls c mpaison indi cated S h a t there wasan i rrQ rrrert, thealrnou nt of the imp trn itwas typi cal I y calalated using discounted expected future cam. flows The disoount .rats appli ed to theea cash fl awe was based ontha Corrpanysweighted averMs oost .of capital, whlch.reprasented:the wended costsof debt :aid equity .

VNarranty Obligation sThe Company prove des aOrd warranty for most of i is products ran g i ng from ome to fi ye yEers from the date of psrd . The Company provides

for the estimated cost of product warraitiesat the ti me revenue is recogni zed. The Company ' s.wara ty of igatlon i s affected by product fai lure ratsmaterial usage and service deli very costs]. ncxned i n correcting a product fail I ire . Ekpem e i matesae based onN Sorj cal experience and expectation offutu re conditions See Note 15 .

Stock-Based Compensatio nThe Company aacau tsfor its errpi oyes #o* pl ans in accordance wi th Accounting P'i na pies Board Opi ni on No. 25 ; ' Acmunb ng for Stodc .I steed to

Empioyees (APB 25., and indudesthe diisdoa are-only Wovi aomasreq fi red t nder SFAS No . 12 4Aaooutting for Stock-Bawd Corr lion'SFAS 123) . The Company pr avidee2ddi ti onal pro forma di:sdostires as requi red under SFAS 123 aril SFAS .Mo . 148, 'Accounting for Stock-Bawd

Compenwhon Transition and Diadosure' ,For pun x aea of pro forma died oeu 'e& the estimated fair val ue of the optionsgranted and E5`PR shares to be i 0wed is arlorbzed to etpem over thei r

re spective ves ti rig periods Had oornpensation cost forthe Con pany's stock based camperisati on pl airs been detar ni nad based on the fair value A the grantdates for awards under thos? plans cons scent with the fair val us method of SFAS 123, the Company's net loss and net loss per mare would have bee ni noremec1 to thepro forms atmunt5lndicated below (in thousands, except per wedata):

YearsEnded Deoember 31 ,

2004 20ik~ 2002

Net IDS5

Empi oyee Stock purchase plan oan~on e tpense deterrni net urxier fai rvJ up-based method (928) (1,712}. (.1,99Q)

Pro forma net to% $ (51;178) .. . . . .: . . .. . . :(74 52) $ (79,x

P r o forma bas o and diluted net loss .per ;;tae $ (0.67) $ (1 .W $ (1.09)

Equity instrumentsgranted to non-employees are a counted for under the fair-value method , in aoaordancewith SFAS 123 and EJTF No. 96-18,"Accounti rig for Equi ty I nstrurnents That Are Isaied to Other T ihaEmployees for Acquiring , or in Conjunct on with Selling, Goods or Services" usi ng theBladc-Scholes option pridng model and are recorded in the equity section of the Compmy'sconsoliktated balance sheet as deferred compensation . Theseit rumentsaresublettopenodicrsvaluatonsovertheir vesUng terns, Theexpaise is,recognizedastheire trunentsvest

70

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TERAYON COMM UNI GATI ON SYSTEMS, INC .NOTESTO TOCONSOLI DATFINANCIAL STATEMENTS-( Dbntinued)

umilated Other Comprehensi ve LoseAcctm l aced other oon pret sve losspre9enfed in the wcornpanyi ng oansplIdated belarxe steetsaid corsol i dated stale sof stockholders equityssfsof net uireelizedgain (Ic ) on Mort-teirn rriveatriiehtsaiidarxumJated netforegncirency tra axiom ee sThe followi ng are theoo ntsofaocomulated vther con .rehensivelass(fnthousendo :

fears EndedDecember 31 ,

2004 2003

ClYrkil2ttVetrafil tlKt.2i i 1[i~rUnrealized gaini(loss) on available-for-she inverts (489) 32

Tdat .aoa r nutated cx prat ve.iass $ tZ58 # : : > < : . . . .. .. (Z 8):>

Re cl assi ficati onCetain amotr1s of rezenues reported by9eog aphic d areas in previot s years have been red :assfi ed to conform to the 2!704 pre ntation, Sueti

rectassifixati onshad no effeq* on previously reported re tsof operati ons, total asestsoraoovmulateddefiot, .I m~c,t of Recently Issued Accounting Stanciatd s

On D:icr~tiber 16, 2004, FASB issued SFAS 123(R) wlich is a revia on of SFAS State runt No.123, A intingfor StodrBaSed t eiieadian .SFAS 123(R) aSF APB 25 , Accounting for Stock I saved to Empl oyem ar d arriendW51FAS Statement No. 95, Statement of Cade Flows Generally,the approach i n AS 123 (R) iss rnila to the ap roach des ri bed in Statement 123 . However, SFAS 123(R) reW' res al l share-ba d paymelts toe rrployess, i nd udi ng gw tsof employes stock opti ons, to be recognized in the income statenffl based on thdi r fal r val ues Pro forma disdoa.ire i s nolonger an alternative WAS 123( R)nxwt be adopted no later then July 1, 2(X . EarlyadgptionwiIIbepernittedinperiodsinwhiohfinancialshahamer*shave not yet been Issued. The Company iex pectato adopt SFAS 123 ( R) on ,U y 1, 20f).5 . A comport it of SFAS.'I 23( R) incl udes one of the fol towi rgoptions (a) modified-prosp ective rr h d, b) the n i odfiel- retrospective method, redtati rig ell pnor penods or (c) the rradlfi ed -fetrospective rr ,restating only the prior interim pe iodsof=. A determinati on alto which, of thefussopti onathe(ocp iy will adopt will teamadeat a later date .

As po n fitted by SFAS 123, the Company currently aooountsfor share- based prayments to errl 4oyeas using APB 25s iMi revalue meth d a*nd, assuch, a erally recognizesnocampensationcOstforemployees;cckoptionsAcoordingiy,thea7optlbl1 of SFASI23(R)'sfairvat i ia method wiII haveasgnificwt impact on the Company ' s.rs It of operatonS although it will have no i mpec# an our overall fi nancial posticin , The impart of adoption ofSFAS 123( R) c mnot be predicted at thisbrne boc 4iuse it will dependon levers of share-based payments pranhed in thefutwe. However, had we adoptedSFAS 123(R) in prier periods, the i mpeet of that standard wa 4 d M ave oppToximated the i . of SFAS 123 as daeri bed in the ci sdcuure of pro forma neti nesxr~e and eami nga per share i n Note 2 to our consoti dated fir a r d i s t a t a ne Its SFAS 1 also requi resthe benditsof tic ded.0 ons in eccese ofrecognized com ti on cost to be reported asa fi nand ng cast, flow, ratlierthan sawn opwa i rig oadflow as requi red under wrr® nt literature. Thisrequlrem er+t will reducenetoperadng cash flowsaridinaeasenetfinana ng cash flowsiinpollodsafteradoptioniWhilettieC~on- eny cannot etimatewhettk amountawil l be i n thefuhre (because they depeW on, arnorg other third when:emplQyea ~cerca se stock opt ons), the Corrpany has not recognizedany operating cast flaws for such excesstax d&1utionsin any of the periods presented .

Table of Contents

TERAYONCOMMUNICATION&Y,sTEMS INC.NOTES TO CONSOLIDATED FI NANCIAL STATEMEF'ITS-( COntiriued)

3 . Fair ValueofFinancial Instrument sThe arnardsieported aster " cash. eq.dvalentsaWoxinAefair value die to their short-termrrahxiti es The fair value for the Donpa,y's

i nvs ds in rrrarketabl a debt and eq<ity ascribes ise imated based on quotsd nmaket pri oe sThe f ai r value o f stiiorNtermand I ong-term eapi tal I aria and debt obli gaions i sesti mated based on current i nterest tatesaNail a61e tote Company for

debtinstrurnentswith srnilarte rr d reesof dskand remaining maturities The rarryingvaluesof theseobligat"iorrN'asof each period presentedapproxi m a t e then r re vefai r values

ThefulIowingesb mated fairAuswroxtstw.ebeen determinedWn. gavaiIaUe,workersiriformation. Howe~rer, awAdwaUinterpreting market data to develop the estin of f 6i r value Accord rd y, the estimates presented herei n . are not .ne ariI y Fr c ati ve of the amounts thatthe Company ooul d realize i n a current market exchanga

December 31, 2004

Short-term investments

Gross Gross EstimatedAmortized Unrealized Unrealized FairCost Gains Losses Value

(ln thousands)Ere tiientsnaft rQinlaw#.an 1 year;Govemment agency obligations $ 8,000 $ - $ (72) $ 7,928

Tani $ - (T2) 7,928Inve rre tsrnatunng in 1-2yearsGovernment agency liga§am 47,Q7C . . . (Al A6,

Total 47,Q)6 - (417) 4Q589

Toil $ t . . 6 . . ? s .$ (4bB}< ;' $ 54 517 ";

December 31,203

Grams Gross EstimatedAmortized Unrealized Unrealized Fai r

Short-term investments Cost Gains Losses Value

(I n thounds)InvaAmwUn turing.in 1 e 5& }i an 1 year,Corrrw'Od paw $ 38,940 $ - $ (12) $ .38,92 8Fined if,k neobrporate sea ut es 2223 1 2,224Govern "e t agency obl i gab ons 7,918 - 7,91 9

Tot 49,081 2 (12) 49.07 1J nvestrrer is maturi ng i n 1-2 yearsFixed iricamecorlaorate socurib 1,333 1,33 3Goverrn t agency obligators 58,006 68 (26) 58,04 8

Total $ 68,339 $ 68 $ (28) $ 59381 ;I . ;. .

Total 108,420 $ 70 $ (38) $ 108,452

There were no realized gains or l oses s on short term i nvesttrwits i n either 7the year ended Deceri bar 31, 2004 or 2003, respectively .

Exhibit D(" C/~ r, -YJ,)

Table of Contents

TERAYON COMM UNI CATI ON SYSTEMS; INC .NOTES TO .CONSOLI DATED FINANCIAL STATEMENTS.-(Continued )

TeAat min m~ri3 payments ; . . . .: g 2f 3

As of December 31, 2004 there are approximately $2.4 mi I I ion of future mi ni mun s blease payments to be received under narcanoel abi a sWe®es notreFl acted in the I a above.

Purchase Obligationsand Speci al :ChargesThe Company has purchase obl i gati onstp orrtai n of its W l i ers7tat a.pport the Company ' s ability to rrwnufacttre itsproducts The obl igati onscx> st

of open purchase orders plaoW vAth ve + dorsfor goods and servicesof the vendors' productsat a et>eoified prica As of December 31 , 2004 $30.0 mi ll i on ofpurchase ob1 igati ons were oulsfiarxi ng . Asa result of ded i nes in itsforer a3s the Compehy hascaneel ad oerta n fxrrttas orders witch i tsc

,ntri t

manufachsersthat had exi sting inventory an hand. or on order inartidpafion of the Company ' searfier forecastsvendor cmxel l ati on charges in amou Its that represented n i ement' ses5 mate of the Company's exposure to vendors

y y for

73

TERAYON COMM UNICATI ON .SYSTEMS, INC.NOTES TO CONSOLIDATED Fl NANCIAL STATEM ENTS-(Continued)

inventory corrxiitmaitsAtDecember 31 2004, . accrued vend canoel}ationc argeswae$0 .5million"*there[retying$29.5millionisattributabletoop en putt ee orders that 2reecpected to be utilized In the normal Corse of businsssand areexpeated to become psyabieat vwioustimes tlrc 4 out 2005 .

On February 26, 2003,. theCompany entered into an a eame 1 with Sd ectron Corpordon (Sole Iron) to settle al I outstay d rig obligations under ft esmaru tacturirr . :eerr~erits between the Company and Soleatron. Under the terrr~sof theaettlen~ent:agreaTw t, fhe y pei d 30l proximal l y$3.8 mi If i on, a each party rel eased any and al I dome that' i t may .have hod agai rd the other party. Addibonal ly, mpony recd ved sd ectod inventoryfrom Solectron.TheConpaiypreriou lyaarued$6Qrr lliontowardthesetttlarnwtoftheSol& rt matterasavendor cancellation dhargainthefourthquarter of ZDOQ and the second quarter of 2)01 . I n 2004 .1n connection with the Sol a Iron seW ernerit, the Company reversed $21 mill ion of the accruedvanddr canc~lla ti oCi diarges ind titled i n cost of yootls sold .

On S e p t e m b e r 20, 2003, the Company entered i nto an *reertient with FI ektroni cs(:I srael) Ltd ., .an I srael i cmmxany (FI &troni cs~, to purd-Ase inventoryfrom Fl~ctrorycsancl sgttleall Ong daintsbehveentheCompany er~d Fle9nrrmlgs Wncla theterrt~sof thesetdenlerit a~reerrierrt theCon~pany paidFlo(tronfcsapproximatel y $:1 :5 milI!onto be applied toward thew of future inventory from Aextronics, if ary ..Addtionally, each party released anyand all d of ms that it May have hed agaiiitthe 00W The y pran oud y :accrued $Z4 rni f li on toward the settl err~ent of'the FI froriim ma3tter esa vendor aril lotion thong n the second quarter 20 'f , In 2OR3, i n cox ecti on with the . Flevtrorivs 9 ernent, the Company reversed $t) .5 rni I I ion of theaccrued vendor cancel l anon chargesind uded i n cod of goods sold .

Letts sof CreditAsof December 31, 2004, theCompany hed $0.5 mill ion in unusexi outafand'ir g letters of cxedt primedl y regui rid to aapport operating"leasea which

expi re at various elates through 2009 .Royalties

The Company has va 1 ous royalty: ar anger lts, wN ch requ re it to pay nominal amounts to various 9.0 i ersfor usage of licensed property . Royaltieswe general I y cal «i aced on a per- unit boas, and to e I essa' extent, as a percerttage of sal eaa The Company's total accrued od i gallons for royalti es atDecar>ber 31, 2004 and 2003 were $0.4 mill ion and $1 .3 rri 11 1 on, respe tivel .

The Company haepurohesed, throe laitsacxauisiti on of RadmvizLtd . (i z), cataintiriolngy that utiUzed funding provided byiheJeneli CivefScientist of the i ni*y of I rsi y arx! Trade. The Company haacor imitted to pay royaltiesto the twvenment of Israel on proceeds from sal as ofproducts based on thi stechnology at rates of 30i6-5% per sal .e. The Company does not expect s3les of producisud ng th s ted d ogy to be material in 2005 .5 . Accrued Severance Pay

In .1i vie 2004, the Company entered into an erriployment a ireeinent with an exec utive offi cer . The axecuti ve offi cer rea .nest effeative asof October 1,2004 . T he Company recorded a severance provision of $1 .4 :mi Ilion related to tern ina6 on:cosisfor this.offi cer in the third quarter of 2)04. M ost of theseverancemssrelat dtothisofffoewere,paidin:thfourthquarlerof2A04withnormnal amountsforemployee benefits payable into ttisfourth quarter of2005.

In1ina2004, the Company entered into separation agreements with two other Gceaiti ve officers Qne officer resigned i n the sa ond quarter of 2004: andthe other officer resigned from the Company do ring the thi rrl cater of 200 .4. The Company tecorded a severance provi d on of $1 .7 m I lion related totemiinalioncosts forthem off cars inthe. ssaandgAvterof2)04 Most of the severance postswerepaid inthethird quarter of2004with raminalamount

s for employee benefits payable through the third quarter of. 2W5.74

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TERAYONCOMMUNICATIONSYSTEMS INC .NOTES TO CONSOLIDATED FI NA14CIAL STATEM EIJTS-

I n August 2004, the Company entered into an employment agreement with another exec utive officer: IDecember 31, ZO I. The Company recorded a 8e✓eral1Oe provision of $403,QQ • related to temii naion oastMost of the severa'toe coEts related to this offi cer were pai d in thefi rst quarter of 2005 with nominal zriou,i4ater of 3305. .

Thi stahlesunT arizzesthe executive severance balance asof Decerriber 31, 2004 (i n thousands) :

ExecutiveSereranne

Batas o at Outs 3i, 20Charges.,. 3,451,

h {inerds : . . . . . . . .. {.3 f>afJ} . . . . :I

Balance at December 31,20C)4 431

The 2004 char ge for ekwAve sarerarx e. of $3. 5 nil lion isi nd udedwith in ruing charges (Tet).;. .aicewHve se,+er a and asset write-off in theConsolidated Statarront of Opeations . The.$0.4 million in ex eoWve wvaanee isaccrued nn the Consul elated Bal ance .5hedwithi n anxued restructuringand eKea ive severance A December 31, 2004 .

One of the Co rrPany'ssai diariesiss. 4eetb leash law and labor agrearnsitts, under which it is required to makesereanoe paymentsto dsttiseedanployei3s and empl oyees Ivan ng its ar ipl oyrnait i in ca'tai n other d ra miter nee Thesub6 a ie ;; severance pay I iabi l ity to its err oyms, which iscalculated on the bas sof the s#ar)t of e3cfi errpl ayes for the last month of the reported year mul ti pl sad by the years of such arpia,/a serrploymerit isincluded in the Company's:oonsolidafiad,bWarxe sh eatsorttheacmral bass and isparti:ally funded by a purd>aseof inarava poliaesin the aubsdianedname. A t December 31, 2004 a n d XM, $1 3 mill ion a id $1 :9 mi I 11 on ,, respectively, for accrued saves' a pay was l rid valet i n I ongtterm obl iga6ons I naocordancewithEITF No. 88-1, " DeEei unabon of Vested Bendit .Obl gati on fora Defined Benefit Person Elam" theCompaiy ir iduded $0.7 million and$1 .3 mill ion re l ati ng to the an ritefuncled by the purchase of i na ranee poll idea for the I sadi se✓ erence I i abil sty in its oonaol i dated balance sheets es otherasaeksat ;beoernbsr 31, 2004 and 201X3, respectively :6 . Restructuring Charges net artd Abet VNrite-offs

TheCoompenyaaxi,~esforterminationoostsinaocord~xewithSFASNo.146'AcxoLrtingforCostsA atedwithExit or Disposal Activities;'(SFAS146) andSFASNo . 112"Employers As a~rtingforPo~Ert~ploymentBetrefits " Liab(Iitieexare initially rciea5lteiiS4 their farv. ueonthedateinwhich they are

;(Tnredbaexdonpta~sapprovedbytheComp~Y 'sBaarclofDirectorsArauedernploq esternin ionmstsprnapallyoane st oftivee

components nyraxn severarce payment based upon yeersof Service {a~ . two wasps per year of 6 ervi ere), 2) CO8 RA ire ranee haled on years ofserviosand rounded y~ to the morph; a cal 3) art a~ rn~de of oo for outQla t wrvicesi n mealashy provided to the affeited erployees anti al Iyali employeesw.e ::.terrrxrrated on the date of notificaDon it~ere was no additional same s period recctuired to be i ncluded in the deters ii ionof aga+,sdtemina ti on costs ftieremch servi ass were requi red for a period over 60 days, the Company ratably amortized t rrni sari an cost over the required viceperiod .

2004 RestructuringsDuringthe fir quater of 2004 , theCompany i viti ated a Board of Directorsapproved raring piers to bring opting expa sin linewith revenue

levels, The Company inctrredre ruturiNchargesin theamountof $ 3.3millionofwhich$1,0millionrelatedtoemployestermnaboncosts,$0.9miIlionrel ated to

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TERAYON COMM UN;I CATI ON SYSTEMS; I NC .NOTESTO .CONSOL1DATED FINANCIAL STATEM ENTS -(Continued )

tFrrnirratl on cods for an araaft laves ; and $1 .4 :million related to a tsfor exc leased faal hies The Company insured restructuring charges in theamount of $1 .1 million in the.secorxl quarter of 2004rel4ed to additional. coatsfor excess lensed :fad ll ties, w hich were ontentplated in tfie fi rst quarterrear uxuri n pIan I n the fourth quarterto further conform the Corr pany"s eaipenses tin its revenue and to cease i nvestrrient i n the .c i a modern terry neti onsystems (CMTS) prodvd 1 ine the Corr Wy'sBoard of Di rectors approved a third restructuring plan with a chargeinthe amount of $1,3 m ll i on related toemployee tern nation s

In the second, third and fourth quarters of 2004, the Con sty 're-evaluated the fi rat and second quarter 2004 redaictuni ng dtarges for the anployesseverarxe , a cemf*dI iti es and the ai n raftItermi nati on . Based on market cotx lro new ass, i ipbons provided by its real-estate froker, and the termsof ai rcrsft eubl ease apreornont which ttie Conpany entered into in thetfii rd quarter of 2004, the Company increased the res -u i ng charge for the aircraftlease by atotalof$1 .0rrIIion , thefadliteeaoau wasinoreased $0.3rrlIionanda IoyeesaVarariceaoctualwesdecreasedby $0:2ntiIlion, fortheyear

ended December 31, 2t 4..As of December 31, 2004,. $3.3 i riIl ion remained accrued , The empl oyment of 168 0rooyees1jad bash tetrr nated , and we Thad psi d $1 .5 mi I i ion i n

to n re on co3s, $1 .2 nil I ll bh o f c o s t s MW tied t o the aircraft Wasp, gnd $0.9 mi I li on of . '> rel eted to.ecess [eased facia i tee The:bal amm of the employeetermnation charges were paid in thefirat quarbsr of 2005.

The Company anidtlatestheremairrrQre3nxtuingaccrualrelatedtotheoiraaft .l tobesib ti ll y utilized forservirirky operatingleasepaymentsithroi , iar~ 2007, andttiereroi ryrgrestructuringaccn+al relatedtoexcessIeaeedfadlitiestobeutilizedforsevicingoperabnpleasepayments or n egobati rip abuyout of operating I cores c o mi tments ftougfi October 2008.

The reserve forthedreiltIeassapprdxinatesthedifferenoebetweentheCornpony ' sdwrentcostsfortheamr t Ieasyandtheesti mated incomederived f rom sub!ees ng .

Theamo ur * ofnetdiarges accrued under the.2004restnucturirigplans assumes that theCompany wi11 s. ulfysW ease, excess l eased faciIifies, Thereserve for .theeecw$leased fa 1itiesindudestheemtimatedimamaderived from subl.eating, w'chistasedoninformation from theCompany'sreal- e e brok%A wtV edi ntaCed it based on a ttpti one rel avant: to the reel estate. market cotdlions as of the data of the Company' s i mpl amentati on ofthe resirudun.ng :planarrdthetirre itwould likdytaketosu6lemethe:eccesleasedfaolilies . Eventlroughtt .i tteCorrpenysintenttosu61easeitsi nterests i n the exam fad Iity at the eerli eat pose bletimA the Company cannot detantine with oertai my a fixed date by wt di .ssuch events wiI I occur, i f atal I . In I i ght of chi s urxertai nty, the Company wi l I co

Th stall a s mrnari zest* accrued restruduri rig . of Demrrt 31, 2004(intfwsan4s) ;

Aircraft ExcessI rnvol untary L ease . L eased

Terminations Termination Fa ci lities Total

M4 404 []ec er 31, 2Q43 ~. > . . . . . . : ; . - & ; . .. . . . $

Gtars 2,247 1334 Z523 s754.Ch i tti 96 325 1 039maanges n es es ( 2 ,

Balance at Detaar3{; 2004Q > 18 4 332

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TERAYON COMM UN I GATI ON SYSTEMS, I NC .NOTESTO CONSOLI DATED FINANCIAL STATEMENTS-(Cbntinu,ed )

2003 Restru LuringDurirng the fi rst quarter of 2003, the .Conipany's Board of Dirriim approved a redructUring plan to oonforril the Company's expensesto its revenue

level s and #o b er r og tion the ConT eny for futwra gr»N/th and averltual profitability . The GorCpeny incurred res u%xing chargm i n the amour t of$2 .7millionrelatedtoemployeeterminationoastsa9partofthe2 3restr urfng .AsofDer rkwi31,2003, 81employeeswere terminated throughoutthe Company' and the Company paid $2.7 mi II i bn i n t ermi rrati on costs I n :the.aeoond quarter of 2W3, the Corr iehy reversed $86,0..00 of pi ioud y aoa iedtermination aoats:due to a charge in eali mete. At December 31, 2004, no re&uduring s mrges:re r iained apgrued. .

2002 ReEtructuringDuring 2002, a. restt uctuii ng plan (2X 2 Flan) was approved by the . Board of Directors and the Company incurred regruduri ng diarges i n the amaint of

$3.6 million of which $15 OOO remained accrued at .Decerrt er 31, 2W. , for ecoasa feared fapl ftl es i n I sael . The 2I7Cf2 Pl an i ncrwaed the reserve for eKoess:leasedfacilitiesduetothee~rifingofaddibon space vitNrithesat'tlefaalityinIsvefssint e2W.1 Man, As pat ofthe2002Flan153employeesweretan minatedtFmdiortheCorr y .During2004,Improvingreala ntarketoordtiauinIsraelnaverise'toth6Company'sinproved tersaiitaheseeasaumptions, thereby creating a.dun Bin edrnated $1pQ lapplication of cash paymentstothhe appropriate reserve ; deanremarxrg nx&ucturingaoa'ual relatingto ®ceae .leaeedfaI

Thist lesanmenzestheaxruedrestructuingbalances

res vefor the 3 lO2 Plan by $1,1 million. The company accent)be:utiIlz foi'setvicing operating IeaaapaynWft ough2005.the 2002 res►ucturi ngs as of Decernher 31, 2QD4 (i n thousands) :

the

Exc essLeased

Faalftiesa m

Involuntary Cancelle dTerminations Contracts Tota l

Charges $' 3i9' $ 1,322 3,64 1C i eymsnts (2,131) - (2,131 )Rc~efe fic4ions (16b) _ 100'Bala a at Dawn bar 31, 2002 $8 . . .. . : 1,422cam pwprierts

Sal once at Dewrbw 31 .2001 - 203. ., : 1,203Cam payfiterl

. . . . .-

Reda9aficationseCt xje in lir t `

- (11)QS) .~l

(1 Q$8)1f ':. a r~t e .. { ) k . .

Bal anee at December 31, 2004 $ - $ 15 $ 15

2001 RestructuringDuri nq 2CID1, the Board of Directors approved a re struc#uri ng plan (200.1 Plan) and the Co y. insured redh'u turi ng chargesi n the amount of

$13:7millionofwhich $ 1 .8miIIionren-4nedac ued .at December 31 , 2)O4,foreocce~.1eased fari Iiiesi nIsra d ,Terminaions cove•ing293techni cal .produetionandadmini&ativeerrpioyeas occurred as part ofthe2(801 Plan. Duri ng 20134 i r►provirxg real eat e market corxfi ti onsin Isae) gave ri sototheCompany' s improved tens t ski . ea a mpf ons thereby creating a change in e ti mate of $1 .4 million Addti one i y , aredass(fication between the 2002Ran and 2a31 Flans

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TE.RAYONCOMMUNICATIONSYSTEMS INC .NOTES TO :CONSOLIDATEDFl NANCIAL STATEMEr4TS-(Continued )

correcting the application of c paym~itsto the approp1atere roe , i riae ed the reserve font 2J01 Klan by $1 .1 mil lion. The Company cxrrantldpatsstheremainirgrestrL tngaoaual relabngtR eDctess leased faalitie$vwilI be u ti lized forservidng operab ng lease payn~e*s through .2005 .

Th s t 3U a turrn ti zestheamnied restructure ng dater ess related taithe 2001 redruc3uri ngs asof Demn'tbei' 31, 2004 ( n thousands) .

Ek2ewLease d

Faglitiesend

InvoluntaryTerminations

CancelledContracts Tota l

G~i> ments844 Wd Dawnb 31, 2001Ca pajrrtenrsI ecta fii at+ons

(t ff~1 11X77

( 100)f 1 ,17

S258Q)x$21 .

t1,177

(4,471 )8,198

(2956) „

-m at 1)omTtber 31, 2002GattayrnerrtsChange in estirr e

-5 243 :.

(1 i5 X43 .. ..

(1,685) :: ::.(261 )

Balatw.at December 31 ,2tl03 3,297 z .. . . 3,297< '

ChangBinesbmate (11371,088

(1,377 ). . .

Asgat Wite-offsAsa result ofCMTSproductlinerestr'urturing .activitiesln2004, ft. Company recognized afixed asset impairn tchargeof$24miIlion .The

impannentcharge reflactsawrits-dawn ofthea :' 11 earryinQvaluetoafarvaluebased onathirdparty valusbonin2004 .Pri rner'i ly asa r e a. 1 t of r e s t n i c t u ri r x ~ aetviti es ri 2 0 0 : 1 t h e Company w r o t e off $0 .4 mi Ilion o f fixed a s s e t s ! n 2D(73, which were deterrrned to have no

rerrai rang useful life Asa reatlt of restrtctun ng actvitiesi n2002 Ger.tai:n property and equiprront were detami ned .to have no rernairiirU wsf l I ifs Durirg

2D0l, $1 .3 million of fixed asei3tswerewtitten-off . The impared fixed assets in each period refxesantedthe net book value of ide rnanuf®oturin g.94 6 prTant, I easehol d, and office equi pTient ,

The Company adopted SFAS No . 142 on .sway 1, 20OZ The Company red.asa fi ed $1 .3 mi 11 ion of as embl ad workforte,~ net of acwrrwl atedamortization, with an' indefinite life, to goodwill at the date .of adoption . The Company tests goodwill for i mpai nrient tai rig the two-step process presori bedin SFAS No. 142.T efirststepisascreenforpotenialimpairment,wt' lethesecondstpp urestheaniotitoftheimpairment,ifthy .Duetoadiffictiteoononi c environment and heightened. pace cony eti tiort (n t11e rr lern aid elscom burr di ring U ie tFn eatrnrtttts ended Jima Q, 200horpayZ. te Cexperienced a dgriificant drop in ifsnlarket c pitalizabon, and therdoreproeeeded to perform a-i intgimtest to m regoo&ill aid intarigible assetsforrq rrnent at Jne 3Q, 2002; Based ohtheforisoast ,. the esti mated uncfsootnted future rah fl owsfrom the use of the goodwii I I would here beefi I eas than its

canyirg amount . The Company determined that the.o orne of thiste# reflected that the fair valueoFthe goodwill wesaao . Thisrealted in a non-cashcharge of$4.0milfiontowrite offthereelernirig .gobdwill ofwhich .$3.omillioni n

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TERAYONCOMMUNICATIONS'STEIVI6, ,INC .NOTESTO CONSOU DATED FINANCIAL SfATEM ENTS-(Continued)

2002 was related to the Gabresa9rn~nt:and $1 .0 million was:related to the former Telecom segment. Subsequart 0 this write-off, the Company had noirrtangi de assets, that werede»ned to have lrxieffHte useful lives

7. I mpairmant of Long-Term I nvestmentThe Company's long--I ived assets previ ousty ind uded l:org-term equi ty i.nvestn ants Durirg 20Q2 the Company det®rrnined that one long term equity

investment in aprivately-haul company was inpaired. TheinvesteesforawAswerenotmetarxir rketcoriditiansegni .ficantlydetaioretedarid.accord r l y, the Company recorded an impel rtria~t dirge of $4 .S rri I I ion. The net book value of the Campeny slong term equity i twee rnen€s wee zero asof December 31, 2004 and 30 ,8. Convertible&ibordinatedtotes

In July 2000, the. Company imred $500 mi Ilion of 5% Convertile Sebordi nated Notes(Notes) due i n August2C107 result ng In net prooearls to theCompany of &prwci mat~ly :$.484 .4 million . The Notes are the y' s. general uiseared okil ig~hon and am saborcfnated in right of pay, not to al IodSti rig and fufuie seai or indebtedness and to all of the I is bi lilies o the f~rx Any's subsidfari es i I Notes s oonverti d e i nto dares of ttte Company'scommon stock at aoommrsion gripe of $IR01 prrsa'e at any un on . or after October 24, 2000 .tt rough maturi ty, uN essproviousil y redeerned o rrcpt rehawd, The Company could have :redwried some or all of the Notes at any ti me on or after (*ctotir 24, 2C ) and before August T, 2003 at aredemptionpnce of $100, 0 per $1,000 pri napai amount of th® Notes 0 us accrued and uripai d i ntereet, if arty, i f the dosing pri ce of the Company's stockexceeded 150%of the opnverson puce, or $ 726 .01 for at least ?0 trading days within a .penod of 30 oor~sacxrtivetracfirg days anti ng on the tradeng dayprior to the Bete of mai I ing of the reds npti on notice. Ttte Con r would ale crake anadditional payment of $193,'' per $1 ., pre na pal amount of theNotes, lee;the amantof any it eredaetuaily 'donUie Notes before thedabe .of rederro on. TheCorripany may redeem the NatesI any ti no on or afterAugust 7, 2003 at fled prices plus a and unpaid interest . Interest ispayabfassmi-arx lly .DebtissuancecostsreleitedtotheNoteswereapproxi M901 y $15.8 mi Ili on" are amortized over severs years At December 31, 2004 and 2 3, aocutnUl ated alt orro zaaion of debt ies arxe ooststatal ed$15.3 million and $14 .6. million, respectively.

I n 2002, the.Company rap r oxi mately $109.1 nil l i on of theNctesfor$67.6millionin-casK reel flrg in a gai n of approxi matei y$49.1 million, net of relateduamortized ice. anm odstsof $24 m I lion . In 2001, the Conp3ay repurchased apprca itnetd.y $325;8 million Qfthe Notes TheCompany d d not repurd- .any Notes dud rig 2004 or 2003.

n Ap i l 2002, the Company adopted SFAS No. 145 and determined that the extinguislment of Its debt di d not meet the criteria-of an ectraord nary itemas aet forth in. SFAS No . 14 .5 Accordingly, in 2002, the Company began reporting the gain from yeti rernentd the Notes in . Operating results:

Approximately. $65.1 rnIlion of the Notes were outsta,dinga[December31, and :3003.9. Contingencies

LitigationBeginning in April 2000, several pi4ntiffsfileddassaction laAWtsinfederal court nsttheCompa7c andc~talnoftheCompany'soffioersand

directors Later chef year, the comes were mnsRl i dated in the United States District Court erthem Di strit i al i farina as I n re Terayon Con ni cat onSystems, Inc. S ec ri.ties Litiga5on . The Court then appointed lead plc Miffs Who .filed an amended complaint . In 2001, the Court granted in part and damselin part defendants' motion to di cri es, and pl ai stiffs fi I ed a neav oornpl ai nt, In 2f)02, the Court denied defe, rte rnot on to di sri ssthet cwrp .ai nt, whi eh,like the earlier conn laints,aIagesthatthed6fendantsvioiatedthefederal sectritieslawsbyissuing maderiallyfalse andrrii Meeting

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TERAYON .COMMUNICATIONS STEM$;INC.NOTESTO CONSOLI DATED FI NANCIAL STATEMENTS- (Continued)

~taten~eritsandfiaili . to diadowrr>alai al information r egarding the Company' steduplogy . On Febrtary 24,2X3, #teCourt oertif[ ed a plaintiff classconsisting of those: purchased or Ptherwtsp acqui red theCompany ' ss®ai es between . November 15, 1899 and April 11, 2000.

OnSeptember8, the court heard defendantd motion todrsqualifytwooftheIs aidplaintifisa~idtiemodifythedelinitionofthe pI airitffdass .OnSeptember 10, 2003, the Court i s9ued an ord er Xarali rig th e head rig date for the parties surrnary j tl<{gri nt mp.on arid , on Se ternber 2? 24D31 to Courtimuedanother order alayingall d sovery unti l furt 'noti ce and varati the teal date, whi ch had been November 4,26.03-

On F e bw ua r y 23,2004, -the Court i s te e d an o r d e r d equal ifyi ng two t he lead plainti ffs The order ailed st> s that pl a ntif fd counsel mud provi decertaininformationtotheCourtatoutoounsl ' srelationship with tfiedishified lead pldnbffgenditprovidWsthattlrfenda'itsm. yservecertainaldi ti onWcisoovery . On March 24 , 2004 ,plaintiffs subentlodcertaindocurrettstotheCovtinrey)or toitsorder , and,on April l6, .20b4, theCompanyreponded to chi s sabrriad cn . The Cot7lpeny hasalso hale initiated discovery pratent to the Cout ' s February 23, 2004 .ofder .

On October t6, 2000, a IaNSidt Wasf i led.ageiC theCprrpany aid the individual d&erKkY ts# ab Rakib Salim 1~akibanci Raymond Fritz) in theGglifornia :iperior Court Sep LuisObispo county . Ttislawsit istidad Bertram v . Terayon Inc.Cam~unicalronsSysbarr~ . Thefacdual 4 1egationsin theBertram complai ntwsre s hiller tothin the federal dassaatioh, W: the. Bertram cnmpl ai nt sbt9ht remedi as understate .l2W. Defer r ed theBertram rasa to the United States District Court, ;Central Distri ott of Cal i fomia, which di srismd the corrf ai nt and transferred the saes to the Uri ted StatesDi tri ct Court, Nortf n Di strict of California That Court eventually iss,ed an order cfsmiesing thocase . Raintiffs have appealed this order, and theirappeal was heard on April 16, 2004. . On June 9,'2W4, the. Urted States Court of Appeal sfor the :Ninth Circuit affi rmed the order-di sriad ng the .Betramcage .

The Court of Appeals' opinion rnii ng c6 S6 sW of the Bertram case does not end the dam act ion. TheCarnpany believes that the :al l egationa in thedam acti on are without morn t, "we intend to contest tN s Irmiter v iigoroudy, This matter, however, could prove c+ I y aid ti nieconsuiming to defend, : andthere can be no asaxanoes about the eventual outcome.

In 20 2 two st-weholders fi led derivative i s puportedl y on behalf of the Company again net aorta n of itsarrent and former diifedors, off c" andInvestors (The de(endantsdi fferad sari what In the two rases ) Since the wseswere filed; the investor defendants have been dismissed without prejud ce,and the lawsuits have been consolidated M Campbell v. R*tb in the Cal iforr i a &ipen or Court , $aita Cl ara Corny . The Carp" isa nominal defaidantin these Ia wsri ts~ which 4 1 egscl aims relating to essentially the s purportedly misl eating staterf> entstha2 :we at i sisie inth e psntli ng seariti asd assacti on.] n the sewri ties dassgciian, the

C 0sputoo rlakinganyml sleadingstatrn~entsThederi vati vecgnlnlaintselsoallegedaitnsrelad .ngto dock

sAlas by om,W n of the dlrertttor ark affroer isThe company believesthatthereare many defects intheCarrpb2II and O' Brersdorivative .~mpIaintsOn Jxxrary 19, 2003 Crrniband Group Limited , a Rus® ancompany (Omni band) filed, re ua for atbitraIion with the Zuri ch Chamber of Cor xnerce,

d a mi ng damages i n an emouit of $2,094,970 fegedy caused by the breach of an agreement by the Company ; Terayon Co mi w i ca ti on Systems Ltd., awholly-owned subsidi ary of theCorr~any, andRadwizLtd(Raiwiz) ,afomverwhdly-ownedau idairyof theCornpany , toselltoOm bandcertainewprint pursuant toanagreementbetweenOrrinbandandRadwiz,OnD ecembor'18,2003 , theparielofarbitarswiththeZurichChamberofCommerceallowed the arbi trati on proceeding to. contl rxle agai nst Radwiz but dismissed the proceedi ngsagai net the Company and Terayon Ltd Onnnibet appealed theZurich Chamber of Com neYce" s d®dson to deniesthe proceed ngsa.Cyainat the:Cerrpany and Terayon Ltd., and the dap son was affirmed on October15,2004. On January 13, 2005, the

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Zuidh Chamber of Comrnercedisniawd the comwith prejudice after On niband fated to respondaid pay thearbitrahon feesIn 4xwy 5, AdelpNa Corporati on sued the Company In the District Court-of the: City and Canty of Denver, Colorado. Adelphia' s comp)a rit

alleganong .other th ings &eachofcontra tandrrisrepiesznt ion in conrraclion .vriththeCorr~pa s'ssralerifCMTSproduds~GiAddp hi aaidtheCompany' sannouncernenttooasesfutureinyesrrierrt intheCMTSmarket Addphia .seeksunspeCifiedrrarielarXdan esanddedaratory rdef,TheCompany filedamotanfiodisnissthecomplaintonFebruary 24,2005.Asthe Company betievestH2tAtAeiphiasallee ationsarevnthautmerit itintendstocontest this matter vigorous) y . TNi s matter, however, could prove oostl y and ti me oons mirg to .cW d,, and there can to noa~g out the eventualoutcome.

From ti meto tir ne, the Company receivestottersda mingthatthe Company IStedvwl aqy and products infringe on intell property ri ghtsofthird par ties The Compeny aisa has i rift pad agro d t6l and m6y from ti me to time in thefutire agree to,iffy.a aaorrier of its .ted'snol ogy or

ofproducts f o r t h e aufana by athird party based on dai m5 that theCon ny ' sbedtnoiclgy or ixgdu4is i.rdd lge irttdlectua property rightsthatti'urdparty . Thowtypesofdeirr*meritorlausbrnot , 3anrasa)tinCosi ! yard ti rne-cor ziinglitigation diventn >snepertlerd`'sattenticanendotl>erresouroeK requrethe Company to enter into royaltyarrangerrents; sibje tthe•Cornpanyto dan7a& esor innufxitionsresriCtngthesW eof its productrequirett>eCoirpenytoindertxrfyitsr arr~ersfortineusaof th eall egedlyinfringingprQdwcf recp re. tthe Company to refurOpaymentofalleged.yinfringi ng productss'to its c nmers or lay forgo future payment% requirethe Company to redW gn certain of its producls; 0r dMiage .the Conperiy'sreputation atyoneofwhicheould materially aridadvet'sefyaff ectth Compwy'sbCWriess , . resUtsof ' onsartdfinarxial ooncition ,

The Company hasreoeivedIattersdaimingtl atitsteiulogyirdriagestheinteller#tal property rf sofothers The Companyf asoonsltedwithitsportent. and isi n the procea of re ii ewl ngtt9aal

IS*one made by sudti third ~rxti es If these 21 legations were submitted to:a court, the court coul d

it rd that the Company' S products infringe third party i nteil actual property rights If the Company is found to have infringed tiii rd ~ rights, the Companycould be subject to s bdunti ai darrMps arxilor an i rgxncti on pre ienti ng the Company f rom :andudi ng itsbusir ss In addtion, otl~third par ti es mayassert infrir pert dairnsaga nsttha:Corpaiy inthefutLra A daim .of infringernart, whether rneritoriausor not, oauld be ti me -ooreuming, result incostlylitigation , divettha y' srronayerrtent' sresouraestsasaprocY.x Shipp delays or require theCompeny 'toerterinto royal ty.or•11 amid iga rar~gerr~erts These royal ty o cemfg.arrangecnarts may not be wail able on terms aoceptagl e .po the Company, if at all .

Furthermore, the. Compa ny hasinthe pad agreed to, andmay from ti rrieto time inthe.iuturavgreeta, indemnifya o0slorner of itstedvalogy orproductsfordaimsegainstthecustpmerbya thirdpartybasedondaimstFatttstechrologyor odudsinfringeint el le ctual propertytightsofthattN dparty . These typesof dal rn% moritori od or not, can reailt in 000Y and 1i me-cons rni ng l i ti g2hon; divert rr~arr ronk'sattenH on and Duller revurcrequite the Compwy to enter into royalty arrangements) subjeotthe Company to damggesor IryundtionsrestticUng the salebf itsproducts; re irotheCompany to indemnify itscrAetomersforthe .ueeaf the allegedly infnngng products require theCornpeny torelvid payment of allegedly infnngngproducts to i t s a ~ s t o m e r s or to forgo future payment, require the Con-any to rede~gn cortam of its lord or dens e .its reputati on, any one of whidtcould materiallyandAdversely affecttbeCbtitpeny' st nesq re uitsof operations and fi Hans) conditi on

The Cornpaiy i sarren y a petty to various otter I opal prooeeii rig i n adcition to thgge noted above , and may bearriib i nuol ved from) ime to ti me i nether legal proi edrgslnttlgfudme. 4lihilethe Cornpany currently bsiievastI he ultimateoutcoineoftheseotl>erproceedin siruividuallyandintheaggredd e, will rat have a materi el aiverae effW on itsfinaneial portion oroveaall re9 tsof operati .an litigation issiibject to ithera •rt .uncat nties Werean unfavor i e rui irg to occur in any of theCompany' slegal proceed nps ,. there adststhe

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possi bit i ty of a nxnbari d adverse i n a t on the Company' s rea. its ofopetaiions :for the period i rt which the rul i ng ooara, Thee i mate of the potentiali rnpatt on the Company sfi nandai positi on and overai i rm its of opeiationsfor any of the above legal proceed nog could dh.Wge in the future.

10. Stockholders EquityCommon Stodf.Whrrai s

In oor "anti on With a 1999 pmferred dock finenang, the Company issued Shama warrant (Anti =Dilution Warrant) to prcfiasean i ndeterrrinatenumber of aharesof oorrvnon ;took TheAnti-Dilution Warier t was exerpsabie at the option of y duri n. g.the period that. lr canned equty i n theCorry and i n tfie event the f ompery issued new equity sscairities at below the turrent market. . asdefined i n the Ant-Di l Lid or! Warrant. The aggregateexera w price was $0.50. The tbrnpany issued tertA n e*ty sacxr.. es#i~a, asof 13eoer t r 31, god 20f1Q regui red the Company to issue. an.addi tional 3723 and 17,283wwran% repa tlvety, to purehase.O,aresgf con an sbxk piralant to the Anti-Dilution Warrant The Company recorded0cpsne ti5of app-;xin&y SAS:fC10 and $?60(iE1 ref sting to the isaeaioo of warrants pursuant to t eAntI-Dilution Warrant in=and 2002, re esfivel y .Theexperise Wascalculated bymultiplyingttèannualised fair market vatue .of the Company' astockicy thedharodilution attributabletotJteArid -DilutionWarrant lnFebruary2003, tanr transferred ifaawnershiptoathirdpartyandtheAnti -DilukionWarrantecpiredunexeroisad, Asof Decerrter31,2X03 ,

In February 2001 , the Corrpary issued ados rig price of the Corripany ` scomrnon stock o(TrueC)hat). UrxW termeofTheworrant 100 OWe e-dsabie at the rate of 1/24th per nbnth, beQBI ack-Sctol a me hod and wasreoorded as addwas aoterdsabl a for an aggegate of 2oo,wo § ar

Siod<hoider MghtsPIart

warnint to pur`cPiase 200;006 erree of the Co=d r17x n stock at a price of $5.4375 per slure, then the datethe warra t wesi~ued , i n cone on with the Deca giber ZQQD aoquist on of TrueChat, Im.

ni no 1 0 ODD taresvest and becomeshares are vested and ebcerd sekl e i mmediatel y ",ft r.*Tioinri rig .J axxx y 31, 2001 . The fat r val.ueof ttie warait of approximately $O.7 mil II ion was calculated us rig theti or conq deration relad rig to the purchase of TrueChat As of. D.ecen bee 31, 20033, the TrusChat warrantesof the Cornpany'sasmrr n stock. The TnieCt~at warrant (pied ur eraeed in . Febne y 2004.

I n February 2001, the Company' s Board of DirectFeixt y 20, reaeive.d .ri g is to purdidwm.(expire in ten yearsfrom the rawrd date. The dghfswiainourioes a tender offer for 15% or more of the ConW J rig}#hol dare except the buyerwill be enti tl ed to atime or redeem the ri ghts pri or to the ti rtitie a person or

ion of a Stoddtal der Ri tft Plan under which all :stadd1oldersof record as .ofrred stoat. The rightswere dish i bated asa non-taxable dividend and.wi I I° a p e r s o n or gro acquires I more of the Company' .s common stock orI fa paraort or grouppaaluires 15% or snore of the Company'sconvrnn stock,;onvrxn stock it a di scount. The Board n*y taunt nate the Rights l1 an at any .an 15% of the Co nrahy'scormron stock .82

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TERAYON COMMUNICATION SYSTEMS, I NC .NOTES TO .CCNSOLIDATED FINANCIAL STATEMENTS-( Continued )

Common StodtcRaserltedCon nu stock reserved forIsarance .isasfot lows

December 31,20D4

..Ca nrr~arisixk opeatis: :>2 ,11999'4 2%.` .

Employee stock purchasepen 1,M733

Stock Option and Stork Purchase Plans.1595 Pla n

In March 1 995, the Boafd of Di rector ved a stock option plan (1995 pl ai) that a Aha za1 Eharesfor future i skmica to begra led as opti ons topurchase sharesof our oorrrron stock . As Decanbe 31 , 2404 a tots of 4,229 , 494 mares have been "W zed for issua iC related to the 1995 Plan .

1997 PlanIn March 1997 , the Board of Directorsapprovedan .ecJty ir%witiVeplan ( 1997 Plan ) that a~uthorized 16©00(Q aresfor futureie roe to begfaitad

as opti onto fx.rthase'ares .of our corm x n stock . In .lne 1998. the Board of Directors .a thonzed the adopti on of tl~a:a ieided 1997 Plan, i.rxxea5i n taleaggregatenumber of shares authalized for issuance under the 1997 Plan to 6,6DO OW shares (5, WO OW addi tional shares) . Theantierxhwnt also providedfor an i ncrease tolhe authorized shareseach year on .Ja[nary 1 , stzti ng with Jens iary 1,1999, i f the nur #~er of ,Freres reserved for future iavange was l essthan 5% of our outstanding ccommon dock the, the rx> hodied .# ee would be I raea od toe balazeequal to5% of the aornmon dock outsfardng . Therewere no i ricreases to the 1957 Plan in 1998 or 1999 On J vxwy 1,217DD, 2,384528 shareswe a added to the 1997 F1 an for a told 0(8,984;528 shares

The 1997 Rai wasaneided on June 13,20ODtoinaaRSetheshrasauthonzedfor issuance, by 3, 770,000 add tioro sh s"toprovideforani rxreaee i n the txrrter of saes of mmrnon s Ic beginni ng ,}emery 1, 2000 tMa agh .. teary 1, tart by the I weer of 5% of the wnmcxt stock out #arxli rtgon sucfi hia°y 1 or 3,000,wo shares In May 2003, the Company's Board of DIrectors auttarized the adop ti onof. an amar dment to rarixethe nunber ofatlhonzed shares in the 1997 :PIan .by 6,237,826 sttarea Asof December 31, 2004; a total of 15,516702 shares have been authorized for isasrioe related tothe 1997 Pl an.

1998 PlanI n the 1998 , he Bowd of Di rectors a4hori zed the adopt on of the 19M Non-Employee Directory Stock Option Ran ( 196$ Plan), pursuant to which

400.=d,aree of our convrion stock h a r v e been reserved for futh ~a i say r m t o our non-employee directors I n 2002, the Board of pi recborsaimnded the1998 Ran to i nireesei the sheresautf-aized for iswa-ce : by 400,000 addi tional el es As of Dearnber 31, 2004, a total of 800,000:shareshave hashauthorized for ismarce related to the 1 998 Plan.

1988 PlanIn Sep ember 1998, our Board of Di rectorseutlwri zed th e adopt on of the 1:999 Non-O fficars Equity Incentive PIan(1999 Rai), pursuant to whi dt

6 0004(X0 thanes of our common stock have been reserved for futurei s tike to ow non-offi cer employees Adcti orally, in May 20©(3 our Board ofDirectorsauthon zed the adoption of an . onrw nehtto reduce the number of authorized shares in the 1969 PIa7 by 13,762174 shares

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As of Decerrtter 31, 2004 , a total of 14, 737, t6 std hate t authorized for i sararx3e rela ted to :tl ie '19$9 PI ai ,The 1995 and 1897Ransprovideforir vestocIFoodomornonqualifledstockoptionstobeiseuedtoemployees , dira ors, and .oonaitantsofthe

Dorn any . Prices for i rroeruive stock options may not be Ierecthan ifie fair rnatket value of Uie oamlon stock at the data of grant Prices for nonqu al iftedstock op i ons may not be lessthan 85% of the fat mark.Ek vai ye of °the oormion stock at the data of grant Options are 1mnedaW y exerds3bi :e and veg over.a period not to repm* by: theCompanyattheonigirAiss obepriceupon tmi riab on of the option hol da' s e r !oyment Unexerciasd options expi re ten yeersafter tha :dats of grant .

The 1.999 Plan pravidesfor nonqupl Fred sibck options to be is d to non-officer e mpioyeesarrd conaultantsof the Company:. Slices fornonquaiifedstock op i one may not be i ass than 85% of thefai r merket .vai ue of the comnon stock at the d&te of the grant Optionsgenerai I y vest :and bwo a exeta embl eover a peri od not to exceed f NO yeelsfror the date of:grant: Uhebcertlsad bptforaexpi re .ten .yearsaker date of grant,

Dui ng t e yea c dad December 31, 2002, the rnpgny :remr.ded aggro deferred on of a rro?4met ®1y $38,a0Q n liresenting thedifference between the grant piece and the deeimd fair Val ue of the Company ' s ownpn stock opti on granted during: t e peiod. Dori rig the yeors erxkmlDee -ita 31, 2004 and 20M, the Company did not record array addi ti ord deferred oonper on . Thean1ort zatl on of defertod ocn-W1 Lion i s bei ragcttarged :to operahonsarid isbang amortized over tl ves'ing period of ttleoptiarA Which is typcaUy fiveyeas In each swbwW w,, t repo ti r g~p~~eriod(through the ves ti ng period) the rental of ng deferred wroper vibi on Zvi II be re-rrieASt r d . For tti i yearsonded De umber 31, .2004, 20113, and .2X)2; theamortization expense wasapproxirrabaly $22,000,$53,000, and$0..5niillion, re. edivety.

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The Col lowirg isa sumnay of aJd1ioctal informa(ion with re to the 1995 Rai , the 1997 Plan, the 49,98 Plan, the 1939 Plan, outstaridng optionsassumed by the C ortpanyinoonjunctlonwi th itsbWHessacquls onsa,doptongrants made outside the. plais(ifany) :

Options Outstanding'Options

Available for Number of Weighted-AverageGrant Shares ExarisePrice

B91ri>a at Dec aitlet 31,,2=. 2f1397 r;99 ^~(#E7€lfX,t 6 _ _ : ` . . .. :$ f1.75X.ttv mci 3,400 OO Q

t IGt pfatiteE€ : (?, 34,400 1 $ 3 40pho(i9 ~cerdsed0

1 .66 . . . . : . . .

Bal Wipe at: Aecember.31,2QD2 28,9128QG 14635 ,025 $ z p5c~a is e<idtcui ;•ecC <; ~ dJt3 4bt3 ,, ; ;Ophonsreduc I.. (20,J3O. 7 . . . . .~ . .. .. . .~#crr>ggra<rte+.1> 7153,520 1: 3.03Qpti ons scerdaed - (&Q2 . . . $ 4 .20CEpfioris eEf 3,72114 (3 (J4 $ 7,58

balancxtat 0ecernber31 ,2003 8,481,609 17;4 395Q $ 6.20.Ooonsatafhon d 3,t1(112,OLyJ «» . . . . .;

Opbonsvanted (4,738,944) 4,738944 $ 1 .95i€>L~phrins•eecarc~d

.`` -~- ~ $ 219

Op(rorisca1( ed 5,174,420 (5:174,40) $ 5 .1 8

4arim4: tleoember 31, 20U4` 11,917,0176

In add bon , the following table smr narizes i nformation about stock opti onsthat were owtstar J rig and exerci sable of Decanter 31, 2004:

OptionsOutst andingOptions Exercisabl e

Weighte dAverage Weighted Weighted

Remaining Average. Average,%ares Contract ual Exer ci se Exerci sable Exercis e

Rangenf Exercise Prioes Outstanding Life Price Options Price

$0.00 - $1 .99 2.777,0 9 .48 $ 1 .74 167.549 $ 1 .26$2.46-$426 3,562:965 8 .40 244 1,963,959 245$4.27- $6,50 3;312,257 7.22 4.59 9 . 98 ,L1A0 4 .85$& 51 - $8 .39 .5,345,910 6.12 6.80 5,220,337 680$$8,51 - $123,50 801,606 6 .34 29,23 735213 3254

Total 16 ,802,338 7 .54 $ 5.37 1 .0,080,154 $ 7.24

At Decernber 31, 2004, the were no5hares6f the Gom y'socxrunon s t o ;s .tbject t o repurtase by the C rr ny.Employee Stock Purchase Pla n

I n Am 1998, the Board of Di rectors approved, and the Company adopted, the 1998 Employee Stock Purclvse Ran (ESPP), which is deggnedto allowel i0ble empl oyeesof the Company to pLiju'as ttaresof

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cormmonstock atsemi-ann uaiintervaistfroughperiodi cpayrolldedu ortsIn21Q2,theESPPwasanar 4edtoaddaaddi ti onal 3,000,00.0tharestotheESPP. An gegateof 4,400,000 wasof common dock are reserved for the ESPP, aid 3,197,267 sti2res .have. been iswed through Deoenrrber 31, 2004 .The ESPP is i r emerted in a series of s~ ve offen ng periods; .eeth wi th a maximum durati on of 24 monthis EI i . bl eer riployeas can have up to, 15%o f their base sal d e c l < x t s c i tat can be used t o p►rd vaee shares of the co i i n s t o c k on sped fi osfales dete-n- ned ~r the Board of Djre rs (Up to an-acimum pf $25 Per-year based upon thef ai r n~xketval ue of the shares at the begi rani ng date .pf the offeii ng) . The price of common stock purchasedCrider thte.ESPP wi l I be eq~ gal to 85%of the I time of the fair market value of the mrmnn stock on t . corrrheiicenn rt date of each offeri rig period or thedeafied purch~e date. l n Novc er 20D2 the -Corr~sny" s Board of Di reotcrsst died the ESFFWter the final offeri .rg period acq a i.on Jul y 31., 2fJ04.

YheCorr~panyhasalectedtafoIIowAPBOpinionNa . 25a-idreletadinferpretalionsinaccoungngfor IItsemlN eeshpckpiarabecam ascisije dbelow, thealtAma6vefarv iyeaoootyrting pr6videdfor under SFASNo,f23' requirestFreitsofV2llieti4rl rixsdals were netdevslopedforuseinvaluing employee stock inSruna~ts tJncier AP8 Opinion No. 25, whet theecerci a pri ce.of the Gon any'spmplpyee stock optians equalslhe market priceof the under) yir~ :stsfck on the cfaCe oP gtar~~ r~o oan rtsati on ~c ~et~9 iarec prrized .

Proformainfom~abonrogardrgFistlossisreinredunder SFASNO. 123aIdIs.€aleulatedasifthe Company tiad .acoaunted foritsernployesstockopti onsand for its ESPP shares to belssued Undel the fai r yal ue nrelftod of 5FA5 No, 123 . Thefair value for employee stock opfions grafted and ESPP

reswaseatnatedatthe date ofgrantbasedontheBIa .-Sc olesmodef uergthe following weighted averageasstlmpti ons

Risk Free WeightedInterest Volatility Average DividendRates Factor Expected Life Yield

300")Stock Wt on flans 4.22% 1,50 50 yrs. 0.0%Employee snack pE,rrt} e plan 4 3G"h; 1;50 O5 yrs z x:096

Stook option plans 267% 0;87 5O yrs 0.0%5moloyes stock Purchase Plan 288% 1,54 A 5 yrs 000/0. ::.2004Stock opti on .ins 3.47% 079 50yrs 0.0%Employee s :t pia.d'Waptan t;2 96 <.. k 4. . .. t3 yrs .; Q:t3°r6 :<

As di sammd .above , the vaiuat on models used under SFAS No. 123 were developed for useif .estirreting the tai r value of traded Optione that have novesting reslri dia n.sand are filly trwderable . in addt cn, vahfli on modelsregLi re the i nput of highly subjective as urrptiom ind d ng the wpected life ofthe option . Because ft Company` semployee stock bpfi ans haverdvraderisticsspvfi canty. different fro m those of traced onti ft d because dler oesinthe s± active i r xrt a npti nnscan rrjateri al ly affect the fay r val ue esti mate, i n rnar errt t s opi rt on , the e~ti sti ng models not neaeasai l y pouf de areliable single measure of the fair value of itserripl oyes stock! nstnrnents

The options weighted average graft date fa r val ue whi eh i sthe val ue assigned to the :op6 ons under SFAS No . 123, was $1 .28, : $214, and $4.98, foroptions granted duri fig 20D4,2003 and 20(Z ref ecti vely, The wei ghted averag e grant date fair value of ESPP iharesto be issued was $0,99, $1 .00 and$2.25 for the yeasended December31., 2004, 2003 and 2002, respect vdy,

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TERAYON COMM UNI CAT) ON 6YSTEMS, I NO .NOTES TO CONSOLIDATED Fl NANCIAL STATEMENTS-("Continued )

11 . I noomeTaxesFor the years aided December 31, 2004,20M and 2m2, the Company had an iroxne tax (benefit) e tperm .of $(76,DD[)), $316 DQQa i $238 ;OO04

reped; vd y .

Years EndedDecember 31 ,

2004 2003 2W2

Tatal deferred -Tot s trsj > ~1~.. 238. . .

The reconciliaton of it osrne tax benefit attributable to netlossapplicabla to common ttockhdtlsrs mmputedat the U .S. federal statutory ratestoi nmrne tax berdit (ecpense)(i n thpuswncis) :

YearsEndel December 31 ,

2J04 2El3 2002

Tar benefitatU.5,' cry rate % (12,8l2). }'> ~ . .(.17,624} ~ : (15.391Lossforwhichnota(benefitiscurrant)yrecvgnigotle 12 74? 17539 15,391Otttit' t

(76) $ 316 $ 238

Deferred in ornetexesreflectthenettateffectsofterrporarydifferenossbetweenthecarryingamount8of s~eetsandIiabiIitiesforfinand reportingpurposes and the amounts used for incarnetab( ptrpo s

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TERAYON COMM UNI GATT ON SYSTEM, INC . .NOTESTO CONSOLI DATED FI NANCIAL OTATEM ENTS- C bntinued )

S gi ficantcompwwTts of the Company' s deferredl w a9aats and I i abi f hies as of Decornber 31, 30M and areas foil ows (in ti lls) :

Dearnber 31 ,

2DO4 2003. . . .. . . .. . . .. . . . . . . .. . . . .. . .Ddarzed.t@x assets

Netaperatmg lossc .forwards $ 1g5O66 .. $ 149,863Tatt .ti6C7~tC21fy : r)t1Wall~e '> : (6,2<: . . <19,5G5

Rervesan a s 10+1, 9949Cepitat~a ii sei d aitddeJelapt,~aIt

Intarpi bl a asset arnorti nati on 30.051 38,864t; w 1.419I >: 92430

Groff deferred tax emitsUaEuabotfahof~uailce r

} `.

(239 Ul i )

Total deferred tax, assets $ - $ -

Realization of deferred tar assets i s depederit .on future Sarni ngs, if any, the timi rig and the amount of wh th we uncertain . Acbordi rd yI aval uati onallowancehasbeen establishedtoref[ectthe trioertaintiesasof Decombor31,2004ad2DD3 .ThedlangeinthevaluationalIowanswasanetdecre aseof $185 million and $5.7 milli on " anet incree of approximately $2&4 million for the yearsended Deoeirtier 31, 2M4 2003 and 2DD2, vdy .ApproximaWy $46.6 million of thevaluation .allowance related to .dock options benefits MII bea ditedto oquity'when realized ,

As of December 31, 2004, the Company had federal, Cal ifomia and foreign net operating lose carryforwards of approximately $366 .6 mill ion,$184.3 mil lion and $49.8 million, respectively, The Company also had federal and California tax credit carryforwardsof approxirn try $9.1 pillion and$16 .7 rimi Ilion, respei#ivdy . Thefedefa : and California net bporab rg loss and credit carryforwardswil I expire at various . dates beg rwti ng i n the yeam2005through 2024, if notuplized . Theforeig.n not operating1osseshaveatunlimitedcarryover period.

Uti Iization of not operatl ng loss and tax credit carryforwards maybe subject to asrbstantial annual limitation due to the ownership changelimitationsprovided by t e l n t e m a l Revenue Code of 1986, as arr~erxied, . and a mi l ar state provisions The anr~ual l l rnitati .on m a y result I n the exp rati on of net operating

:and to credit carry forwards before full utilization .

12. Defined Contribution PlanDuring 1995, the Company adopted a401(k) profit Sharing Ran and Trust that all ow* Al gi bl a empl oyees to make confri but ions iibject to oectai n

lirnitaition5, TheCompany may n kedwvtiorwy contriWions based on profitability asdetermined by the Board of Directors No :arriountwasoontributedby the Company to the pl an dud ng the years ended December 31 ., 2004, 2003 and 20OZ13 . Segment Informatio n

Since late 2000, theworkkvide telecom aid well its indusfriesttave experienced .were do wnturrsthat have teslted in sgriifi cal l y reduced purdhasesof new broadband equipment : Because of this overall I drop i n demand, the Company has refocused itseFforts.on thec able i rxi~ry., and has sign ficant yreduced its investment in thetelecom aid Bartell Its bua nesaes Consequently, begi t ing i n 2003, the CaTpay s evioud reported Teleco mlonger meets the itatvethresholdforriadogxe andtheCompany now operates as one hue r~ess aegr~ent

Table of Contents

TERAYON COM MUNI CATION E'STEM$ J NC.NOTES TO :CONSOLI DATED FINANCIAL STATEMENTS-(Continued )

The Company operates solely in one bus nezs:sagrnent, the dave)oprrpnt and rr ar keti rig of CM T ; home access sol.wti one (HAS), DVS products"related services TheCorrpeny :sforei operatiorsoor~efst .of safes niarketirig"supporfactivltiestfYovighitsforsignabsdiaries.TheCorr ny'sCNefExecutive Officerhoeresporsi bi hty asthediief opere6ngdeason maker (CDDM ) asdefined by Statement of Financial Axo z r1g Standards limber131, "Died os res aboutSegnentsof a Fnte riss and Relater! I rforrnation " . The CODM revfews f ( rranaal in. fa riabon presorted on a con dated besAacoin>pani eel by dis'we . gated irtonnabon a664 revenuesand certain direct expenses by geographic :repiort for pcrposesof making operating dedsonsaoda~sese rg fi nand al perforrri9n e . The Company' s a~t#s are p

rimari ly located in its corporate offr os in the United Stakes anti are not al located to any saes fi e

region, thaefore the Company. does not produce reports for, or rrs 'e the perform anaaof,itsgeograptvcregionsbasedona?ryas3et -L asedmeh j ca Asaresult , geographio information is presented onlyfor revenues" ibng-I Ived esaets

Years Ended Dam, ber31 ,

2004 2063 .2002

. . . (In thousaryds)Geagraphi c aeas

RererwiesUrrteelSfaE s g 83,212 $ 74, 341 $ 41,1~a0Amen ~c d u c f i ng Uru t Stakes 4,126 3. 713 20 3Q : . .EM FA 4attud+agisa~ 29"M 17, 635 11381> :s a~1

As1a i06d tt ng . n :6,681 ,

} 7:~g7 .Q369,575

8 23 . .3E~i ^f E . i,'

9,172 21, 183 11,645

Total 15D.538 $ 1'33, 1 <' 129.403 '

December 31 ,

2004 ZOD3:

Lc~g> livacla~t.~(I n thousands)

: rUrrted StatesAmericas, exducfingI United Stci~es

$ 4,423 $402

8,555810 -

EM EA €aduding Isad 131 176Isaei,

Asa667 1,157117 173

Total long-lived assets 5;760 1 y 87 1Total aarrait amts 137,2 . 34H19 1C7ttaesets 1a;49.,

12,021

Tots assets $ 153,734 $ 215,240

Two customer- Adelphi a and Conicast accounted for more than 10% of total revenues for the year ended December 31, M ; 18%. and 1.2%0,,respertivel y . Threew orne s, Adolphe, Cross Been Networks" Corricast accounted for morethah 10%of total revehuesfor the year ende dDe anher31, 20Q3; 220l, 16%o and 13% ; respectively . Ttreea-opmers, Corrxask Harmonica id Sun tronim a xouited for 10°x6 or more oftotal accountsreceivable forftyear ended Dece►rbt' 31, 2004; 18°Ao, 10% and 10°x, respectively a id twoa~stol v, AdelpHaaidCorr , acooulted for 10%of moreof total a rsceivablafortheyewaidaf Dboanber31, 2003,244 and 20%, respectively .

89

Table of Contents

TERAYON COMM U NI CAT I ON SYSTEMS, INC .NOTESTO CONSOLIDATED FINANCIAL STATEM ENTS-("Continued)

14 . Related PartyTransaUions:During to years.ende i December 31, 2004, 2003 and3002, the Company rata ized reuerm of $9 .9 milli on, $4.7 mill ion and $9.1 million,

r vely in oonnedionwith p roduct sNpmentsmadebr (ded parties Relatedparty reveruaesirr2OD4wwofrom Hwmgnic, Inc . (Ha rmonic) . Relatedparty revenues i n 2Da3 and 2002 f.nd Lided reverxaacs from Harmon ic and Rogers Convmy i Calf ons, Inc. (Rogers). Lauri s l;otomon, a merr y the Company' sboard of di rectors, is a mernbW of the board of di rem orsof Harnonic, All mm %m attri lAitth eto Hamoni c *ere i nd uded i n relatd patty reuerwts i n - -end 2003 . Al ek Krstaj i c, awtl w member of our board of di rector writhe Seriior Vice Preddeit of j me active Service: Sales and Product Dw opniaitfor Rogers unti I .January . 2003: Effec ti ve in April Z$, Ro rswasno longer a related partly to us Consquend . y, re~!ernres atbibutad a to Rogwsare onl yd asdfied as rel ated paty reveriuas in the fi rst quarter of 2(TO3 Neither of these rd eked par as area sippl i ®r to the Company.

Cost of related. party produ ct re enuesin the Con- iy s :cons Iidated ementsof operati .ons .conaatsof of red and irx rent product costs Accountsreceivabl a from Rogers and Ha moni c totaled approximately $30 ni I I i on and $0,6 mi Ilion at Decwt er 31I, 2004 and . reqxec#i el y .

In Decent a Z0f11 . the Company entered i nto oo-marketing arraig is with Shaw Commun cati onq Inc. (Shaw)and Rogers The Company paid$7.5 million t o Shaw and $ 0.9 m I lion t o Rogers aid recorded these amounts a s other cu r a f t amts I n Uy 2(X)2, the Company began -Ortla ng theseprepaid assets and chorgi ng them against raided party revenues i n accordance with PIT 501"M, " Accaxib ng for Conad ®rad tin given by :a Vendorto aCustomer or R/®l I er in Connec ti on with the Puchaasor Pronioti on of the Vendor's R'oducts" The Company diarged $ 1 .4 nv l l i on per quarter of theamortiz lion of tow aseehs against total revenues3troygh Deaernk 31,2003 Ammx~ts dwged aaai nst total t ~YQnues i n the year ended Da a tier 31,2042 and Dec tiber .31, 2003, total ed.approxi metal y $28 million and $5,6 mi Ilion, recectively . Ofto vo-rr rketing amorti zation charged to totalrevenues $0.15 mil [ion and $0.3 mi II ion wares arged to related party revenues i n time year ended 2003 an d 2002, re fivelar. No hither arnounts of theseco-market ng arrangarnants are i nd uded i n other arrant assets at Dec rter31, 2pa3 and no furtherwrord nation ooa ,rred i n 2004.

I n October 2002r the Company incurred a rtra~'keti ng a parft of $15(3000 for Teem Honor ; al orgartiialion That a, ni~Esa profess oral sat ling teemErneoftheCorn's Board . members Alek Kis jicisthefounderand Presdent of Teen Honor.15. Product Warranties

The Company providesfor estimated product warranty experweewhen it sellsthe related products Beca warranty estimates are forecasts that arebased on the test A/ei Ithle information- mostly hisbon cil dam ms experience- dai rris.costa may differ from amounts provided An analyasof dianges i nthe i iabiI ity for product warra itiesi sas fol lows (I n thousands) :

Balance Additions Balanceat Charged to at. End

B~nning Coatsand ofofPe mod Expenses Settlements Period

Year aid& Uwen bat 31, 20a2ACYY'h3BdW 'Y6r ended D fiber 31, 2003 $ 8,368 7313 (249€} $ 8,607

Aaxuad wary . $ 8.607 2,287 (5.3035) $ 5,509Year ended D t 1 J04Accrued warfanly` $' S 509 1 .460 : ' f3 1 $ R7n

90

Table of Contents

TE.RAYON COMM UNI OATI ON SYSTEMS, INC .NOT ES TO CONSOLIDATED FINANCIAL STATEMENTS.-(Continued )

Guarantees, Ind ud ng.I .ndired G.uaranteesof I ndebtednessof OthersIn addition to product warranties tho-Compariy, from time to S me , in the nomrdl souse of bug rm inde i fi es other parti eswi th whom i t esters i nto

oantraetualydation w*xrwA lessor .ancfpartiesto oilier tray adions with theCiorr-Wy, with reepedtocotainmattersTheseotligatonspr i marily rel ate to cefain agreerne twith the Company' s offices directorsarxl employees; .under whi ci the Con,painy may be required to indenriify suchpereonsforIiabili .tiesaris.ngoutof their employmentrdaiorthipTheCoiripaiyhas .greedto hold theall>erpartyharm)ess.aLyairist redfiedloiws ; sach asthose aril ng from a breach of repre@entat one or c ovenants% third party clai me Chet tho Cbrripany s products when used for tI ei r intended purpose(s) infringethe i nbel lectual p ro perty ri ghtsof e a c h third party or otter d ai m s maleagai r r. oc t a t n pad m I t is not poss do to detern i no the maxi mu n potent of amountof I i abi I ity under these i nderrinfoakion obl igati onsdueto the limited history of prior i ndenrrfi .rati on .rns and the uni que faetsand a rarmtances theta elikely to be i resolved in each part alai da m Historically, p.ay merits made by the Company under these odigatiorlswere not material and no I labi litieshave.been recorded for #vwoUigationsonthebataince eetsasofDeoerr r31 20(ka' is16. Sale of Certain Meats

In Jul y Zfl3, the Company entered i nto an a font with Veri link. Corporation (Ven link) m :sd I eertai n assetsto Veri I ink, for up to a maximum of$09 million. The Company received $O 45 million in A y 2003andan addti one [ $0.13 rriil l ion by year a Dec Tiber 31, i. During Z04, theConpany received sn add tional $0 .11 n i I I i on toward the asset sal a The aas t& Were on gi nal l y aoqUi terl through the l;otrp y'Sacqui ati on of AccowNetwork Electronics (ANE) in February 2000 . Additionally, Ve ri link egged to purchmpat.lewt $2. 1 mill ion of related inventory from the Company on orbefore December 31, 2004 . A s ofQeoamber31, and20M , VeriIInkhadpurdiased $0.56millionand$0 .73miIlion,reqx& ivdy , ofthisinvento ry .

As:pat of thisVcement , Veil i nk agred to acme al I werrxnty otil i gahone related to ANE products mild prior to, on, or after July 20)3. The Companyagreed to re rnbursaV eri link for up to $.2 4 mill ion of certain war[anty ot~figafi :ons for AN E products sd d psis to July2903. Further, Verili nk aea.jmed theobii nati on for one of the Con shy' s operating l eeees, prevvious y accrued. as reeitucturing, resulting in a recovery of nbtnic u i ng charges of $03 million in20 T-

On April 2, 2 0 0 4 , the Company s td al I of itsowrxerrship in 1Raiwiz, Ltd Ultracom Communications HoldingsLtd .. and Corr ox Ltd. to athi rd party fora cash payrr nt of $Q 15 mill ion In connecti an With this di os ti on, the ax rer recei ved obilete.inventories with no book value, $0.2 rri I Lion of. selectednetasaft andamurned $1 .35millionofnetliabiIi ti esrelatedtothesulxatlanes The Con anyrsoorcledalistgainof $1 .5miIlion,whichisind udsd3sawmponent of other income (expense) in the aooornp yi rgoonden deoneol i deed statement of operations.17. Subsequent Evetit s

On February 8, 2005, the Company amouxed the s gni rig of an ogreement with ATI Tactnol ogi es, Inc ~ATI ) relab rig to the sale of certain Companycable modern semicondudor .assets The a8reerrsnt of l s for ATI to ac . 're the Company' s cable modern s l i con Intel I actual property aid rel ated a ftwErassume a lei and hire approxi matel y twenty-five elrpl oyees from the s des team . Under the terms of .the agreement, All will pay theConpaiy $6.95million upon#*dosi rig,With a batanoeof $7.175miIIion~tn theCo ipenyachievingmilestoneslorcertainoo~tior servecesonddeliverables tnni rig o period of 15 months On M arch 9, X05 ATI and the~rpaiy signed doing doarre- tsfor the sagreem nt . Upon doe ng theCompany reserved $8 .6 ml II ion i n cash which was wnpli sad of the $695 mi I I ionfor'the i riittai payment and $1 .65 rniIIIon of the $ 1 .9 ni Ilion for havi ngmet thefirst mi I eel one . The difference between ttie $1 .9 mi I I i on milestone and the payment of $1 .65 mi I I ion was.money reW ned by ATI to pay forCompany

91

Quarter

2003 first Second Third Fourth

Tot4 re-4 tow $ 22 $ 1598 37,6Ld $. . 42,99Orm profi t 2 ft76 6A$3 10 ,1194 12 71 . . .. .R C "es (rat), ice va sgverar~cs an;i ass tI rigN

. 115 244(23 .(i 139} (7210) >6A.15~

8asa:and:diluted rd lO*.Pwstw.e

Loss per rare are computed i ndep idenU y for each of the quarters presented . The sxrf::of the quantal y I oss per 5re n 2004 and 2C 3 does notnecessarf ly equal the total cc nputed for the year due to chaVes i n dYares outstandi ng and round ng .

(1) See Note 6 for an explanation for re Luring charges and asset write-off s

92

Exhibit E

Table .of .Contents

UNI TED STATES SECURI TI ES .AND EXCHANGE COM M I Sul ONWashington , D .C. 20549

Form 10- K

(Mark One)

8 ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934FOR TH E FISCAL YEAR: ENDED DECEMBER 31, 2005

OR11 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIE S

EXCHANGE ACT OF 1 9FOR TH E TRANSITION PERIOD. FROM TO

COMMISSION FILE NUMBER: 0000-24647

TERAYON COMMUNICATION SYSTEMS, INC .(Exad:Narneo( i istrantas$erifiedinItsChart er)

Delaware 77-0328533(State or other Jurisliaion of (I PS Enploye r

Inmrporatiohor Organization IdentificationNo_)

2450WALSHAVENUESANTA CLARA, CALIFORNIA 95M 1

(4408)235-5500(Address, I ndt4i rrg Zi p Code, and Telephone Nxriber,

lnduchrg ,MeaCodeof ftittrant'sRindpat Executive Odic

SECURITIESREGI STERED PURSUANT TO SECTION 12(b) OF THE ACT :

Nameof

EachTitle Exchang e

of onEach Which

C l ass Registered :None None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g ) :OFTHE ACT:COMMON STOCK, parvalue $0.061 per ar e

(Title: of Class)

Indicate by check mark, if the registrant isawell -known s easoned issuer , asdefined in Rule 405 of the SecuhtiesAct. Yes ❑ Nog

Indicateby check mark if the registrant is rat. requi.red to file reports pursuant to Secti on 13 or Secti on 15(d) :of the Act. Yes O Nog

Indicate by check mark whether the regi strant (1) has fi .l ed al I reports required to befiled by Section 13 or 15 (d) of the Seeuriti es ExchangeAct of 1934 dud ng the preceding 12 months ( or for such thorter period that the registrant was required to file with reports), and (2) has beensubject to such filing requirement for the past 90 days Yes O No El.

Indicate by check mark if di soI ostre of del i nquerit fi I ers pursuant to Item 405 of Regulation S-K is not Contained herein , and Will not becontained, to the best of regi tart' s knovrl edge, in definitive proxy or information staterr >erits incorporated by ref ererxe in Part I I I of thisForm 10-K or any amendment to this Form 1O-K. 0

Indicate by check mark whether the registrant i sa large accelerated filer, an aoW erated filer or a non-accelerated filer. See definition of" accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act . (Check one) .

Large Accelerated Filer ❑ Accelerated Filer0 Non-Aec l erated Filer ❑

Indicate by check mark whether the regi strant i s a shell I company (as def i ned in Exchange Act Rule 12b -2). Ye* E] N o

The aggregate market value ofthe voti ng ai d non-voting stock held by non-affi l i ates of the registrard was approxi mately $186,172,000 o n

Jun e30, 2006 . For purposm of thi scalct iBion only , the registrant hagexd uded dock bmefiaally owned by directors and officersa id owr>ersofmore than ten p e r t n't o f i t s common s t o c k . By doing so, the registrant does not admi t that such persons are: afflli ates within the meaning ofRule 405 under the Sec urib sAct of 1933 or for any other purpose .

Indicate th e number of cares outstanck ng of each of the regi strant' s d asses of common stock, as of th e latest practicable date: CommonStock, $0. 001 par value, 77,637,177 shares outstandi ng as of November 30, 2006 .

DOCUMENTS INCORPORATED BY REFERENCE

None

I NDE X

TERAYON COMMUNICATION SYSTEMS, I Nc .

PageNo.

Item 1 . BtianGItem 1A . Ri* FactorsItem 1B . 1jnrg22yg-d 2f CoriItem 2 Proberld esItem . LgA Etg9 adir

-Item 4 o a Vob f of&Jbrre ' n f -7- t e- ~

IriYroductory Mite

Items.

I tHEZIsm 7A .Item8.Item 9.Item -9kItem 9B .

Item 10 .Item ItItsItem 13,Item 14.

Item 5,Si r®EXHIBIT'1 Q :18EXHIBIT 1 0 .EXHI31T1Q28EXHI IT 10131EXHIBIT 1 .3'EXH131T 1A.33E Xjjl 10.24E BIT 10.35EXHIBIT 21,1EXHI BIT 31 .1EXHIBIT 31 .2EXHIBIT 32.1EXHI SIT32- 2E7H 9IT 99AEXHEX.H T a9.33

PART I IMarketfor R i strant'sCommon Equity . RRelated Stockholder Mattersard lss r Purciasesof EquitySeourite s

Exhi t it Pi nand al statement Scheduf esPART i V

INTRODUCTORY NOTE

102042424245

464850

106108186186194

194198203204204

205209

The Company'sAnnual Reporton Form 10-K (Form 10-K) forthe year ended December 3l, 2005, indudesrestated and auditedconsolidated f i nai d al stater tints for the yeas ended December 31, 2004 and 2003, restated financial statements for theyear ends dDecember 31 ., 2002, and adjusted financial statenientsfor the year ended December 31, 2001 . This form 10-Kelso includesinformation for the quarterly periods ended September 30, 2005 and December 31, 2005 and the restated quarterly information for thefirst two quarters of 2005 and for the fourquarte s of 2004 . This information i s di srl osed in Note 3, "Restatement of CQnsol i datedFinancial Statenns;" and Note 18, "2005 Unaudited Condenses Consd i dated Qua .&I y Information," toConsul i dated Fin. 6nc alStatements.

Table .of Contents

Item 6. Selected Financial Data

The fol lowi rig sal ected consolidated fi nanci al ;data has been restated or adjusted , applicable; and is derived from ourconsolidated financial statenents and should be read in conjunction with the coneol i dated fi nand aI staterrients and notes theret ,andwith' Marl a isDiswsslrnandAnalyssofFinanci alConditionandResultsofOperations'andotherfinanialdataindudedeEsewherein this report . Our historical resi .disof operationsarenotneo rily inc taliveof resiltsof operatipristotie Expected foranyfuture period. We have not amended our previousl y filed Annual Reports on Form 1o-K or Quarterly Reports on Form 10-Q for theperiodsaffected by the restatErrient. !he information that hgsbeen previously filed or otherwise reported for these periodsiss; -cededby the information i n thi s Form 10-K ,

See Note 3, ` Restatement of Coneel i dated Financial S lerr>nt s " to Consolidated Fi nodal 3tatementsfor more, detail Edinformation regerdi rig the restatement of our con lidated fi nand al statements for the years ended December 31, 2ti70.5, 2004 and 2003and our sal ected Gonsd i dated fi nand al data as of and for the yews ended December 31,2035, 2004 2003, 2002 and 2001 .

2004 2003 2002 2001(asrestated )(1) (as r estated)(1) (asrestated) (asadjusted)(5)

(in thousands, except per share data)

tfernent ofCciris©I d ted .s a . . . . .riper atiotfst f a

Retenues .: $ 90,664 $ 136,484 $ .: 130,187 $ 130,730 $ 279,461Cost of iUd 56,635 10.)887 . 103,835 101,908 . . . . . 6811 7

Gross profit 35,029 34,597 26,352 28,922 16 ;364

O erahng expenses . .Research ands elopnsnt 17,650 33,199 42,634 58,696 79927Safes anef marketing 22;534 24,145 29,781 35,704 55,7011General and administrative 20 356 12,039 11,934 15639 33 .163C"oC x+ il '' ~lortiaationRestructureng charges, executive

severance and ass etwrite offs(2) 2,257 12,336 2,803 8,922 587,149

Total operating ea(pen 2 ;797 81,719 84;152 1'i8,961 7$1 ;35()

Loss from operations (27,768) (47122) (57,800) 90 .039) (764980)1 ntcresr i r'me (exr s ) and othe r

incomeiexperm), net (59 ) 1,891 (618) 164 5Gain on early exti ngui thment o f

)e S 1lrubm r -eFrt (ex}>e )tz (149) 76 (316) (238) 3,9 11 8

Net Ioss $ (26,951) $ (47,105) $ (56,225) $ (39,912) 5 (557,123)

Basic and r toted nd l oss per dare $ (035} ; ;. (062) `'$ (0 76) $ <(fl .55) '$ ; (8 .17)

Shares used i in computing bag c anddiluted net I per share(4) 77,154 75,751 74,074 72,718 68 .164

Consolidated Balance Sheet Data :Cash, cash equivalents and wort-ter m

investments $ 101,301 $ 97,735 $ 138,640 $ 206,503 $ 333,688Wordng cri tat 22,045 107,052 133035 178,091 327150Total as 146,648 156,981 213,099 279169 469,981Converti bke i berrtuaes 65,367 65, 588 65,809 66,03D 177,368Long-term obligati ons (I ass current

portion) 1,455 2,076 1356,_ 1,936 181,869Accumulated deficit (1,062,438} (1,035,487) ( 9681382) ::;:.;: (932,1 ate,) (892;245) ; :Total stockholders equity X, 6,57 44, 943 90,563 142 , 191 181,052

(1) See Note 3, "Restatement of Consolidated Financial Staternent$" to Consolidated Fi nancial Statements.

48

Table .of Contents

(2) See Note 6, "Aoctued SoverertcePay," and Note 7, ° Restructuring Ghargesand As86t Write-offs" to Consolidated Finandal3tatementsfor an explanation for restructuring charms executive severaneeand at write-off s

(3) See : Note 8, "Conve'tibleSubordinated Notes," to ConsolidatedFnandal Statements foranecplahatianoftherepurchase ofsbordi nated converti bl a notes end redasdficaton of related gain s

(4) See Note 2, " Sunvnary of Signifi cant Aocoun6 ng Pbl i a .es," to Consolidated Financial Statements foran e q anation of themethod employed to determine the number of th^dres used to compute per Jrare data.

(5) We made three adj ustmerifista the f i nand al ate~t~etits for the year ended Oece~nber 31, 2001 whi th resulted i n a dec reaw i nacs 'nul eted net loss of $6 .7 mil I i on . The I ar e t adjustment of $7.9 rrii I I i on gai n rel sled to the redemption of a porti on of theembedded deri yative (I as C l21 .Opt on) Citai ned ur $500.0 million of 5% c nver ti Fil e a bordinated Notes due August2007 (Nate a xl the ranti ning $1 .9 million end $0.6 million rel sled to our anal y9sof the al I owartee for dout~tf ul a=unts andan adj .u rrt for a pleulou~ y recorded to accrual , re vely . During>2D01, we r chased $325.9 million of fere value ofNotes; requiring $7 . 0 million of the bAnd prerni um to be redee~i~ed . An additi oral $1 million was recorded to ref lest theernort zat on of the bond premi um. As part of our reviarv of the all owanae for doubtful accounts , we determi ned that anadjL It to increase bad debt expense . and the corre ondi ng al I owanoe for doubtful accounts by $1 .9 million was neve r yfor the year ended D ecember 31 , 2001, In 2001, we recorded afore gn inoometac continget►t expense to acv rue for potential tartI to pot-a4zi'sitionaeti vi tiesof foreign subsi diaries During therestatem prooess~ itwasdeterminedthatthisongi nel a'xx al was not vubstatiti aced and amordi ngl y, thould not h we been recorded, and we adjusted the balance ac of dingl yas of December31 , 2901 .

49

Exhibit F

Date Open High Low Close Volume Adj Close3/31/2006 1 .85 1 .93 1 .8 1 .83 660400 1 .833/30/2006 1 .89 1 .91 1 .8 1 .86 459100 1 .863/29/2006 1 .93 1 .95 1 .75 1 .91 1146200 1 .9 13/28/2006 1 .94 2.05 1 .94 1 .96 289900 1 .963/27/2006 2 .01 2.02 1 .92 1 .95 302300 1 .953/24/2006 2.07 2.08 2 2.01 576500 2.0 13/23/2006 2.05 2.19 2 2.05 850100 2.053/22/2006 1 .78 2.01 1 .73 1 .88 1407300 1 .883/21/2006 2.2 2 .2 1 .88 1 .89 2954900 1 .893/20/2006 2.26 2.28 2.1 2.22 862300 2 .223/17/2006 2.31 2.35 2.27 2.29 692400 2 .293/16/2006 2.32 2.32 2 .21 2.31 297700 2 .3 13/15/2006 2.32 2.33 2 .24 2.31 231200 2.3 13/14/2006 2.28 2.33 2 .25 2 .3 196100 2 . 33/13/2006 2.3 2.34 2 .25 2.29 290900 2.293/10/2006 2.25 2.27 2 .16 2.26 254500 2.263/9/2006 2.26 2.35 2.2 2.25 475000 2.253/8/2006 2.18 2.33 2.18 2.24 459500 2.243/7/2006 2.23 2.24 2.16 2.18 436600 2.1 83/6/2006 2.31 2.33 2.23 2.23 918500 2.233/3/2006 2.38 2.43 2.26 2.27 1266300 2.273/2/2006 2.25 2 .61 2.16 2.33 4873200 2.333/1/2006 2.66 2 .82 2.66 2.7 641100 2 . 7

2/28/2006 2.81 2 .84 2.65 2.68 1043500 2.682/27/2006 2.55 2 .91 2.51 2 .83 3214800 2.832/24/2006 2.51 2 .61 2.44 2 .52 263900 2.522/23/2006 2.47 2 .54 2.42 2.5 335800 2 . 52/22/2006 2.45 2 .48 2 .4 2 .45 140700 2.452/21/2006 2.37 2 .49 2.35 2 .45 358500 2.452/17/2006 2.42 2 .45 2 .3 2 .38 256400 2 .382/16/2006 2.38 2 .45 2 .3 2.4 317700 2.42/15/2006 2.29 2 .36 2.22 2 .36 330500 2 .362/14/2006 2.22 2 .35 2.21 2 .29 237000 2 .292/13/2006 2.25 2 .26 2.15 2 .23 108900 2 .232/10/2006 2.23 2 .27 2.17 2 .24 238000 2 .24

2/9/2006 2.19 2 .28 2.19 2 .25 366500 2 .252/8/2006 2.24 2 .32 2.12 2 .21 257900 2 .2 12/7/2006 2 .24 2 .35 2.16 2 .26 213500 2 .262/6/2006 2 .17 2.29 2.13 2.26 155900 2 .262/3/2006 2.23 2.29 2.13 2.19 236800 2 .1 92/2/2006 2.35 2.39 2.25 2.25 230700 2 .252/1/2006 2.37 2.39 2.28 2.36 314900 2 .36

1 /31 /2006 2.41 2.44 2 .35 2.39 392100 2 .391/30/2006 2.34 2.44 2.29 2.43 1025100 2 .431/27/2006 2.24 2.33 2.1 2 .31 1373500 2 .3 11/26/2006 2.03 2.28 2 .01 2.23 897800 2 .231/25/2006 2.06 2 .1 2 .02 2.05 223700 2 .051/24/2006 2 2.05 1 .97 2.05 383400 2 .051/23/2006 2.12 2.13 2 2.02 373600 2 .021/20/2006 2 2.15 1 .97 2.08 1102000 2 .081/19/2006 1 .95 1 .99 1 .92 1 .98 507700 1 .98

http ://ichart .finance.yahoo .com/table .csv

1/18/2006 1 .71 1 .93 1 .66 1 .9 1336300 1 . 91/17/2006 1 .87 1 .92 1 .63 1 .75 2152300 1 .751/13/2006 1 .99 1 .99 1 .86 1 .91 2421300 1 .9 11/12/2006 2 2 .01 1 .94 1 .97 568800 1 .971/11/2006 2 2 .05 1 .83 2 2454700 21/10/2006 2.1 2 .13 2.02 2 .06 713100 2 .06

1/9/2006 2 .07 2 .13 2.07 2 .13 232900 2.1 31/6/2006 2.19 2.2 2.07 2 .08 593200 2.081/5/2006 2 .13 2 .19 2.13 2 .15 296200 2.1 51/4/2006 2 .29 2 .32 2.15 2 .15 542400 2.1 51/3/2006 2.28 2 .31 2.19 2 .26 608500 2.26

12/30/2005 2.21 2 .33 2.2 2 .31 569800 2.3 112/29/2005 2.29 2 .42 2.23 2 .24 713800 2.2412/28/2005 2.25 2.39 2.25 2 .31 348300 2.3 112/27/2005 2.26 2.35 2.24 2 .28 204800 2.2812/23/2005 2.38 2 .4 2.33 2.34 101800 2.3412/22/2005 2.27 2.39 2.24 2.37 163800 2.3712/21/2005 2.28 2.37 2.25 2.29 437500 2.2912/20/2005 2.17 2.31 2.16 2.29 445700 2.2912/19/2005 2.24 2.28 2.18 2.18 225800 2.1 812/16/2005 2.34 2.37 2.23 2.27 690900 2.2712/15/2005 2.27 2.32 2.18 2.31 337000 2.3 112/14/2005 2.21 2 .3 2.18 2.29 349600 2.2912/13/2005 2.19 2.25 2 .13 2.22 744300 2.2212/12/2005 2.35 2.37 2 .15 2.21 757400 2.2 112/9/2005 2.12 2.39 2 .04 2.35 668600 2.3512/8/2005 2.02 2.13 1 .97 2.13 510400 2.1 312/7/2005 2.09 2.09 2.01 2.03 266900 2.0312/6/2005 2.03 2.11 2 .01 2.07 395300 2.0712/5/2005 2.06 2.09 2 .01 2.04 281100 2.0412/2/2005 2.09 2.13 2 .06 2.09 411600 2.0912/1/2005 2.05 2.16 2 .05 2.11 571200 2.1 1

11/30/2005 2.08 2.13 1 .98 2.07 1040300 2.0711/29/2005 2.23 2.23 2 .02 2.11 922000 2.1 111/28/2005 2.38 2 .4 2 .18 2.24 859600 2.2411/25/2005 2.39 2.44 2 .37 2.37 99300 2.3711/23/2005 2.52 2.52 2 .36 2.42 415700 2.4211/22/2005 2.38 2.59 2 .36 2.55 436400 2.5511/21/2005 2.45 2.46 2 .36 2.43 356100 2.4311/18/2005 2.44 2.59 2.4 2.43 504400 2.4311/17/2005 2.38 2.47 2 .35 2.41 350900 2.4 111/16/2005 2.35 2.41 2 .32 2.38 313000 2.3811/15/2005 2.4 2.41 2 .31 2.37 292100 2.3711/14/2005 2.34 2 .5 2 .32 2.39 448900 2.3911/11/2005 2.29 2.36 2 .29 2.31 541400 2 .3 111/10/2005 2.32 2.36 2 .22 2.31 715300 2 .3 1

11/9/2005 2.26 2.39 2 .23 2.34 478500 2 .3411/8/2005 2.37 2.37 2 .17 2.25 2538400 2 .2511/7/2005 2.4 2.61 2 .36 2.57 903400 2 .5711/4/2005 2.58 2.62 2 .36 2.36 666100 2 .3611/3/2006 2.6 2.66 2 .53 2.59 497900 2 .5911/2/2005 2 .59 2 .59 2.53 2 .58 406700 2 .58

http ://ichart .finance .yahoo . com/table .csv

11/l/2005 2.67 2.68 2 .53 2 .57 696300 2.57

10/31/2005 2.59 2.69 2 .57 2.69 748700 2.6910/28/2005 2.39 2.65 2 .38 2.65 1592400 2.6510/27/2005 2.66 2.66 2 .38 2.39 2135600 2.39

10/26/2005 2.95 2.95 2 .55 2.64 1572100 2.6410/25/2005 2.93 2.95 2 .74 2.94 882200 2.94

10/24/2005 3.05 3 .1 2 .89 2.95 828800 2.9510/21/2005 3.14 3.2 3.03 3.05 552100 3 .05

10/20/2005 3 .27 3.33 3.14 3.14 237600 3 .1 410/19/2005 3.2 3.29 3 3.26 819200 3 .2610/18/2005 3.47 3.5 3.22 3.22 792900 3 .2210/17/2005 3.57 3 .58 3 .3 3 .51 419200 3 .5 1

10/14/2005 3.37 3 .57 3.34 3 .57 675500 3.5710/13/2005 3.26 3.5 3.15 3.4 1405600 3.4

10/12/2005 3.46 3 .48 3.23 3 .27 1047100 3.2710/11/2005 3.55 3 .57 3.42 3 .49 492000 3.4910/10/2005 3 .6 3.65 3.49 3.53 822200 3.5310/7/2005 3.59 3.68 3.57 3.62 171000 3.6210/6/2005 3.6 3.65 3.5 3.56 595300 3.5610/5/2005 3.81 3.81 3.6 3.63 728600 3.6310/4/2005 3.89 3.95 3.78 3.79 508700 3.7910/3/2005 3.91 3.92 3.77 3.84 467400 3.849/30/2005 3.88 3.95 3.76 3 .9 478600 3 . 99/29/2005 3 .74 3.93 3.65 3 .9 681800 3 . 99/28/2005 3 .83 3.87 3.7 3.76 575100 3.769/27/2005 3 .89 3 .91 3.8 3.8 546700 3 . 8

9/26/2005 4 4 .04 3.84 3.9 1344300 3 . 99/23/2005 3.88 3.9 3 .8 3 .88 592200 3 .889/22/2005 3 .96 4 3 .7 3 .83 894700 3 .839/21/2005 3.99 3 .99 3.76 3 .81 1072200 3 .8 19/20/2005 3.92 4.1 3.84 3 .92 1679000 3 .929/19/2005 3.81 3 .96 3.7 3 .91 1315000 3.9 19/16/2005 3.67 3.8 3.6 3.8 1572500 3.89/15/2005 3.57 3 .62 3.54 3 .62 617500 3.629/14/2005 3.52 3 .65 3.52 3 .58 1005000 3.589/13/2005 3.75 3.75 3.54 3.54 293400 3.549/12/2005 3.64 3.72 3.54 3.67 999500 3.679/9/2005 3.52 3.67 3.41 3.62 1508000 3.629/8/2005 3 .4 3.56 3.37 3.54 745100 3.549/7/2005 3.43 3.43 3.35 3.4 272300 3 . 49/6/2005 3.28 3.46 3.28 3.44 962700 3.449/2/2005 3 .3 3.35 3.27 3.33 604300 3.339/1/2005 3 .3 3.33 3 .27 3 .3 360700 3 . 3

8/31/2005 3.29 3.35 3 .28 3.31 425000 3.3 18/30/2005 3.34 3.39 3.3 3.31 385700 3 .3 18/29/2005 3.33 3.35 3.2 3.33 496900 3 .338/26/2005 3.37 3.37 3 .25 3.3 323400 3 . 38/25/2005 3.45 3.45 3 .38 3.38 211000 3 .388/24/2005 3 .34 3.46 3.34 3.42 555900 3 .428/23/2005 3 .42 3.47 3.33 3 .34 357500 3.348/22/2005 3 .27 3.47 3.25 3 .45 819900 3.45

8/19/2005 3.28 3 .33 3.19 3 .29 1754200 3.29

http ://ichart .finance .yahoo.com/table .csv

8/18/2005 3.27 3.31 3 .22 3 .3 739500 3 . 38/17/2005 3.25 3.32 3 .25 3 .3 537100 3 . 38/16/2005 3.25 3.34 3.17 3.28 1188400 3.288/15/2005 3.1 3.27 3.07 3.26 810300 3.268/12/2005 2.95 3 .1 2 .91 3.08 312400 3.088/11/2005 2.95 3 2.95 2.98 252700 2.988/10/2005 3.05 3.09 2.95 2.96 289200 2 .96

8/9/2005 3 .03 3.08 3.03 3.05 231800 3 .058/8/2005 3.04 3.09 3.04 3.05 268800 3 .058/5/2005 3.05 3.12 3.05 3.05 234900 3 .058/4/2005 3.14 3.14 3.06 3 .06 388200 3 .068/3/2005 3.12 3 .14 3.09 3 .14 367700 3.1 48/2/2005 3.16 3.2 3 .1 3 .15 499300 3.1 58/l/2005 3.14 3 .21 3 .1 3 .17 789200 3.1 7

7/29/2005 3.18 3.2 3.01 3 .14 1580900 3.1 47/28/2005 3.27 3 .35 3.18 3 .23 1095300 3.237/27/2005 3.19 3 .33 3.16 3 .28 1034900 3.287/26/2005 3.15 3 .28 3.15 3.27 414100 3.277/25/2005 3.19 3.28 3.14 3.15 742100 3.1 57/22/2005 3.23 3.28 3.18 3.25 573300 3.257/21/2005 3.4 3.4 3.22 3.24 386000 3.247/20/2005 3.24 3.43 3.21 3.39 2286400 3.397/19/2005 3.18 3 .3 3.18 3.26 866400 3.267/18/2005 3.25 3.25 3.18 3.19 786400 3.1 97/15/2005 3.29 3.33 3.17 3.26 439300 3.267/14/2005 3.31 3.38 3 .27 3.32 906600 3.327/13/2005 3.3 3 .3 3 .23 3.27 676600 3.277/12/2005 3.25 3.28 3.22 3.26 610300 3.267/11/2005 3.11 3.27 3 .11 3.25 910900 3.257/8/2005 3.07 3.15 3.07 3.11 368000 3.1 17/7/2005 3.04 3.15 3.03 3 .1 1194800 3 . 17/6/2005 3.03 3.11 3.03 3.08 522800 3 .087/5/2005 3.05 3 .1 3 .04 3.08 633500 3 .087/1/2005 3.1 3 .1 3 .05 3.09 411600 3 .09

6/30/2005 3.1 3 .11 2.98 3.09 1604100 3 .096/29/2005 3.1 3 .2 3.06 3.16 1241900 3 .1 66/28/2005 2.98 3.11 2.98 3 .1 894500 3 . 16/27/2005 3 .05 3.1 2.89 3.01 949500 3 .0 16/24/2005 3.2 3.26 3.03 3.09 1843800 3 .096/23/2005 3 .59 3.6 3.15 3.26 3757300 3 .266/22/2005 3 .55 3 .65 3.47 3 .49 668000 3 .496/21/2005 3.6 3 .65 3.52 3 .58 343500 3 .586/20/2005 3 .69 3 .77 3.61 3 .61 421100 3 .6 16/17/2005 3 .76 3.78 3.61 3.7 799300 3. 76/16/2005 3 .47 3 .74 3.45 3.7 1995800 3. 76/15/2005 3 .34 3 .47 3.33 3 .45 810400 3.456/14/2005 3 .26 3.3 3.25 3 .28 234200 3.286/13/2005 3 .27 3 .35 3.21 3 .33 211400 3.336/10/2005 3 .29 3 .29 3 .2 3 .25 203600 3.25

6/9/2005 3 .25 3 .28 3.15 3 .28 142300 3.286/8/2005 3.34 3 .39 3.24 3.25 191000 3.256/7/2005 3.34 3.43 3.25 3.33 343600 3.33

http ://ichart . finance .yahoo . com/table .csv

6/6/2005 3.24 3 .43 3 .2 3 .31 428900 3 .3 16/3/2005 3.21 3 .31 2.97 3 .24 375500 3 .24

6/2/2005 3.3 3 .31 3.2 3.2 278600 3. 2

6/l/2005 3.19 3 .35 3.17 3 .29 692700 3.295/31/2005 2.99 3 .18 2.96 3 .17 1027900 3.1 75/27/2005 2 .9 3 .04 2.9 3 443500 35/26/2005 2.95 3.04 2.95 3 309800 35/25/2005 2.96 2.99 2.93 2.95 179800 2.955/24/2005 2.94 3.04 2.93 2.97 151900 2.975/23/2005 2.96 3.05 2 .95 2.99 246900 2.995/20/2005 2.97 3.04 2 .93 2.99 174800 2.995/19/2005 2.9 3.04 2 .87 3.03 345100 3.035/18/2005 2.89 2.98 2 .86 2.94 276100 2.945/17/2005 2.75 2.87 2 .75 2.87 144300 2.87

5/16/2005 2.78 2 .8 2.72 2.78 227000 2 .785/13/2005 2.76 2.85 2.72 2.78 377600 2 .785/12/2005 2.9 2.95 2.72 2.74 336900 2 .745/11/2005 3 .03 3.06 2.88 2.91 324100 2 .9 15/10/2005 3 .03 3 .08 3 3 185000 3

5/9/2005 3 .08 3 .14 3.05 3 .12 363800 3 .1 25/6/2005 3 .09 3 .15 3.06 3 .09 243000 3 .095/5/2005 3.1 3 .14 2.99 3 .08 397600 3 .085/4/2005 3.05 3 .24 2.92 3 .09 1307300 3 .095/3/2005 2 .8 2 .87 2.69 2 .75 447300 2 .755/2/2005 2.91 2 .94 2.78 2 .82 234300 2.82

4/29/2005 2.73 2.94 2.73 2 .91 400600 2.9 14/28/2005 2.86 2.9 2.75 2.8 373500 2 . 84/27/2005 2.93 2.93 2.87 2.88 367800 2.884/26/2005 2.97 3.11 2.96 2.96 345100 2.964/25/2005 3.15 3.21 2.94 3.01 419200 3.0 14/22/2005 3.15 3.22 3.09 3.16 624100 3.1 64/21/2005 2.95 3.15 2.94 3.15 548700 3.1 54/20/2005 3.01 3.04 2 .94 2.95 632200 2.954/19/2005 2.87 2.99 2 .87 2.97 826700 2.974/18/2005 2.72 2 .9 2.7 2.88 816800 2.884/15/2005 2.62 2.82 2 .52 2.75 683100 2 .754/14/2005 2.71 2 .8 2 .54 2.65 979700 2 .654/13/2005 2.77 2.79 2 .71 2.72 558100 2 .724/12/2005 2 .82 2.93 2 .75 2 .8 675200 2 . 84/11/2005 2.9 2.96 2 .81 2.86 552500 2 .864/8/2005 2 .94 2.96 2 .87 2.87 214100 2 .874/7/2005 2 .94 3 2.94 2 .97 157700 2 .974/6/2005 3 3 .05 2.96 2 .99 168200 2 .994/5/2005 2 .98 3 .05 2.93 3 203300 34/4/2005 3 .02 3 .05 2.98 2 .99 295400 2.994/l/2005 3.05 3.1 2.98 3 .05 262100 3.05

3/31/2005 2.94 3 .09 2.78 3 .08 855400 3.083/30/2005 2.89 2 .99 2.87 2 .98 216900 2.983/29/2005 3.04 3.07 2 .9 2.9 305700 2 . 93/28/2005 2.97 3.01 2.95 2.99 161500 2.993/24/2005 2.98 3.06 2 .97 2.99 327800 2.993/23/2005 3 3.05 2 .76 2.99 539100 2.99


3/22/2005 3.13 3.17 2 .99 3.03 262000 3.03

3/21/2005 3 3.18 3 3.16 285900 3.1 6

3/18/2005 3 .04 3.12 3 3.05 698600 3.05

3/17/2005 3 .22 3.28 3.06 3.08 376600 3.08

3/16/2005 3 .28 3.33 3.22 3.27 209100 3.27

3/15/2005 3.24 3.29 3 .2 3.24 235600 3 .24

3/14/2005 3.21 3 .36 3.21 3.27 276800 3.27

3/11/2005 3.26 3 .32 3.24 3 .29 226900 3.29

3/10/2005 3.31 3.4 3.26 3 .26 420800 3.26

3/9/2005 3.09 3 .37 3.05 3 .26 1115000 3.26

3/8/2005 3.19 3.25 3 .05 3.1 324900 3 . 1

3/7/2005 3.25 3.33 3.2 3.21 363800 3.2 13/4/2005 3.43 3.44 3 .23 3.25 296000 3.25

3/3/2005 3.35 3.45 3 .29 3 .4 394600 3 . 4

3/2/2005 3.31 3.44 3.27 3.35 277400 3.35

3/1/2005 3.45 3.45 3.29 3.35 390000 3 .35

2/28/2005 3 .37 3.45 3.29 3.42 585200 3 .42

2/25/2005 3.24 3.33 3 .2 3 .28 535000 3 .28

2/24/2005 3.05 3 .25 2.97 3 .18 464400 3 .1 8

2/23/2005 3.18 3 .28 3.02 3.1 473200 3. 1

2/22/2005 3.39 3 .47 3.16 3 .16 570600 3.1 6

2/18/2005 3.4 3 .61 3.35 3 .47 710800 3.47

2/17/2005 3.35 3.52 3.35 3.37 494300 3.37

2/16/2005 3.41 3.73 3.3 3.45 2114800 3.452/15/2005 3.17 3.53 3.05 3.49 2345100 3.492/14/2005 3 3.17 2 .98 3 .1 760300 3 . 1

2/11/2005 2.68 3 2 .65 2.98 1539800 2 .98

2/10/2005 2.65 2.81 2.63 2 .7 1948200 2 . 7

2/9/2005 2 .72 2.86 2.7 2.8 1031900 2 . 82/8/2005 2 .85 2 .93 2.68 2 .72 1271800 2 .72

2/7/2005 2 .89 2 .96 2.85 2 .88 668800 2 .882/4/2005 3 .01 3 .09 2.89 3 987200 32/3/2005 3.08 3 .15 3.06 3 .06 486700 3.06

2/2/2005 3.18 3 .27 3.07 3 .09 726600 3.09

2/l/2005 3.21 3.31 3.07 3 .18 1228500 3.1 81 /31 /2005 3.08 3.3 3.05 3.2 1031300 3 . 2

1/28/2005 2.98 3.16 2.96 3.03 636000 3.03

1/27/2005 2.99 3.07 2 .88 3.02 799400 3.02

1/26/2005 3 3.17 2 .95 3.06 967000 3.061/25/2005 3 .03 3.07 2 .87 3.06 1412700 3 .06

1/24/2005 2 .94 3.1 2 .81 3 2273000 31 /21 /2005 2 .59 2 .99 2.54 2 .96 4493700 2 .96

1/20/2005 2.6 2 .65 2.5 2 .59 558200 2 .591/19/2005 2 .77 2 .78 2.53 2 .62 1017700 2 .621/18/2005 2 .58 3 .04 2.48 2 .67 8123200 2.67

1/14/2005 2 .25 2 .45 2.25 2 .44 828800 2.441/13/2005 2.28 2 .29 2.19 2.24 917300 2.24

1/12/2005 2.19 2.32 1 .99 2.29 1114500 2.291/11/2005 2.36 2.36 2 .17 2.19 1063900 2.1 91/10/2005 2.38 2.44 2 .33 2.41 488200 2 .4 1

1/7/2005 2.43 2.45 2 .33 2.37 522300 2 .37

1/6/2005 2.5 2.61 2.33 2.46 1109300 2 .46


1/5/2005 2.54 2.64 2.5 2 .61 695000 2.6 1

1/4/2005 2.63 2 .7 2.5 2.6 750600 2 . 61/3/2005 2.81 2.81 2 .56 2.62 703000 2.62

12/31/2004 2.78 2.81 2 .67 2.71 456100 2.7 112/30/2004 2.88 2.89 2 .78 2.78 548300 2.7812/29/2004 2.83 2.98 2 .81 2.85 891900 2.8512/28/2004 2.69 2.84 2.65 2.81 938000 2.8 112/27/2004 2.64 2.69 2.57 2.66 495400 2.6612/23/2004 2 .64 2.67 2.58 2.64 480300 2 .6412/22/2004 2 .65 2.65 2.57 2 .6 278300 2 . 612/21/2004 2.53 2 .66 2.52 2.62 493300 2 .6212/20/2004 2.7 2 .74 2.55 2 .61 794800 2 .6 112/17/2004 2.78 2 .85 2.69 2 .74 735400 2 .7412/16/2004 2.56 2 .81 2.51 2 .74 1675700 2 .74

12/15/2004 2.55 2 .64 2 .5 2 .56 727300 2 .5612/14/2004 2.65 2 .73 2.51 2 .57 911400 2 .5712/13/2004 2.85 2 .88 2.59 2 .61 1935800 2 .6 112/10/2004 2.48 2.87 2.42 2 .87 2869100 2 .87

12/9/2004 2.29 2.43 2.15 2 .43 826300 2.4312/8/2004 2.27 2.35 2.2 2.32 491400 2.3212/7/2004 2.32 2.38 2.29 2.3 918800 2 . 312/6/2004 2.18 2.39 2 .13 2 .3 1153900 2 . 312/3/2004 2.13 2.22 2 .08 2.18 779200 2.1 812/2/2004 2.05 2.13 1 .97 2.08 702600 2.0812/1/2004 1 .9 2.13 1 .89 2.01 915800 2.0 1

11/30/2004 2.1 2.13 1 .96 1 .99 1065800 1 .9911/29/2004 2.23 2.23 2 .06 2.12 538900 2.1 211/26/2004 2.3 2 .3 2.05 2.11 402300 2 .1 111/24/2004 2.2 2.28 2.1 2 .21 1052000 2 .2 1

11/23/2004 2 .05 2.2 2 2.17 965200 2 .1 711/22/2004 1 .96 2 .08 1 .95 2.06 506600 2 .0611/19/2004 2 .09 2 .09 2 2 .03 683500 2 .0311/18/2004 2 .01 2 .1 1 .98 2 .09 709800 2 .0911/17/2004 1 .83 2 .04 1 .8 2 .02 1566500 2 .0211/16/2004 1 .8 1 .85 1 .79 1 .79 244000 1 .7911/15/2004 1 .81 1 .88 1 .78 1 .84 480500 1 .8411/12/2004 1 .87 1 .91 1 .78 1 .86 617500 1 .8611/11/2004 1 .89 1 .95 1 .85 1 .88 703700 1 .8811/10/2004 1 .91 1 .93 1 .83 1 .89 594400 1 .8911/9/2004 1 .85 1 .92 1 .8 1 .89 1932400 1 .8911/8/2004 1 .72 1 .72 1 .59 1 .6 349300 1 . 611/5/2004 1 .63 1 .7 1 .63 1 .66 203300 1 .6611/4/2004 1 .64 1 .69 1 .62 1 .66 262900 1 .6611/3/2004 1 .65 1 .73 1 .64 1 .69 183000 1 .6911/2/2004 1 .66 1 .69 1 .62 1 .63 271700 1 .6311/l/2004 1 .61 1 .68 1 .6 1 .66 329100 1 .66

10/29/2004 1 .75 1 .84 1 .56 1 .64 831300 1 .6410/28/2004 1 .8 1 .88 1 .76 1 .83 532100 1 .8310/27/2004 1 .56 1 .76 1 .56 1 .76 476000 1 .7610/26/2004 1 .54 1 .63 1 .54 1 .62 244400 1 .6210/25/2004 1 .57 1 .65 1 .55 1 .56 238000 1 .5610/22/2004 1 .62 1 .62 1 .57 1 .59 301500 1 .59


10/21/2004 1 .57 1 .62 1 .56 1 .62 378600 1 .62

10/20/2004 1 .59 1 .62 1 .55 1 .6 300700 1 . 6

10/19/2004 1 .64 1 .64 1 .56 1 .59 375800 1 .59

10/18/2004 1 .56 1 .64 1 .55 1 .62 274700 1 .62

10/15/2004 1 .57 1 .64 1 .55 1 .57 459200 1 .57

10/14/2004 1 .58 1 .61 1 .52 1 .52 388100 1 .52

10/13/2004 1 .74 1 .75 1 .6 1 .61 353300 1 .6 1

10/12/2004 1 .7 1 .76 1 .66 1 .68 291800 1 .6810/11/2004 1 .7 1 .79 1 .69 1 .75 250900 1 .7510/8/2004 1 .79 2 1 .74 1 .76 1363100 1 .7610/7/2004 2.01 2.09 1 .99 2.01 258100 2.0 1

10/6/2004 2.08 2 .1 2 2.07 321200 2.0710/5/2004 2.18 2.18 2 .05 2 .1 193300 2 . 110/4/2004 2.13 2.18 2 .02 2.13 387800 2.1 310/l/2004 2.2 2 .2 2 .02 2.06 421400 2 .069/30/2004 2.18 2.18 2 .01 2.12 302100 2 .1 29/29/2004 2.06 2.12 2.02 2.08 327700 2 .089/28/2004 2 2.08 2 2.04 289100 2 .049/27/2004 2 .06 2.1 1 .97 1 .99 1031300 1 .999/24/2004 2 .26 2 .35 2.08 2.1 1778500 2. 19/23/2004 2 2 .23 1 .96 2.2 2137000 2. 29/22/2004 1 .92 1 .96 1 .85 1 .85 253000 1 .859/21/2004 1 .93 1 .96 1 .88 1 .95 231900 1 .959/20/2004 1 .85 1 .92 1 .81 1 .89 207000 1 .899/17/2004 1 .89 2 .09 1 .83 1 .88 352800 1 .889/16/2004 1 .93 1 .94 1 .84 1 .87 336100 1 .879/15/2004 1 .97 1 .97 1 .86 1 .9 295200 1 . 99/14/2004 1 .96 1 .98 1 .85 1 .97 250900 1 .979/13/2004 1 .91 1 .96 1 .84 1 .89 337100 1 .899/10/2004 1 .81 1 .93 1 .75 1 .86 288400 1 .869/9/2004 1 .65 1 .8 1 .65 1 .79 278600 1 .799/8/2004 1 .71 1 .81 1 .66 1 .67 332400 1 .679/7/2004 1 .77 1 .84 1 .74 1 .77 155900 1 .779/3/2004 1 .66 1 .8 1 .66 1 .72 153000 1 .729/2/2004 1 .67 1 .83 1 .67 1 .72 285700 1 .729/ 1 /2004 1 .64 2.05 1 .58 1 .72 770800 1 .72

8/31/2004 1 .53 1 .63 1 .53 1 .63 262200 1 .638/30/2004 1 .62 1 .64 1 .54 1 .55 282700 1 .558/27/2004 1 .59 1 .65 1 .57 1 .6 196100 1 . 68/26/2004 1 .7 1 .71 1 .6 1 .61 385700 1 .6 18/25/2004 1 .67 1 .72 1 .65 1 .72 146900 1 .728/24/2004 1 .75 1 .75 1 .64 1 .68 206200 1 .688/23/2004 1 .75 1 .76 1 .65 1 .67 166700 1 .678/20/2004 1 .7 1 .73 1 .6 1 .72 256200 1 .728/19/2004 1 .69 1 .75 1 .63 1 .7 378300 1 .78/18/2004 1 .55 1 .75 1 .55 1 .75 416800 1 .758/17/2004 1 .6 1 .6 1 .5 1 .54 173100 1 .548/16/2004 1 .47 1 .56 1 .47 1 .56 183300 1 .568/13/2004 1 .51 1 .52 1 .44 1 .47 213600 1 .478/12/2004 1 .48 1 .6 1 .45 1 .45 356800 1 .458/11/2004 1 .6 1 .62 1 .49 1 .52 259300 1 .528/10/2004 1 .5 1 .6 1 .48 1 .6 366600 1 . 6

http ://ichart .finance.yahoo.com/table .csv

8/9/2004 1 .47 1 .56 1 .45 1 .46 353100 1 .468/6/2004 1 .55 1 .57 1 .45 1 .45 728500 1 .458/5/2004 1 .66 1 .68 1 .55 1 .58 332300 1 .588/4/2004 1 .6 1 .66 1 .56 1 .63 329100 1 .638/3/2004 1 .65 1 .69 1 .57 1 .6 435900 1 . 68/2/2004 1 .66 1 .7 1 .62 1 .65 510800 1 .65

7/30/2004 1 .8 1 .88 1 .69 1 .74 376600 1 .74

7/29/2004 1 .68 1 .77 1 .65 1 .76 433700 1 .767/28/2004 1 .7 1 .76 1 .62 1 .65 450000 1 .65

7/27/2004 1 .78 1 .83 1 .68 1 .73 916100 1 .737/26/2004 1 .81 1 .89 1 .73 1 .85 373300 1 .85

7/23/2004 1 .86 1 .87 1 .78 1 .8 280300 1 . 87/22/2004 1 .86 1 .93 1 .78 1 .83 587900 1 .83

7/21/2004 2.06 2.12 1 .84 1 .84 407000 1 .847/20/2004 1 .91 2.02 1 .84 2.02 316300 2.027/19/2004 1 .95 1 .97 1 .83 1 .85 357400 1 .85

7/16/2004 1 .95 2.01 1 .9 1 .91 309800 1 .9 17/15/2004 1 .99 2 .01 1 .96 2.01 301000 2.0 1

7/14/2004 1 .95 2 .05 1 .94 1 .95 345500 1 .95

7/13/2004 2.04 2 .05 1 .97 2 161400 2

7/12/2004 1 .99 2 .05 1 .94 2 .01 207800 2.0 17/9/2004 2 2 .06 2, 2 182000 2

7/8/2004 1 .98 2 .06 1 .98 1 .99 404000 1 .997/7/2004 2.05 2 .14 2 .05 2.07 268000 2.077/6/2004 2.14 2.18 2 .05 2.06 485500 2.067/2/2004 2.08 2.18 2 .08 2.17 228800 2.1 7

7/l/2004 2.38 2.38 2 .13 2.18 656500 2.1 8

6/30/2004 2.38 2.39 2.29 2.34 247500 2 .346/29/2004 2.32 2.38 2.27 2.32 475700 2 .32

6/28/2004 2.16 2.34 2.16 2.32 833300 2 .32

6/25/2004 2 .27 2.27 2.08 2 .1 1672100 2 . 16/24/2004 2 .46 2.49 2.22 2.26 1114900 2 .26

6/23/2004 2 .13 2 .38 2.05 2 .31 1328000 2 .3 16/22/2004 2.08 2 .13 2 2 .04 772700 2 .046/21/2004 1 .95 2 .04 1 .88 1 .98 672800 1 .986/18/2004 1 .9 2 1 .66 1 .92 2064000 1 .92

6/17/2004 2.09 2 .09 1 .99 2 654000 26/16/2004 2.08 2 .12 2.03 2 .05 578200 2.056/15/2004 2.04 2.1 1 .98 2 .06 1875900 2.066/14/2004 2.19 2 .24 1 .95 2.01 2661700 2.0 16/10/2004 2.28 2.34 2.23 2.25 619900 2.256/9/2004 2.35 2.43 2 .28 2 .3 786700 2 . 36/8/2004 2.45 2.45 2 .39 2.41 539600 2.4 16/7/2004 2.55 2.59 2 .34 2.45 985300 2.456/4/2004 2.48 2 .6 2.43 2.44 697400 2 .446/3/2004 2.61 2.64 2.48 2.48 749900 2 .486/2/2004 2.63 2.68 2.56 2.61 590000 2 .6 16/l/2004 2.7 2.79 2.58 2.65 897900 2 .65

5/28/2004 2 .85 2.97 2.71 2 .75 1673100 2 .755/27/2004 3.1 3 .18 3 3 .04 508100 3.045/26/2004 2 .93 3 .08 2.88 3 .07 464600 3.07

5/25/2004 2.96 2.99 2.88 2 .95 426300 2.95


5/24/2004 2 .98 2.98 2.83 2.91 220100 2 .9 1

5/21/2004 2 .85 2 .95 2.83 2.9 238500 2 . 9

5/20/2004 2.96 3 .02 2.82 2 .86 654800 2 .86

5/19/2004 3.05 3.1 2.95 2 .98 490200 2.98

5/18/2004 3.02 3.1 2.92 2.99 486700 2.99

5/17/2004 3.09 3 .11 2.99 3 472700 3

5/14/2004 3.18 3.27 3 .15 3.16 243400 3.1 65/13/2004 3.21 3.38 3 .16 3.24 302900 3.24

5/12/2004 3.4 3 .4 3 .11 3.24 552200 3.245/11/2004 3.22 3.41 3 .15 3.37 306300 3.37

5/10/2004 3 .09 3.26 3.05 3.13 580700 3.1 35/7/2004 3 .37 3.38 3.16 3.16 550600 3 .1 65/6/2004 3 .24 3.48 3.14 3.46 539200 3 .46

5/5/2004 3.41 3.55 3 .3 3.3 558000 3. 3

5/4/2004 3.08 3 .33 3.06 3 .24 401300 3.24

5/3/2004 2.92 3 .16 2.87 3 .11 1130300 3.1 1

4/30/2004 3 .2 3 .27 2.85 2.9 2023100 2.9

4/29/2004 3.45 3 .48 3.19 3.2 752000 3 . 2

4/28/2004 3.69 3.7 3.45 3 .45 392100 3.45

4/27/2004 3.73 3.78 3 .61 3.72 385400 3.72

4/26/2004 3.78 3.95 3 .73 3.74 428100 3.74

4/23/2004 3.4 3.78 3.4 3.78 532200 3.784/22/2004 3.55 3.58 3.4 3 .5 270000 3 . 54/21/2004 3.49 3 .6 3.42 3.57 420100 3.574/20/2004 3 .48 3.68 3.35 3.35 430800 3 .354/19/2004 3 .36 3.63 3.35 3.54 519700 3 .54

4/16/2004 3.31 3.53 3 .3 3.36 408400 3 .364/15/2004 3.39 3 .44 3 .3 3 .31 350500 3 .3 14/14/2004 3.39 3 .47 3.29 3.38 548400 3 .38

4/13/2004 3.75 3 .84 3.43 3 .43 524800 3 .434/12/2004 3.83 3 .89 3.68 3 .75 276700 3 .75

4/8/2004 3.97 3 .99 3.8 3.8 410800 3.84/7/2004 3.58 3 .84 3.56 3 .84 439100 3.84

4/6/2004 3.78 3.79 3.58 3.65 437700 3.65

4/5/2004 3.73 3.8 3.63 3.8 349800 3 . 84/2/2004 3.63 3.74 3.55 3.72 620700 3.724/1/2004 3.37 3.52 3.35 3.5 357000 3 . 5

3/31/2004 3.33 3.56 3.32 3.42 588100 3.423/30/2004 3.62 3.63 3 .53 3.59 260700 3.593/29/2004 3.57 3.65 3.51 3.63 558100 3 .63

3/26/2004 3.47 3.55 3.31 3.54 638300 3 .543/25/2004 3.24 3.45 3.19 3.4 673500 3 . 43/24/2004 3 .11 3.24 3.07 3.12 450300 3 .1 23/23/2004 3 .11 3.24 3.1 3 .12 591900 3 .1 23/22/2004 3.1 3 .15 3.02 3 .06 713600 3 .063/19/2004 3 .21 3 .29 3 .1 3 .1 541200 3 . 1

3/18/2004 3 .01 3 .19 3 3 .18 589900 3.1 83/17/2004 3.18 3 .26 3.11 3.2 693600 3 . 23/16/2004 3.24 3.36 2.96 3.1 1791600 3 . 13/15/2004 3.31 3.39 3.2 3.21 890300 3.2 13/12/2004 3.43 3.55 3 .35 3.38 1192900 3.38

3/11/2004 3 .67 3.87 3 .28 3.29 1269700 3.29


3/10/2004 3.92 3.99 3 .72 3.75 449300 3.75

3/9/2004 4.04 4.09 3 .74 3.89 686200 3.89

3/8/2004 4.12 4.28 4 4.01 678200 4.0 1

3/5/2004 4.2 4.25 4 .15 4.18 451000 4.1 8

3/4/2004 4 .22 4.26 4.18 4.25 384500 4 .25

3/3/2004 4 .41 4.52 4.18 4.19 515500 4 .1 9

3/2/2004 4 .62 4.63 4.34 4.34 450300 4.34

3/1/2004 4.49 4 .63 4 .4 4.58 428800 4.58

2/27/2004 4.38 4.5 4.35 4.42 409600 4.42

2/26/2004 4.25 4 .43 4.2 4.41 433700 4.4 1

2/25/2004 4.12 4.28 4 .09 4.23 356500 4.232/24/2004 4.16 4.34 4 .06 4.16 478400 4.1 6

2/23/2004 4.39 4 .4 4 .12 4.18 724600 4.1 8

2/20/2004 4 .39 4 .5 4 .26 4.42 686000 4.42

2/19/2004 4 .65 4 .7 4.31 4.4 615100 4 . 4

2/18/2004 4 .75 4 .8 4.6 4.6 404400 4 . 6

2/17/2004 4 .61 4.77 4.58 4.69 527900 4.69

2/13/2004 4.75 4 .81 4 .5 4.56 579100 4.56

2/12/2004 4.79 4 .85 4.66 4 .72 406100 4.72

2/11/2004 4.86 4.9 4.71 4 .71 359100 4.7 1

2/10/2004 4.75 4 .87 4.7 4 .85 428200 4.85

2/9/2004 4 .8 4 .87 4.7 4.77 707900 4.77

2/6/2004 4.45 4.8 4 .34 4.75 807900 4.75

2/5/2004 4.3 4 .5 4 .29 4.44 505900 4.44

2/4/2004 4.61 4.65 4 .25 4.25 875900 4.252/3/2004 4.83 4.85 4.6 4.61 544700 4.6 12/2/2004 4.87 4.99 4.79 4.79 791000 4 .79

1/30/2004 4.86 4.93 4.72 4.79 645500 4 .791/29/2004 5.05 5.09 4 .6 4.84 1695000 4 .84

1/28/2004 5.2 5.4 4.93 5 3116200 5

1/27/2004 5.72 5 .75 5.53 5.6 1122800 5. 61/26/2004 5.73 5 .85 5.67 5 .78 593300 5.78

1/23/2004 5.73 5 .89 5.51 5.8 942600 5 . 8

1/22/2004 6 6 .11 5.6 5.63 943100 5.631 /21 /2004 6.17 6.21 5.72 5.9 941100 5 . 91/20/2004 5.99 6.25 5.75 6.2 2241200 6 . 21/16/2004 5.47 5.95 5.32 5.83 2292400 5.831/15/2004 5.55 5.59 5.27 5.36 894900 5.36

1/14/2004 5.67 5.71 5.46 5.58 496900 5.581/13/2004 5.74 5.77 5.43 5.6 628500 5 . 61/12/2004 5.67 5.8 5.55 5.79 645200 5 .79

1/9/2004 5.6 5.9 5.4 5.57 789100 5 .57

1/8/2004 5 .59 5.79 5.51 5 .61 1176700 5 .6 1

1/7/2004 5 .15 5.6 5 .1 5 .5 2358000 5.51/6/2004 5 5 .17 4.93 5 1212700 51/5/2004 4 .73 4 .96 4.72 4 .93 1190700 4.931/2/2004 4.67 4.7 4.56 4.7 541300 4 . 7

12/31/2003 4.64 4.71 4.5 4.5 682000 4 . 512/30/2003 4 .8 4.82 4.46 4.68 660000 4.68

12/29/2003 4.61 4.78 4 .55 4.78 902600 4.7812/26/2003 4.48 4 .6 4 .41 4.59 374500 4 .59

12/24/2003 4.4 4.68 4.3 4.4 302200 4 . 4

http ://ichart . finance .yahoo . com/table .csv

12/23/2003 4.38 4 .49 4.29 4.49 521000 4.49

12/22/2003 4.29 4.43 4.27 4.42 347300 4.42

12/19/2003 4.53 4.54 4 .25 4.29 538600 4.29

12/18/2003 4.26 4.49 4 .21 4.38 830300 4.38

12/17/2003 4 .12 4.26 4 .07 4.23 557800 4.23

12/16/2003 4 .28 4.32 4.05 4.17 1235100 4.1 712/15/2003 4 .75 4.77 4.26 4.27 709500 4.27

12/12/2003 4 .55 4.68 4.45 4.5 568800 4 . 5

12/11/2003 4 .21 4.55 4.16 4.5 814200 4 . 512/10/2003 4 .35 4.38 4.11 4.18 1391000 4.1 8

12/9/2003 4.69 4.7 4.24 4 .26 2262600 4.26

12/8/2003 5.19 5 .38 4.55 4 .57 4507500 4.57

12/5/2003 4.88 5.05 4.44 4 .55 4308400 4.5512/4/2003 6 .3 6.37 5 .71 5.77 983500 5.77

12/3/2003 6.48 6.48 6 .24 6.3 955400 6 . 312/2/2003 6.2 6.41 6.2 6.29 828800 6.29

12/l/2003 5.98 6.24 5.93 6.23 690700 6.23

11/28/2003 5.81 6 5.81 5.98 143300 5.98

11/26/2003 5.76 5.94 5.74 5.83 419000 5.8311/25/2003 5.85 5.97 5.72 5.75 586900 5.75

11/24/2003 5.8 5.9 5.67 5.78 575900 5.7811/21/2003 5.81 5 .85 5 .5 5.79 609700 5.79

11/20/2003 5.74 5 .93 5.62 5.75 611800 5 .7511/19/2003 5.98 6 5.75 5 .93 489200 5 .93

11/18/2003 5.9 6 .15 5.75 5 .75 996200 5.7511/17/2003 6 6 5.77 5.84 1081000 5.84

11/14/2003 6.49 6.75 6 6 .04 2197400 6.0411/13/2003 6.01 6.06 5.69 5.84 2111400 5.84

11/12/2003 6 6.16 5.84 6.05 1071200 6.0511/11/2003 6.21 6.28 5.85 6 1158500 6

11/10/2003 6.6 6 .7 6 .06 6.23 1166800 6.23

11/7/2003 6.8 6.83 6.5 6.51 1331000 6.5 1

11/6/2003 7.19 7.23 6.84 6.92 581700 6.9211/5/2003 7.05 7.26 6.92 6.94 410600 6.94

11/4/2003 6.99 7.2 6.84 7.07 549100 7 .0711/3/2003 6.8 7.14 6.8 7 469300 7

10/31/2003 6 .91 7 .1 6 .71 6.87 583500 6 .8710/30/2003 7.4 7 .65 6.96 7 1023600 710/29/2003 6 .83 7 .29 6.67 7 .29 776700 7 .2910/28/2003 7 7 .09 6.66 6 .89 665700 6.8910/27/2003 6.85 7 .09 6.73 6 .84 625900 6.8410/24/2003 7.15 7 .25 6.85 6 .91 606600 6.9 1

10/23/2003 7.22 7 .49 6.65 7.21 1639900 7.2 110/22/2003 7.49 7.72 7.2 7.23 793500 7.2310/21/2003 7 .3 7.65 7.2 7.49 589900 7.4910/20/2003 7.38 7.65 7.2 7.63 748000 7.6310/17/2003 7 .8 7 .8 7 .44 7.53 829800 7.5310/16/2003 7.77 7.88 7 .51 7.82 877400 7 .8210/15/2003 8 8.02 7.6 7.76 1057700 7 .7610/14/2003 7 .73 7.96 7.7 7.9 951800 7. 9

10/13/2003 7 .78 8 .04 7.64 7 .79 877400 7 .79

10/10/2003 7 .86 7 .87 7.44 7.8 1116300 7. 8


10/9/2003 7 .25 8.03 7.25 7.73 3006500 7 .7310/8/2003 7 .36 7.5 7 .1 7 .23 1844500 7 .23

10/7/2003 6.71 7.8 6.65 7 .71 6742400 7.7 1

10/6/2003 6.2 6.3 6 6.21 1126800 6.2 1

10/3/2003 6.3 6.4 6.05 6 .08 1355700 6.08

10/2/2003 6 .3 6 .74 6.03 6.04 3691100 6.04

10/1/2003 5.94 6 5.52 5.72 1129500 5.72

9/30/2003 5.99 6.18 5.7 5.76 607300 5.76

9/29/2003 5.95 6.01 5.42 6 1493100 6

9/26/2003 5.9 6 .2 5.74 5.76 799100 5.769/25/2003 6 .22 6.42 5.87 5.91 604700 5.9 1

9/24/2003 6.8 6.84 6.15 6.15 1029400 6 .1 59/23/2003 6 .97 7.15 6.71 6.74 998800 6 .74

9/22/2003 6 .43 6.98 6 .4 6.95 1236200 6.959/19/2003 6 .55 6 .84 6.42 6.84 1541800 6.84

9/18/2003 6.51 6.9 6 .5 6 .78 1550900 6.789/17/2003 6 6 .45 5.9 6 .38 1898700 6.38

9/16/2003 5.57 5.99 5.54 5.9 1738500 5 . 99/15/2003 6 .1 6 .12 5 .56 5.62 2915000 5.62

9/12/2003 6.59 6.64 6 .04 6.09 2057900 6.099/11/2003 6.39 6.86 6 .16 6.7 1943500 6 . 79/10/2003 7.13 7.37 6 .71 6.73 3076200 6.739/9/2003 7.99 8.12 7 .84 8.01 1277000 8.0 19/8/2003 7.85 8 .1 7 .84 8 1095300 89/5/2003 7.8 8.25 7.52 7.86 1626900 7 .869/4/2003 7.09 8.16 7.03 7.99 2825700 7 .99

9/3/2003 6 .88 7 6.64 6.99 1096700 6 .999/2/2003 6.6 6 .93 6 .4 6 .87 1399700 6 .87

8/29/2003 6.47 6 .75 6.47 6 .51 498700 6 .5 18/28/2003 6.7 7 .1 6.68 6 .73 947900 6.73

8/27/2003 6.37 6 .71 6 .2 6 .71 753300 6.7 18/26/2003 6.2 6.5 6.05 6.3 834100 6 . 38/25/2003 6.39 6.4 6.03 6.18 510400 6.1 88/22/2003 6.85 6.89 6.21 6.48 1398100 6.488/21/2003 7.15 7.2 6.5 6.6 1964400 6 . 68/20/2003 6.54 7 .1 6 .25 7 2323300 78/19/2003 6.03 6.67 5.82 6.65 2480100 6.658/18/2003 5.05 5.98 4 .92 5.95 1762700 5.958/15/2003 5.08 5.09 4.91 5 199700 58/14/2003 4.91 5.04 4.91 5.03 389200 5.038/13/2003 4.95 5 4.85 4.96 471700 4 .968/12/2003 4.64 4.98 4.55 4.98 466600 4 .988/11/2003 4.95 5.04 4.5 4.63 818300 4 .63

8/8/2003 4.9 4.98 4.63 4.92 466100 4 .928/7/2003 4.7 4.9 4.51 4 .88 581500 4 .888/6/2003 4.7 4.9 4.67 4.7 556500 4. 78/5/2003 5.05 5 .06 4.67 4 .77 768500 4.778/4/2003 4.95 5.09 4.92 5 855800 58/1/2003 4.87 5.06 4.61 5 1395800 5

7/31/2003 4.52 5.13 4.5 4.94 3831000 4.947/30/2003 4.15 4.19 3.98 4.08 899000 4.087/29/2003 4.2 4.25 4 .06 4.21 559900 4.2 1


7/28/2003 4 .3 4.4 4.03 4.2 1573200 4 . 2

7/25/2003 4 .3 4.55 4.3 4.52 458700 4.52

7/24/2003 4.23 4.52 4.23 4.41 676100 4.4 1

7/23/2003 4.36 4.4 3 .93 4.25 300100 4.25

7/22/2003 4.3 4 .4 4 .02 4.29 608700 4 .29

7/21/2003 4 .21 4.7 4 .19 4.21 1357500 4 .2 1

7/18/2003 3.8 3.98 3.75 3.95 264300 3 .95

7/17/2003 4.1 4 .11 3.69 3.75 670400 3 .757/16/2003 4 .28 4.35 4 .1 4.14 276000 4.14

7/15/2003 4.16 4 .45 4.16 4 .26 475500 4.26

7/14/2003 4.13 4 .34 4.07 4.16 753200 4.1 67/11/2003 4.21 4 .38 4.01 4.13 2003500 4.1 3

7/10/2003 3 .5 4 .39 3.5 4.25 1824600 4.25

7/9/2003 3 .6 3.66 3 .49 3.59 345800 3.59

7/8/2003 3 .5 3.62 3 .28 3.61 576100 3.6 17/7/2003 3.74 3.75 3.5 3.55 1228900 3.557/3/2003 3.42 3.74 3 .35 3 .5 2581000 3 . 5

7/2/2003 2 .67 2.97 2 .67 2.91 553700 2.9 1

7/1/2003 2 .58 2.77 2 .52 2.71 147200 2.7 16/30/2003 2 .62 2.76 2.53 2.71 302900 2 .7 1

6/27/2003 2 .56 2.79 2.45 2.67 223500 2 .67

6/26/2003 2.69 2 .69 2.53 2.6 121200 2 . 6

6/25/2003 2.63 2 .68 2.53 2 .56 183900 2.566/24/2003 2.65 2 .73 2.61 2 .64 111200 2.64

6/23/2003 2.65 2 .72 2 .5 2.7 295600 2.7

6/20/2003 2.55 2 .71 2.55 2 .71 150800 2.7 1

6/19/2003 2.53 2 .76 2.52 2 .62 290400 2.626/18/2003 2.52 2.7 2 .52 2.6 260200 2 . 6

6/17/2003 2.58 2 .61 2 .49 2.57 346500 2.576/16/2003 2.73 2.78 2 .57 2 .6 276000 2 . 6

6/13/2003 2.83 2.85 2 .62 2.73 303300 2.736/12/2003 2.69 2.89 2 .69 2.83 444800 2.836/11/2003 2.7 2.75 2 .64 2 .7 162700 2 . 76/10/2003 2.65 2.76 2.54 2 .7 300900 2 . 7

6/9/2003 2.74 2.86 2.59 2.68 456100 2 .686/6/2003 3.13 3.2 2.84 2 .9 510800 2 . 96/5/2003 2 .97 3.1 2.88 3.06 519200 3 .066/4/2003 2 .82 3 .03 2.76 2 .92 339200 2 .926/3/2003 2.76 2 .92 2.71 2 .82 234200 2 .826/2/2003 2.87 3.1 2.68 2 .75 755500 2 .75

5/30/2003 2.59 3 .03 2.55 2 .96 981900 2.965/29/2003 2.47 2 .65 2.47 2 .53 380900 2.535/28/2003 2.5 2.6 2.45 2 .45 346500 2.455/27/2003 2.39 2 .53 2.35 2 .51 548800 2.5 15/23/2003 2.27 2 .39 2.2 2 .37 280700 2.375/22/2003 2.23 2.38 2.19 2.25 219600 2.255/21/2003 2.16 2.24 2 .15 2.22 130000 2.225/20/2003 2.19 2.28 2 .14 2.22 251400 2.225/19/2003 2.3 2.36 2 .12 2.19 515000 2 .1 95/16/2003 2.25 2.48 2.25 2.38 305600 2 .385/15/2003 2.4 2.48 2.3 2.42 239400 2 .42

5/14/2003 2 .36 2 .45 2.27 2.4 343900 2.4


5/13/2003 2.45 2 .45 2 .3 2 .33 254300 2.335/12/2003 2.32 2 .43 2.31 2 .41 196700 2.4 15/9/2003 2.31 2.4 2.31 2 .38 140500 2.385/8/2003 2.55 2 .55 2.22 2.3 369900 2. 35/7/2003 2 .5 2.5 2.38 2 .43 369800 2.435/6/2003 2.51 2 .62 2.38 2.5 885000 2 . 55/5/2003 2.08 2 .61 2.07 2 .55 1961300 2.555/2/2003 1 .95 2.1 1 .9 2 .05 400100 2.055/l/2003 1 .87 1 .98 1 .86 1 .94 250700 1 .94

4/30/2003 1 .78 1 .95 1 .71 1 .93 949800 1 .934/29/2003 1 .87 2.1 1 .87 2 .1 583500 2 . 14/28/2003 1 .83 1 .94 1 .8 1 .88 245000 1 .884/25/2003 1 .85 1 .94 1 .78 1 .84 216700 1 .844/24/2003 1 .85 1 .94 1 .82 1 .86 157400 1 .864/23/2003 1 .98 2 1 .83 1 .85 308000 1 .854/22/2003 1 .65 1 .99 1 .62 1 .96 556900 1 .964/21/2003 1 .67 1 .7 1 .59 1 .66 224800 1 .664/17/2003 1 .59 1 .67 1 .59 1 .67 201800 1 .674/16/2003 1 .67 1 .68 1 .58 1 .61 216100 1 .6 14/15/2003 1 .68 1 .68 1 .6 1 .66 154300 1 .664/14/2003 1 .7 1 .71 1 .6 1 .64 148400 1 .644/11/2003 1 .67 1 .68 1 .57 1 .66 164400 1 .664/10/2003 1 .67 1 .69 1 .62 1 .64 144900 1 .64

4/9/2003 1 .69 1 .75 1 .62 1 .69 234800 1 .694/8/2003 1 .7 1 .75 1 .65 1 .68 111500 1 .684/7/2003 1 .76 1 .8 1 .7 1 .71 184400 1 .7 14/4/2003 1 .71 1 .77 1 .7 1 .71 157800 1 .7 14/3/2003 1 .76 1 .8 1 .72 1 .73 91700 1 .734/2/2003 1 .72 1 .82 1 .72 1 .78 104900 1 .784/ 1 /2003 1 .82 1 .82 1 .63 1 .71 92600 1 .7 1

3/31/2003 1 .6 1 .85 1 .6 1 .71 367900 1 .7 13/28/2003 1 .62 1 .66 1 .6 1 .6 68400 1 . 63/27/2003 1 .69 1 .7 1 .6 1 .68 153400 1 .683/26/2003 1 .78 1 .78 1 .69 1 .71 125200 1 .7 13/25/2003 1 .69 1 .88 1 .65 1 .79 135200 1 .793/24/2003 1 .84 1 .85 1 .66 1 .69 160900 1 .693/21/2003 1 .92 1 .94 1 .85 1 .87 206800 1 .873/20/2003 1 .61 1 .86 1 .61 1 .84 126000 1 .843/19/2003 1 .67 1 .81 1 .6 1 .8 135500 1 . 83/18/2003 1 .69 1 .86 1 .63 1 .7 203000 1 . 73/17/2003 1 .67 1 .76 1 .55 1 .72 213800 1 .723/14/2003 1 .73 1 .75 1 .64 1 .73 214300 1 .733/13/2003 1 .46 1 .73 1 .45 1 .67 288700 1 .673/12/2003 1 .52 1 .55 1 .39 1 .46 268100 1 .463/11/2003 1 .65 1 .68 1 .5 1 .54 217400 1 .543/10/2003 1 .81 1 .82 1 .6 1 .66 385100 1 .663/7/2003 1 .93 1 .98 1 .84 1 .84 217800 1 .843/6/2003 1 .98 2 .02' 1 .91 1 .93 151800 1 .933/5/2003 1 .91 2 1 .91 1 .97 85900 1 .973/4/2003 1 .94 2.02 1 .92 1 .93 144700 1 .933/3/2003 2.02 2.05 1 .91 1 .94 172500 1 .94

2/28/2003 2.04 2.04 1 .95 1 .96 145200 1 .96


2/27/2003 2 2.1 1 .97 2.02 282000 2.022/26/2003 2 2.1 2 2.01 98800 2.0 1

2/25/2003 2.07 2.08 1 .94 2.05 183000 2.052/24/2003 2 .12 2.12 2 .04 2.04 78100 2.04

2/21/2003 2 .11 2.12 2 .04 2.12 115400 2 .1 22/20/2003 2 .08 2.11 2 .05 2.11 59300 2 .1 1

2/19/2003 2 .13 2.14 2 .06 2.06 137300 2 .062/18/2003 2.1 2.18 2 .07 2.14 201200 2 .1 4

2/14/2003 2 .07 2.12 2.02 2.12 202700 2 .1 22/13/2003 2 .02 2.09 2.01 2.04 263700 2 .042/12/2003 2 .02 2 .09 2.01 2.05 276100 2 .052/11/2003 2 .11 2 .22 2.03 2 .03 234300 2.032/10/2003 2.11 2 .12 2.03 2 .09 180600 2.09

2/7/2003 2.18 2.2 2 .1 2 .1 154600 2 . 1

2/6/2003 2.18 2 .27 2.15 2.15 116900 2.1 52/5/2003 2 .2 2 .29 2.16 2.19 169700 2.1 92/4/2003 2.17 2.2 2 .15 2.18 290900 2.1 8

2/3/2003 2.27 2.3 2 .03 2.22 688100 2.221 /31 /2003 2.28 2.32 2 .11 2.27 318100 2.271/30/2003 2.56 2 .6 2.3 2.45 239900 2.45

1/29/2003 2 .46 2.64 2 .26 2.56 204800 2.56

1/28/2003 2 .33 2 .5 2 .33 2 .5 185700 2 . 5

1/27/2003 2 .39 2.43 2.3 2.35 240800 2.351/24/2003 2 .55 2.58 2 .44 2.46 262200 2.46

1/23/2003 2 .66 2.69 2 .49 2.57 225500 2 .571/22/2003 2 .71 2.73 2.56 2.57 242100 2 .571 /21 /2003 2.6 2.76 2.57 2.68 561100 2 .681/17/2003 2.6 2.68 2.49 2.57 380300 2 .571/16/2003 2.6 2 .75 2 .6 2 .68 286900 2.681/15/2003 2 .71 2 .76 2.64 2 .65 592100 2.651/14/2003 2.77 2 .84 2.66 2 .73 458800 2.731/13/2003 2.53 2.8 2.48 2 .72 1046900 2.721/10/2003 2.45 2 .66 2 .4 2 .54 526700 2.54

1/9/2003 2.44 2.6 2.27 2.5 764000 2 . 51/8/2003 2.35 2 .48 2.34 2 .44 506200 2.441/7/2003 2.35 2 .49 2.28 2 .48 788100 2.48

1/6/2003 2.18 2 .31 2.15 2 .26 270800 2.261/3/2003 2.27 2 .33 2 .15 2 .23 114100 2.231/2/2003 2 .1 2 .3 2 .1 2 .27 212300 2.27

12/31/2002 2.12 2.28 2 .03 2.05 722800 2.0512/30/2002 2.33 2.33 2.2 2.22 231500 2.2212/27/2002 2.31 2.35 2 .25 2.33 229900 2.3312/26/2002 2.26 2 .4 2 .25 2.32 198700 2.3212/24/2002 2.35 2 .4 2 .22 2.23 91100 2.2312/23/2002 2.45 2.46 2 .18 2 .3 364000 2 . 312/20/2002 2.57 2.83 2 .35 2.43 909500 2.4312/19/2002 1 .84 2 .7 1 .77 2.67 2096900 2 .6712/18/2002 1 .99 2.02 1 .78 1 .81 367700 1 .8 112/17/2002 2.05 2.05 1 .96 2 209400 212/16/2002 1 .98 2.09 1 .92 2.08 278000 2 .0812/13/2002 2 .05 2.09 1 .95 2.06 287600 2 .0612/12/2002 2.1 2 .11 2.01 2 .08 187700 2 .08


12/11/2002 2 .12 2.14 2.05 2 .05 185100 2 .05

12/10/2002 2.04 2 .18 2.04 2 .13 331400 2 .1 3

12/9/2002 2.19 2.2 2.01 2 .09 458500 2.09

12/6/2002 2.14 2 .35 2.14 2 .27 272900 2.2712/5/2002 2.37 2.38 2 .2 2.24 246700 2.2412/4/2002 2.26 2.3 2 .13 2.21 279500 2.2 1

12/3/2002 2.37 2.39 2 .21 2 .3 247500 2 . 3

12/2/2002 2.46 2.52 2.3 2 .4 414000 2 . 4

11/29/2002 2.4 2 .5 2 .35 2.38 138500 2 .3811/27/2002 2 .36 2.51 2 .34 2.48 333300 2 .48

11/26/2002 2 .53 2.6 2.31 2.34 453100 2 .34

11/25/2002 2 .45 2.65 2.44 2.62 533000 2 .6211/22/2002 2.3 2.53 2 .1 2 .41 823200 2.4 1

11/21/2002 2 .08 2.4 2.07 2 .27 680400 2.27

11/20/2002 2.03 2.1 1 .98 2.1 331100 2 . 1

11/19/2002 1 .99 2 .06 1 .99 2.04 317100 2.04

11/18/2002 2.02 2.1 2 .01 2.02 337700 2.0211/15/2002 2.04 2.09 1 .99 2.05 233900 2.0511/14/2002 2.04 2.13 2 .02 2.08 322600 2.08

11/13/2002 2 .01 2.14 1 .99 2.08 283500 2.08

11/12/2002 1 .96 2 .1 1 .95 2.01 183000 2.0 1

11/11/2002 2 .06 2.08 1 .94 1 .95 170500 1 .9511/8/2002 2 .06 2 .1 2 2.07 203500 2 .07

11/7/2002 2 .16 2.19 2.06 2.13 238000 2 .1 3

11/6/2002 2.13 2.2 2.12 2.19 415800 2 .1 9

11/5/2002 2.07 2 .19 1 .98 2 .12 215100 2.1 2

11/4/2002 2 .3 2 .31 1 .97 2 .07 1180000 2.07

11/l/2002 1 .99 2 .15 1 .91 2 .08 328600 2.08

10/31/2002 2.05 2 .19 1 .9 2 567600 2

10/30/2002 2 2 .16 2 2 .05 385200 2.0510/29/2002 2.29 2.3 1 .9 2 1050600 2

10/28/2002 2.73 2 .9 2 .57 2.67 491500 2.6710/25/2002 2.79 2.88 2 .51 2.74 411300 2.74

10/24/2002 2.73 2.97 2 .68 2.81 482200 2.8 110/23/2002 2.49 2.71 2 .48 2.69 532600 2.6910/22/2002 2.35 2.72 2 .25 2.52 641900 2 .5210/21/2002 2.18 2.46 2.1 2.38 695100 2 .38

10/18/2002 2.05 2.05 1 .91 1 .97 112100 1 .9710/17/2002 2 .05 2.1 1 .97 2.03 241400 2 .0310/16/2002 1 .95 1 .96 1 .85 1 .88 154800 1 .8810/15/2002 1 .89 2 .16 1 .89 2 .05 301300 2 .0510/14/2002 1 .89 1 .98 1 .73 1 .79 168700 1 .79

10/11/2002 1 .94 2 .1 1 .8 1 .91 491100 1 .9 110/10/2002 1 .59 1 .95 1 .55 1 .85 403300 1 .8510/9/2002 1 .98 1 .99 1 .51 1 .53 351500 1 .5310/8/2002 2.03 2.1 1 .9 1 .95 331700 1 .9510/7/2002 2.07 2.15 1 .9 2 .1 502000 2 . 110/4/2002 2.23 2.24 2.05 2.06 235500 2.0610/3/2002 2.3 2.38 2 .13 2.15 772200 2.1 510/2/2002 2.42 2.55 2.3 2.31 187200 2 .3 110/l/2002 2.35 2.51 2.17 2.42 381200 2 .429/30/2002 2.5 2 .52 2.25 2.32 650900 2 .32


9/27/2002 2 .66 2.76 2.5 2.51 410000 2 .5 1

9/26/2002 2 .88 2.9 2.68 2.83 1248100 2 .839/25/2002 2.1 2.65 2.03 2.6 732900 2 . 69/24/2002 2 .19 2.21 2.02 2.08 362400 2 .089/23/2002 2 .51 2.54 2.19 2.21 372600 2 .2 1

9/20/2002 2.3 2.52 2.12 2.4 650400 2 . 49/19/2002 2.27 2 .45 2.15 2.2 447500 2 . 2

9/18/2002 2 .5 2 .55 2.01 2 .37 840600 2.379/17/2002 2.82 2 .98 2.68 2.7 367700 2 . 79/16/2002 3.09 3 .19 2.63 2.71 609800 2.7 1

9/13/2002 3.09 3 .22 3 .01 3 .1 220100 3 . 19/12/2002 3.09 3.27 3 .09 3 .1 338400 3 . 1

9/11/2002 3 .2 3.43 3 .16 3.21 622000 3.2 19/10/2002 3.06 3.24 2.9 3.16 670300 3.1 69/9/2002 3 3.05 2 .94 3 359900 39/6/2002 2.92 3 2 .85 2 .9 293700 2 . 99/5/2002 2.83 3.04 2.8 2.93 393100 2.939/4/2002 2 .95 3.04 2 .77 2.89 526700 2.899/3/2002 2.9 3.09 2 .84 2.86 901700 2 .86

8/30/2002 2.8 3.25 2.69 3.13 1793200 3 .1 38/29/2002 2 .67 3.02 2.55 2.8 1004900 2 . 88/28/2002 2 .99 3.11 2.61 2.71 1955500 2 .7 18/27/2002 3.2 3.62 3.06 3.11 5256900 3.1 18/26/2002 2 .35 3.09 2.31 3.03 3884700 3.038/23/2002 2 .35 2.4 2.15 2 .16 662000 2.1 68/22/2002 1 .95 2 .31 1 .88 2 .31 1202200 2.3 18/21/2002 1 .42 1 .95 1 .4 1 .84 1285700 1 .848/20/2002 1 .37 1 .45 1 .34 1 .38 212700 1 .388/19/2002 1 .32 1 .4 1 .29 1 .37 150700 1 .378/16/2002 1 .3 1 .36 1 .3 1 .31 174100 1 .3 18/15/2002 1 .4 1 .42 1 .29 1 .33 157200 1 .338/14/2002 1 .25 1 .42 1 .25 1 .42 155700 1 .428/13/2002 1 .3 1 .33 1 .28 1 .3 227000 1 . 38/12/2002 1 .3 1 .33 1 .3 1 .32 219200 1 .328/9/2002 1 .38 1 .41 1 .27 1 .31 176900 1 .3 18/8/2002 1 .31 1 .39 1 .3 1 .38 146400 1 .388/7/2002 1 .4 1 .48 1 .3 1 .31 190800 1 .3 18/6/2002 1 .28 1 .35 1 .25 1 .35 271000 1 .358/5/2002 1 .19 1 .33 1 .19 1 .2 123300 1 . 28/2/2002 1 .14 1 .26 1 .14 1 .21 160700 1 .2 18/ 1 /2002 1 .19 1 .22 1 .15 1 .17 267900 1 .1 7

7/31/2002 1 .39 1 .4 1 .22 1 .3 228000 1 . 37/30/2002 1 .35 1 .4 1 .1 1 .39 508200 1 .397/29/2002 1 .51 1 .55 1 .3 1 .31 459900 1 .3 17/26/2002 1 .43 1 .53 1 .3 1 .46 512000 1 .467/25/2002 1 .45 1 .55 1 .32 1 .35 182900 1 .357/24/2002 1 .26 1 .59 1 .25 1 .45 336500 1 .457/23/2002 1 .39 1 .49 1 .3 1 .43 197000 1 .437/22/2002 1 .37 1 .48 1 .3 1 .43 247900 1 .437/19/2002 1 .53 1 .56 1 .45 1 .45 265300 1 .457/18/2002 1 .52 1 .63 1 .52 1 .52 122400 1 .52

7/17/2002 1 .7 1 .75 1 .5 1 .57 219300 1 .57

http ://ichart . finance . yahoo . com/table .csv

7/16/2002 1 .76 1 .78 1 .62 1 .63 179900 1 .637/15/2002 1 .73 1 .81 1 .57 1 .75 584900 1 .757/12/2002 1 .36 1 .74 1 .36 1 .69 808300 1 .69

7/11/2002 1 .29 1 .36 1 .26 1 .35 219700 1 .357/10/2002 1 .27 1 .35 1 .26 1 .29 181300 1 .29

7/9/2002 1 .31 1 .35 1 .26 1 .26 165400 1 .267/8/2002 1 .33 1 .34 1 .26 1 .29 193800 1 .297/5/2002 1 .34 1 .42 1 .25 1 .33 166200 1 .337/3/2002 1 .22 1 .3 1 .2 1 .3 513900 1 .37/2/2002 1 .28 1 .33 1 .2 1 .23 524700 1 .237/l/2002 1 .35 1 .4 1 .26 1 .27 682400 1 .27

6/28/2002 1 .29 1 .37 1 .25 1 .33 803000 1 .336/27/2002 1 .19 1 .36 1 .08 1 .26 1042000 1 .266/26/2002 1 .09 1 .2 1 .05 1 .19 883000 1 .1 96/25/2002 1 .3 1 .31 1 .16 1 .21 978200 1 .2 16/24/2002 1 .25 1 .29 1 .1 1 .25 1628500 1 .256/21/2002 1 .13 1 .33 0.86 1 .28 13341300 1 .286/20/2002 1 .56 1 .6 1 .49 1 .53 500500 1 .536/19/2002 1 .81 1 .89 1 .56 1 .59 1639500 1 .596/18/2002 2 2.27 1 .83 1 .9 1319000 1 . 96/17/2002 1 .65 1 .98 1 .62 1 .94 1082700 1 .946/14/2002 1 .57 1 .66 1 .42 1 .65 1294700 1 .656/13/2002 2.11 2.15 1 .5 1 .53 2168000 1 .536/12/2002 2.24 2.27 2 .02 2.09 613600 2.096/11/2002 2.37 2.43 2 .22 2.25 476500 2.256/10/2002 2.54 2.56 2 .37 2.37 329500 2.376/7/2002 2.62 2.76 2 .52 2.55 455600 2.556/6/2002 2.89 2 .9 2 .65 2.65 390900 2.656/5/2002 2.82 2.88 2 .76 2.87 237400 2.876/4/2002 2.78 2.85 2 .72 2.75 346600 2.756/3/2002 2.85 2.87 2 .76 2.78 322700 2.78

5/31/2002 3.11 3.12 2 .82 2.84 367400 2.845/30/2002 2.89 3.23 2 .86 3.07 697200 3.075/29/2002 2.76 2.89 2 .76 2.89 253700 2.895/28/2002 2.82 2.82 2 .74 2.79 253700 2.795/24/2002 2.81 2.85 2 .72 2.82 231300 2.825/23/2002 2.94 2.95 2.8 2 .9 315300 2 . 95/22/2002 2.78 2.93 2 .75 2.93 382400 2.935/21/2002 2.79 2.85 2 .75 2 .8 514100 2 . 85/20/2002 2.89 2.89 2 .75 2.81 284200 2 .8 15/17/2002 2.94 3.06 2.82 2.89 357100 2 .895/16/2002 3.02 3.05 2.8 2.81 575300 2 .8 15/15/2002 2.85 3.14 2.7 3.04 1425200 3 .045/14/2002 2.59 2.85 2.58 2.73 1220200 2 .735/13/2002 2.53 2.64 2.33 2 .4 1583700 2 . 45/10/2002 2.45 2 .5 2.2 2.25 771700 2 .25

5/9/2002 2.62 2.65 2.38 2.43 615500 2 .435/8/2002 2.51 2.79 2.47 2.61 1537700 2 .6 15/7/2002 2.58 2.64 2.17 2.33 1432800 2 .335/6/2002 3 3.04 2.55 2.55 1142500 2 .555/3/2002 3.11 3.19 2.73 2.8 1182400 2 . 85/2/2002 2 .61 3 .09 2.53 3 2292700 3


5/1/2002 2.49 2 .64 2.45 2.5 3006300 2.54/30/2002 3.01 3 .1 2.35 2.4 9425800 2 .4

4/29/2002 5 .5 5.51 4.65 4.92 2018400 4.924/26/2002 5.95 6.2 5.52 5.6 850700 5 . 6

4/25/2002 6.22 6.3 5 .79 5.96 1414300 5.96

4/24/2002 6.25 6.42 6 .15 6.25 467300 6.25

4/23/2002 6.26 6 .4 6 .16 6.21 581500 6.2 1

4/22/2002 6.25 6.46 6 .22 6.25 622800 6 .254/19/2002 7 .15 7.16 6.5 6.55 927500 6 .55

4/18/2002 7 .08 7.19 6.82 7 450500 7

4/17/2002 6 .91 7.24 6 .9 7.12 672400 7 .124/16/2002 6.56 6.93 6.41 6 .89 822100 6.89

4/15/2002 6.87 6.9 6 .2 6.27 610100 6.274/12/2002 6.36 6 .75 6.22 6.7 658200 6 . 7

4/11/2002 6.04 6 .22 5.93 6.19 706600 6.1 9

4/10/2002 6.52 6.69 5 .97 6.16 1486500 6.1 6

4/9/2002 6.7 6.95 6.4 6.43 478200 6.43

4/8/2002 6.8 6 .8 6 .35 6 .7 1042800 6 . 7

4/5/2002 7 .18 7.39 6.8 6.8 520300 6 . 84/4/2002 7 .03 7.25 6.75 7 .1 631700 7 . 14/3/2002 7.5 7.68 6.92 7.03 1465800 7.034/2/2002 7 .92 8 7.37 7 .37 1538500 7.37

4/1/2002 8.36 8 .48 7 .9 8 .18 2045600 8.1 83/28/2002 8 .3 9 .35 7.76 8 .48 10706800 8.483/27/2002 7 .5 8 .24 7.05 8.09 2088700 8.093/26/2002 7 .7 7 .78 7 .16 7.42 1042400 7.42

3/25/2002 7.93 8 7 .67 7.86 845100 7.863/22/2002 8.05 8.24 7 .56 8.05 1248300 8.05

3/21/2002 8.21 8.23 7.6 8 .1 960700 8 . 1

3/20/2002 8 8.44 7.95 8 .2 1483200 8 . 2

3/19/2002 7.64 8.35 7.46 8.14 2095000 8 .1 43/18/2002 7 .25 7.71 7.12 7.63 1785700 7 .63

3/15/2002 6.58 7 .05 6 .5 7 .02 715400 7 .02

3/14/2002 7 7 .01 6.59 6 .62 616200 6.623/13/2002 7.2 7 .25 6.76 6 .88 984100 6.88

3/12/2002 7.18 7 .53 7.05 7 .23 1067600 7.233/11/2002 7 .7 7.9 7.24 7.55 976300 7.55

3/8/2002 7.15 7.8 7.02 7.64 1707200 7.643/7/2002 7.15 7.15 6.71 6 .9 872500 6 . 93/6/2002 6.54 7.08 6 .53 6.89 600800 6.89

3/5/2002 6.95 7.15 6 .75 6.92 834600 6.923/4/2002 6.55 7.03 6.41 6.84 1057400 6 .843/1/2002 5.91 6.44 5.91 6.44 653500 6 .44

2/28/2002 6.27 6.3 5.86 5.91 362600 5 .9 12/27/2002 6.4 6.69 6.04 6.1 458100 6. 12/26/2002 6.1 6 .42 5.8 6 .33 649900 6.332/25/2002 6 .07 6 .15 5.9 6 .11 506000 6.1 12/22/2002 5.83 6 .24 5.55 6 .17 673000 6.1 7

2/21/2002 5.94 6 .29 5.65 5.76 741300 5.762/20/2002 5.73 6.13 5.48 6.13 798900 6.1 3

2/19/2002 6.04 6.11 5 .5 5.69 921200 5.692/15/2002 6.29 6.68 6 6.14 706100 6.1 4

http ://ichart .finance .yahoo .com/table .csv

2/14/2002 6.64 6 .73 6.21 6 .31 578800 6.3 12/13/2002 7.04 7 .25 6.31 6 .35 1145400 6.352/12/2002 6.39 7 .11 6.25 6 .84 809900 6.842/11/2002 6.05 6.5 6 6 .49 946900 6.49

2/8/2002 6.07 6 .22 5.82 6 654200 62/7/2002 6.01 6 .28 5.71 6 .06 614300 6.062/6/2002 6.19 6 .31 5.67 6 909700 62/5/2002 6.11 6 .43 5.95 5.99 1225100 5.992/4/2002 6.81 7 .05 6.26 6.32 906900 6.32

1 /31 /2002 7 .2 7 .4 6 .92 6.98 835900 6.981/30/2002 7.16 7.27 6 .25 7.2 1988400 7 . 21/29/2002 7.76 7.82 6 .81 7.17 5157400 7.1 71/28/2002 7.15 7.27 6.8 6.92 1447100 6.921/25/2002 7.06 7.15 6 .75 6.98 1580500 6.981/24/2002 7.01 7 .5 6 .89 7.02 2439500 7.021/23/2002 6.26 7 6 .11 6.93 1997300 6.931/22/2002 6.5 6.51 6.23 6.29 986500 6.291/18/2002 6.01 6.63 5.8 6.11 1736100 6.1 11/17/2002 6.96 7.13 5.97 6.23 4826600 6.231/16/2002 7.65 7.66 6.15 6.49 6013500 6.491/15/2002 8.11 8.17 7.53 7.82 1119200 7.821/14/2002 8.2 8.25 7.8 8.15 2012800 8 .1 51/11/2002 8.35 8.42 7.86 8.17 1624300 8 .1 71/10/2002 8.9 8.9 8.23 8.25 1244400 8 .251/9/2002 8.7 9.12 8.42 8.7 1358800 8 . 71/8/2002 8.5 8.68 8 .2 8.64 835300 8 .641/7/2002 8 .57 8.77 8 .3 8.39 1673300 8 .391/4/2002 9.1 9.15 8.27 8.55 2078200 8 .551/3/2002 9.15 9.3 8.65 8.86 1549400 8 .861/2/2002 8.5 8.93 8 .4 8 .9 1587000 8 . 9

12/31/2001 8.19 8.5 8.06 8.27 1051300 8 .2712/28/2001 8 .56 8.87 8 .1 8 .11 1956000 8 .1 112/27/2001 8 .05 8.6 8 8.49 2501400 8 .4912/26/2001 8 .13 8.47 8 8 .16 2125800 8 .1 612/24/2001 8.28 8 .28 7.81 8 .06 665500 8 .0612/21/2001 7.65 8.38 7.54 8 .21 6841000 8 .2 112/20/2001 10.44 11 .63 7.26 7 .48 24716300 7 .4812/19/2001 11 .4 11 .85 10.25 10 .34 2589900 10 .3412/18/2001 12 .35 12.6 11 .83 11 .99 1779300 11 .9912/17/2001 10.55 12.02 10.15 12 3273200 1 212/14/2001 11 .62 11 .8 10 .4 10 .77 3013900 10 .7712/13/2001 12 .05 12.4 11 .53 11 .6 1574100 11 . 612/12/2001 12 .65 12 .89 12.05 12 .13 1181200 12 .1 312/11/2001 13.15 13.6 12.13 12 .41 1959700 12 .4 112/10/2001 13.15 13 .45 12.28 12 .95 1586400 12 .95

12/7/2001 14.15 14 .15 13 .1 13 .25 2279400 13.2512/6/2001 14.48 14 .75 14.05 14 .15 1992500 14.1 512/5/2001 13.37 14 .75 13.27 14 .11 4004400 14.1 112/4/2001 11 .59 13.1 11 .55 13 .06 1852700 13.0612/3/2001 12.05 12.2 11 .42 11 .52 1009600 11 .52

11/30/2001 12.9 13.3 12.01 12 .06 1588000 12.0611/29/2001 12 .2 12.81 11 .91 12 .81 1723000 12.8 1


11/28/2001 12.89 13.11 11 .6 11 .95 1580600 11 .9511/27/2001 13 .2 13.75 12.82 13.11 1222800 13.1 111/26/2001 13.31 13.78 12 .65 13.28 1261500 13.2811/23/2001 13 .1 13.45 13 .05 13.21 258200 13.2 111/21/2001 13.27 13.74 12 .75 13.17 1306000 13.1 711/20/2001 13.01 14.34 12 .76 13.37 2546700 13.3711/19/2001 13.53 13.6 12.9 13.11 1399500 13.1 111/16/2001 13.2 13.7 12 .69 13.19 2196300 13.1 911/15/2001 12.87 13.99 12 .33 13 .5 6418500 13 . 511/14/2001 11 .49 13.11 10 .85 13.09 9643800 13 .0911/13/2001 10.52 11 .1 10.3 10.46 2651100 10 .4611/12/2001 10 .55 10.69 9.24 10.15 1077400 10 .1 5

11/9/2001 10 .52 10.87 10.4 10.44 1551500 10 .4411/8/2001 10.3 11 .1 10.16 10.5 2831500 10 . 511/7/2001 10 .35 10.95 10.05 10.15 2362600 10.1 511/6/2001 10 .83 10.87 10.36 10.45 1102500 10.4511/5/2001 11 11 .16 10.56 10.79 1285200 10.7911/2/2001 11 .11 11 .2 10 .7 10.76 818800 10.7611/l/2001 11 .63 11 .75 10 .4 11 .25 1623100 11 .25

10/31/2001 11 .56 12.2 11 .25 11 .35 1513600 11 .3510/30/2001 11 .77 12 .43 11 .03 11 .33 2750400 11 .3310/29/2001 11 .7 12.2 11 .43 11 .87 3151400 11 .8710/26/2001 11 .5 12.2 11 .35 11 .35 2188800 11 .3510/25/2001 10.54 11 .5 10.25 11 .37 2283300 11 .3710/24/2001 10.59 11 .3 10.4 10.74 3330900 10.7410/23/2001 10.91 10 .91 10.08 10.25 1638600 10.2510/22/2001 9.25 11 .08 9.24 10.51 4076600 10.5 110/19/2001 8.66 9 .45 8.5 9.22 1797600 9.2210/18/2001 8.52 9.03 8 .34 8.51 624000 8.5 110/17/2001 8.99 9.29 8.6 8.61 1455400 8.6 110/16/2001 8.98 9.22 8.3 8.9 1208900 8 . 910/15/2001 8.27 9.08 7 .92 8.95 1197800 8.9510/12/2001 8.97 9 .1 8 .25 8.5 1914800 8 . 510/11/2001 9.2 9.31 8.5 8.8 1466400 8 . 810/10/2001 9.36 9.56 8 .47 9 1983400 910/9/2001 9.15 9.62 9 9.25 1579500 9.2510/8/2001 8.05 9.15 7 .94 8.93 1387800 8.9310/5/2001 8.4 8.45 7 .85 8.14 1112100 8.1 410/4/2001 8 .26 8.87 8 .01 8.45 2355500 8.4510/3/2001 6.79 8 .5 6.78 8.16 3080200 8.1 610/2/2001 6 .83 7.06 6.8 6.85 1087200 6.8510/1/2001 7 .05 7.22 6.75 6.86 665800 6.869/28/2001 6 .63 7.19 6.62 7.19 2315400 7.1 99/27/2001 6 .64 6.82 5.26 6.48 2172300 6.489/26/2001 6 .95 7.27 6.6 6.66 793400 6 .669/25/2001 7 .15 7.18 6.75 6.99 697700 6 .999/24/2001 7 .14 7.24 6 .7 7.13 1464900 7 .1 39/21/2001 6 .62 7.33 6.51 6.82 1798400 6.829/20/2001 7 .15 7.5 7 7.09 1224400 7.099/19/2001 7.1 7.55 6.75 7.2 1612500 7. 29/18/2001 6 .24 7.22 6.24 6 .98 1597300 6.98

9/17/2001 6.22 7.1 6.15 6 .45 1536300 6.45


9/10/2001 7 .14 7.22 6.75 7 .1 1660400 7 . 19/7/2001 6.3 7.25 6.21 7.01 3282500 7.0 19/6/2001 6 .13 6.48 5.9 6.38 1772500 6.389/5/2001 6 .32 6.68 5.8 6.24 3369900 6.249/4/2001 5 .94 6.65 5.84 6.3 8678900 6 . 3

8/31/2001 4 .02 4.23 4.01 4.17 142100 4 .1 78/30/2001 4 .03 4.15 4 4.08 254300 4.088/29/2001 4 .39 4.45 4.04 4.11 334900 4.1 18/28/2001 4 .41 4.43 4 .2 4.25 313000 4.258/27/2001 4 .45 4.58 4.4 4.41 228900 4.4 18/24/2001 4 .35 4.67 4.21 4.43 416400 4.438/23/2001 4.2 4.56 4.16 4.21 366600 4.2 18/22/2001 4 .32 4.49 3.98 4.25 640000 4.258/21/2001 4 .51 4.65 4.25 4.35 336400 4.358/20/2001 4 .77 4.87 4 .5 4.65 470800 4.658/17/2001 5 .07 5.08 4.78 4.88 421500 4.888/16/2001 5.67 5.67 5.01 5 .14 451700 5.1 48/15/2001 5.59 5.72 5.45 5.67 387700 5.678/14/2001 6.09 6.11 5.62 5 .77 384500 5.778/13/2001 5.85 5.97 5.46 5.9 379100 5. 98/10/2001 6 .43 6.45 5.68 5.75 573700 5.75

8/9/2001 6 .12 6.45 6.09 6.4 882700 6.48/8/2001 6.3 6.39 6.05 6.33 648100 6.338/7/2001 6 .25 6.49 6.13 6 .33 526900 6.338/6/2001 6 .42 6.43 6.15 6.3 318100 6. 38/3/2001 6 .45 6.6 6 .2 6 .44 515900 6.448/2/2001 6.38 6.76 6.15 6 .54 467200 6.548/l/2001 6.11 6 .55 5 .9 6 .38 1674100 6.38

7/31/2001 5.85 6.78 5.75 6 .52 2364500 6.527/30/2001 5.49 5.89 5.45 5.85 636800 5.857/27/2001 5.2 5.54 5 .2 5 .49 462600 5.497/26/2001 5.02 5.47 4.94 5.4 422400 5.47/25/2001 5.65 5.93 4 .9 4.9 677400 4. 97/24/2001 5.47 5.52 5.27 5 .52 617000 5.527/23/2001 5.4 5 .85 5.25 5.46 540000 5.467/20/2001 5.39 5.68 5.17 5 .44 456400 5.447/19/2001 5.74 5.74 5.37 5.51 569300 5.5 17/18/2001 4 .87 5.74 4.87 5.6 1205000 5 . 67/17/2001 4 .87 5.06 4 .7 5.05 344500 5.057/16/2001 5 .03 5.18 4.86 5 417100 57/13/2001 4 .92 5.06 4.87 5.01 293600 5.0 17/12/2001 5 .02 5.2 4.95 4.95 768500 4.957/11/2001 4 .62 4.84 4.61 4.84 411600 4.847/10/2001 4 .72 4 .9 4.63 4.7 466000 4 . 7

7/9/2001 4 .88 4.97 4.67 4.77 317200 4.777/6/2001 4 .96 4.98 4.78 4.85 511300 4.857/5/2001 5 .26 5.26 5 5 705300 57/3/2001 5.4 5.55 5.35 5.45 642900 5.457/2/2001 5 .31 5.83 5.29 5.71 2161200 5.7 1

6/29/2001 4 .35 6 .2 4.05 6.12 5786200 6.1 26/28/2001 3 .68 3.85 3.52 3.72 584600 3.72

6/27/2001 3 .64 3.71 3.44 3.51 865300 3 .5 1


6/26/2001 3.8 3 .83 3 .5 3.6 1053200 3 . 6

6/25/2001 3 .8 3.91 3 .7 3.78 828700 3.78

6/22/2001 4.03 4.2 3.9 3.91 1442900 3.9 1

6/21/2001 3.84 4.08 3.8 4.01 1232800 4.0 16/20/2001 3.79 4.25 3 .58 3.77 1179900 3.77

6/19/2001 4.75 4.88 3.7 4.06 1523500 4.06

6/18/2001 5.35 5.35 4 .37 4.45 965200 4.45

6/15/2001 5.16 5.7 5.11 5.53 968000 5 .536/14/2001 5 .87 5.93 5.24 5.25 739400 5 .25

6/13/2001 6 .23 6.24 5.75 5.98 722000 5.98

6/12/2001 5 .52 6.19 5.24 6.09 979200 6.09

6/11/2001 5.82 5.89 5 .3 5 .48 752300 5.48

6/8/2001 6.2 6 .21 5.81 5.84 440100 5.84

6/7/2001 5.78 6 .45 5.75 6.16 954600 6.1 6

6/6/2001 5.84 5 .85 5.61 5.85 260000 5.85

6/5/2001 5.85 5.89 5.6 5.88 464800 5.88

6/4/2001 5.99 6 5 .68 5.81 341300 5.8 1

6/1/2001 5.94 6.06 5 .65 5.84 537300 5.84


Documents

Adrian Mongeli, et al. v. Terayon Communication Systems, Inc., et al. 06-CV-03936-Declaration Of