SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 8-K
Current Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
February 14, 2000
Date of Report (Date of earliest event reported)
TUT SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 0-25291 94-2958543
- ------------------------------ ------------------------------- -------------------------------
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation) Identification No.)
2495 ESTAND WAY
PLEASANT HILL, CALIFORNIA 94523
(Address of principal executive offices, including zip code)
(925) 682-6510
(Registrant's telephone number, including area code)
N/A
(Former name or address, if changed since last report)
Item 2. Acquisition or Disposition of Assets
------------------------------------
Pursuant to an Agreement and Plan of Reorganization dated as of November
16, 1999 (the "Agreement") among Tut Systems, Inc., a Delaware corporation
("Tut"), Fortress Acquisition Corporation, a Delaware corporation and a wholly
owned subsidiary of Tut ("Sub"), FreeGate Corporation ("FreeGate"), U.S. Bank
Trust, as Escrow Agent and, with respect to Article VII only, James Mongiello,
as Stockholder Representative, on February 14, 2000 (the "Closing"), Tut
acquired FreeGate by means of a merger of FreeGate with and into Sub (the
"Merger"). As a result of the Merger, each share of FreeGate capital stock was
converted into shares of Tut Common Stock according to the following exchange
ratios: 0.017617 shares of Tut Common Stock for each share of FreeGate common
stock, 0.001516 shares of Tut Common Stock for each share of Series A Preferred
Stock, 0.009476 shares of Tut Common Stock for each share of Series B Preferred
Stock, 0.021478 shares of Tut Common Stock for each share of Series C Preferred
Stock, 0.037903 shares of Tut Common Stock for each share of Series D Preferred
Stock. All options and warrants to purchase shares of FreeGate capital stock
were cancelled upon the Closing. The Company issued options to purchase Tut
Common Stock in substitution for 1,113,000 cancelled options at an exchange
ratio of 0.017617 shares of Tut Common Stock for each one share of FreeGate
common stock subject to those options. At the Closing, ten percent of the
shares issued pursuant to the Merger were deposited into an escrow account to
secure the indemnification obligations of FreeGate (the "Escrow Fund"). The
Escrow fund is to be governed by the terms set forth in the Agreement at Tut's
cost and expense. The Escrow Fund shall be the sole source of funds available
for the fulfillment of any indemnification obligations of FreeGate to Tut and
Sub.
The provisions of the Agreement described in this report are qualified in
their entirety by reference to the actual text of that agreement, included as an
exhibit to this report.
Item 7. Financial Statements and Exhibits.
(a) Financial Statements of Business Acquired.
The audited financial statements for the years ended December 31, 1998
and 1999 of Freegate Corporation.
(b) Pro Forma Financial Information.
The unaudited pro forma combined statement of operations for the year
ended December 31, 1999 gives effect to the transaction as if it had taken place
on January 1, 1999. The unaudited pro forma combined balance sheet as of
December 31, 1999 gives effect to the transaction as if it had taken place on
December 31, 1999. The unaudited pro forma financial information is not
necessarily indicative of the results or financial position that would actually
have been reported had the sale and purchase transactions underlying the pro
forma adjustments actually been consummated on such dates nor is it necessarily
indicative of future operating results or financial position.
(c) Exhibits.
The following exhibits are filed herewith:
2.1 Agreement and Plan of Reorganization dated as of November 16,
1999, as amended, by and among Tut Systems, Inc., Fortress
Acquisition Corporation, FreeGate Corporation, U.S. Bank Trust,
as Escrow Agent, and, with respect to Article VII only, James
Mongiello, as stockholder representative.*
______________________
* Certain exhibits to, and schedules delivered in connection with, the
Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Tut
agrees to supplementally furnish to the Commission a copy of any such exhibit
or schedule upon request.
-2-
Item 7(a) Financial Statements of Business Acquired:
FREEGATE CORPORATION
TABLE OF CONTENTS
Page
----
Report of Independent Accountants.......................................... F-2
Independent Auditors' Report............................................... F-3
Balance Sheets............................................................. F-4
Statements of Operations................................................... F-5
Statements of Stockholder's Equity (Deficit)............................... F-6
Statements of Cash Flows................................................... F-7
Notes to Financial Statements.............................................. F-8
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of
FreeGate Corporation
In our opinion, the accompanying balance sheet as of December 31, 1999 and
the related statements of operations, of cash flows, and of stockholders'
equity (deficit) present fairly, in all material respects, the financial
position of FreeGate Corporation at December 31, 1999, and the results of its
operations and its cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
auditing standards generally accepted in the United States, which 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 a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 14, 2000
F-2
INDEPENDENT AUDITORS' REPORT
The Board of Directors of
FreeGate Corporation
We have audited the accompanying balance sheet of FreeGate Corporation (the
"Company") as of December 31, 1998, and the related statements of operations,
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. 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 a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of FreeGate Corporation as of
December 31, 1998, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has incurred net losses and negative operating cash
flows since inception that cause substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. Continuation of the Company as a going concern is
dependent upon management's ability to obtain additional financing and the
successful development and marketing of its products. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
/s/ KPMG LLP
Mountain View, California
April 23, 1999, except
as to Note 7, which is
as of November 1, 1999
F-3
FREEGATE CORPORATION
BALANCE SHEETS
(in thousands, except per share amounts)
December 31,
------------------
1998 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents ................................ $ 6,120 $ 130
Accounts receivable, net of allowance for doubtful
accounts of $201 and $132, respectively ................. 557 403
Inventory ................................................ 497 210
Prepaid expenses and other current assets ................ 80 224
-------- --------
Total current assets ................................... 7,254 967
Property and equipment, net ................................ 661 394
Other assets ............................................... 50 52
-------- --------
Total assets ........................................... $ 7,965 $ 1,413
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ......................................... $ 306 $ 465
Accrued liabilities ...................................... 690 734
Notes payable ............................................ -- 895
Capital lease obligations ................................ 281 323
Deferred revenue ......................................... 112 418
-------- --------
Total current liabilities .............................. 1,389 2,835
Capital lease obligations, net of current portion .......... 547 279
Deferred revenue, net of current portion.................... 220 134
-------- --------
Total liabilities ...................................... 2,156 3,248
-------- --------
Commitments and contingencies (Note 5)
Stockholders' equity (deficit):
Convertible preferred stock, $0.0001 par value:
Series A: 2,500 shares authorized; 2,500 shares issued
and outstanding as of December 31, 1998 and 1999;
liquidation preference of $300 ......................... -- --
Series B: 5,200 shares authorized; 5,067 shares issued
and outstanding as of December 31, 1998 and 1999;
liquidation preference of $3,800 ....................... -- --
Series C: 5,000 shares authorized; 4,706 shares issued
and outstanding as of December 31, 1998 and 1999;
liquidation preference of $8,000........................ -- --
Series D: 5,000 shares authorized; 4,442 shares issued
and outstanding as of December 31, 1998 and 1999,
respectively; liquidation preference of $13,325 ........ -- --
Restricted common stock, $0.0001 par value; 35,000 shares
authorized; 9,272 and 10,048 shares issued and
outstanding as of December 31, 1998 and 1999,
respectively ............................................ -- --
Additional paid-in capital ............................... 25,779 26,443
Notes receivable from stockholders ....................... (143) (275)
Accumulated deficit ...................................... (19,827) (28,003)
-------- --------
Total stockholders' equity (deficit).................... 5,809 (1,835)
-------- --------
Total liabilities and stockholders' equity (deficit).. $ 7,965 $ 1,413
======== ========
The accompanying notes are an integral part of these financial statements.
F-4
FREEGATE CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended
December 31,
-----------------
1998 1999
-------- -------
Revenue ................................................... $ 2,824 $ 2,134
Cost of revenue ........................................... 1,819 1,159
-------- -------
Gross profit .............................................. 1,005 975
-------- -------
Operating expenses:
Sales and marketing ..................................... 5,771 3,636
Research and development ................................ 4,178 3,899
General and administrative .............................. 1,807 1,406
Noncash expense.......................................... 17 221
-------- -------
Total operating expenses .............................. 11,773 9,162
-------- -------
Loss from operations ...................................... (10,768) (8,187)
Interest expense........................................... (100) (62)
Interest income............................................ 207 76
-------- -------
Loss before income taxes .................................. (10,661) (8,173)
Income taxes .............................................. 1 3
-------- -------
Net loss .................................................. $(10,662) $(8,176)
======== =======
Net loss per share, basic and diluted ................... $ (1.73) $ (1.03)
======== =======
Shares used in computing basic and diluted net loss per
share..................................................... 6,149 7,964
======== =======
The accompanying notes are an integral part of these financial statements.
F-5
FREEGATE CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1998 AND 1999
(in thousands)
Convertible Preferred Stock
-------------------------------------------------------
Restricted Notes
Series A Series B Series C Series D common stock Additional Receivable
------------- ------------- ------------- ------------- -------------- Paid-In from Accumulated
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Capital Stockholders Deficit
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ---------- ------------ -----------
Balances,
December 31,
1997............ 2,500 $ -- 5,067 $ -- 4,706 $ -- -- $ -- 8,963 $ -- $12,338 $ -- $ (9,165)
Issuance of
Series D
preferred stock,
net of issuance
costs of $90.... -- -- -- -- -- -- 4,442 -- -- -- 13,235 -- --
Repurchase of
common stock.... -- -- -- -- -- -- -- -- (790) -- (72) -- --
Issuance of
common stock--
options
exercised....... -- -- -- -- -- -- -- -- 964 -- 221 -- --
Issuance of
common stock in
exchange for
legal services.. -- -- -- -- -- -- -- -- 135 -- 40 -- --
Warrants issued
in connection
with capital
lease........... -- -- -- -- -- -- -- -- -- -- 17 -- --
Issuance of
notes receivable
from
stockholders.... -- -- -- -- -- -- -- -- -- -- -- (143) --
Net loss........ -- -- -- -- -- -- -- -- -- -- -- -- (10,662)
----- ---- ----- ---- ----- ---- ----- ---- ------ ---- ------- ----- --------
Balances,
December 31,
1998............ 2,500 -- 5,067 -- 4,706 -- 4,442 -- 9,272 -- 25,779 (143) (19,827)
Repurchase of
common stock.... -- -- -- -- -- -- -- -- (400) -- (49) -- --
Issuance of
common stock--
options
exercised....... -- -- -- -- -- -- -- -- 886 354 -- --
Issuance of
common stock in
exchange for
services........ -- -- -- -- -- -- -- -- 290 -- 69 -- --
Warrants issued
under capital
lease........... -- -- -- -- -- -- -- -- -- -- 17 -- --
Warrants issued
under financing
activity........ -- -- -- -- -- -- -- -- -- -- 273 -- --
Issuance of
notes receivable
from
stockholders.... -- -- -- -- -- -- -- -- -- -- -- (132) --
Net loss........ -- -- -- -- -- -- -- -- -- -- -- -- (8,176)
----- ---- ----- ---- ----- ---- ----- ---- ------ ---- ------- ----- --------
Balances,
December 31,
1999............ 2,500 $ -- 5,067 $ -- 4,706 $ -- 4,442 $ -- 10,048 $ -- $26,443 $(275) $(28,003)
===== ==== ===== ==== ===== ==== ===== ==== ====== ==== ======= ===== ========
Total
Stockholders'
Equity
(Deficit)
-------------
Balances,
December 31,
1997............ $ 3,173
Issuance of
Series D
preferred stock,
net of issuance
costs of $90.... 13,235
Repurchase of
common stock.... (72)
Issuance of
common stock--
options
exercised....... 221
Issuance of
common stock in
exchange for
legal services.. 40
Warrants issued
in connection
with capital
lease........... 17
Issuance of
notes receivable
from
stockholders.... (143)
Net loss........ (10,662)
-------------
Balances,
December 31,
1998............ 5,809
Repurchase of
common stock.... (49)
Issuance of
common stock--
options
exercised....... 354
Issuance of
common stock in
exchange for
services........ 69
Warrants issued
under capital
lease........... 17
Warrants issued
under financing
activity........ 273
Issuance of
notes receivable
from
stockholders.... (132)
Net loss........ (8,176)
-------------
Balances,
December 31,
1999............ $(1,835)
=============
The accompanying notes are an integral part of these financial statements.
F-6
FREEGATE CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended
December 31,
-----------------
1998 1999
-------- -------
Cash flows from operating activities:
Net loss .................................................. $(10,662) $(8,176)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ............................ 352 418
Noncash warrant expense .................................. 17 221
Common stock issued for services ......................... 40 69
Changes in operating assets and liabilities:
Accounts receivable ..................................... (390) 154
Inventory ............................................... (359) 287
Prepaid expenses and other assets ....................... -- (146)
Accounts payable ........................................ 58 159
Accrued liabilities ..................................... 211 44
Deferred revenue ........................................ 314 220
-------- -------
Net cash used in operating activities .................. (10,419) (6,750)
-------- -------
Cash flows from investing activities:
Purchase of property and equipment ........................ (369) (151)
Notes receivable from stockholders ........................ 200 (10)
-------- -------
Net cash used in investing activities .................. (169) (161)
-------- -------
Cash flows from financing activities:
Proceeds from sale of equipment under sale/leaseback
arrangement .............................................. 378 55
Proceeds from sale of preferred stock ..................... 13,235 --
Proceeds from exercise of stock options ................... 78 222
Principal payments of capital leases ...................... (152) (226)
Repurchase of common stock ................................ (72) (49)
Proceeds from bridge loan financing ....................... -- 919
-------- -------
Net cash provided by financing activities 13,467 921
-------- -------
Net increase (decrease) in cash and cash equivalents ....... 2,879 (5,990)
Cash and cash equivalents at beginning of year ............. 3,241 6,120
-------- -------
Cash and cash equivalents at end of year ................... $ 6,120 $ 130
======== =======
Supplemental disclosure of cash flow information:
Cash paid during year for interest ........................ $ 92 $ 79
======== =======
Noncash financing activity:
Warrants issued in connection with bridge loan............ $ -- $ 273
======== =======
Warrants issued in connection with capital lease.......... $ 17 $ 17
======== =======
Common stock issued for services ......................... $ 40 $ 69
======== =======
Stock options issued in exchange for notes receivable .... $ 143 $ 132
======== =======
The accompanying notes are an integral part of these financial statements.
F-7
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of business
FreeGate Corporation (the "Company") was incorporated in the state of
Delaware on December 26, 1995. FreeGate Corporation provides "all-in-one"
Internet and Intranet connectivity solutions for small to medium sized
businesses and branch offices. These solutions combine E-mail, web access and
publishing, electronic file transfer, remote access, virtual private
networking, firewall security, and LAN/router capabilities in an affordable,
reliable turnkey system for a nontechnical audience.
Beyond this integrated Internet and Intranet functionality, the Company
provides a remote provisioning and management system that opens up business
opportunities for value-added Internet applications and services, with
increased security and reliability.
(b) Basis of presentation
The Company has incurred net losses and negative operating cash flows since
inception that raise substantial doubt about its ability to continue as a going
concern. The accompanying financial statements have been prepared assuming the
Company continues in existence as a going concern. Continuation of the Company
as a going concern is dependent upon the successful conclusion of the merger
agreement signed in November 1999 (see Note 7).
(c) Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
reported results of operations during the reporting period. Actual results
could differ from those estimates.
(d) Revenue recognition
On October 1, 1997, the Company adopted Statement of Position (SOP) 97-2,
Software Revenue Recognition. The adoption of SOP 97-2 did not have a material
effect on the Company's operating results. SOP 97-2 generally requires revenue
earned on software arrangements involving multiple elements to be allocated to
each element based on the relative fair values of the elements. The fair value
of an element must be based on evidence that is specific to the vendor. If a
vendor does not have evidence of the fair value of all elements in a multiple-
element arrangement, all revenue from the arrangement is deferred until such
evidence exists or until all elements are delivered.
Product revenue is generally recognized upon delivery or if sales are made to
a distributor, with right of return, upon sell through, provided the Company
deems the receivable to be collectible. Revenue allocated to maintenance is
recognized ratably over the maintenance term.
(e) Concentrations of credit risk
Financial instruments that subject the Company to concentrations of credit
risk consist primarily of cash and cash equivalents, accounts receivable, and a
note receivable. The Company maintains all of its cash with one financial
institution in the United States. Cash equivalents are comprised of money
market funds. The Company's policy limits the amount of credit exposure in any
one-debt issue. Management believes the financial risks associated with these
financial instruments are minimal. The notes receivable are due from
stockholders of the Company and management believes that the risk of credit
loss is low. With respect to accounts receivable, the Company performs credit
evaluations of its customers and maintains reserves for potential credit
losses.
F-8
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Significant customer information is as follows:
Percentage
of
Total Accounts
Revenues Receivable
------------- -------------
1998 1999 1998 1999
----- ----- ----- -----
Customer A................................. 46% 19% -- --
Customer B................................. 10% -- 21% --
Customer C................................. -- 16% -- 41%
(f) Capitalized software
Costs related to the research and development for new software products and
enhancements to existing software products are expensed as incurred until
technological feasibility of the product has been established, at which time
such costs are capitalized subject to expected recoverability. As of December
31, 1999, the Company had not capitalized any development costs related to
software products.
(g) Inventory
Inventory as of December 31, 1999, consisted of finished goods and raw
materials valued at the lower of cost, using the first in first out method, or
market.
(h) Property and equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is calculated using the straight-line method over
the estimated useful lives of the equipment, generally three years. Assets
under capital leases are amortized over the shorter of the lease terms or the
estimated useful lives of the assets.
(i) Income taxes
The Company utilizes the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. A
valuation allowance is recorded to reduce deferred tax assets to an amount that
is more likely than not to be realized. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
(j) Stock-based compensation
The Company accounts for its employee stock option plan in accordance with
the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. As such,
compensation expense is recorded on the date of grant only if the current
market price of the underlying stock exceeds the exercise price. Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, permits entities to recognize as expense over the vesting period
the fair value of all stock-based awards on the date of grant. Alternatively,
SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma net income or loss disclosures for employee
options granted as if the fair value-based method defined in SFAS No. 123 had
been applied. The Company has elected to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
F-9
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(k) Accumulated other comprehensive income
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, Reporting Comprehensive Income. SFAS No. 130 establishes standards of
reporting and display of comprehensive income and its components of net income
and "Other Comprehensive Income" in a full set of general-purpose financial
statements. Other comprehensive income refers to revenues, expenses, gains, and
losses that are not included in net income but rather are recorded directly in
stockholders' equity. SFAS No. 130 was adopted by the Company in 1998 but the
Company has no elements of other comprehensive income.
(l) Impairment of long-lived assets
In accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, management evaluates the
Company's long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. As of December 31, 1999, the Company does not consider any assets
to be impaired.
(m) Net loss per share
Basic net loss per share is computed using the weighted-average number of
vested outstanding shares of common stock. Diluted net loss per share is
computed using the weighted-average number of shares of vested common stock
outstanding and when dilutive, unvested common stock outstanding, potential
common shares from options and warrants to purchase common and preferred stock
using the treasury stock method and from convertible securities using the as-
if-converted basis. All potential common shares have been excluded from the
computation of diluted net loss per share for all periods presented because the
effect would be antidilutive.
Diluted net loss per share does not include the effect of the following (in
thousands):
1998 1999
------- -------
Shares issuable under common stock options.................... 1,563 1,839
Shares of unvested common stock subject to repurchase......... 2,017 2,579
Shares issuable pursuant to warrants to purchase common and
convertible preferred stock.................................. 89 426
Shares of convertible preferred stock on an "as-if-converted"
basis........................................................ 16,715 16,715
The weighted-average exercise price of stock options outstanding was $0.24
and $0.53 as of December 31, 1998 and 1999, respectively. The weighted-average
purchase price of unvested stock was $0.11 and $0.41 as of December 31, 1998
and 1999, respectively. The weighted-average exercise price of warrants was
$1.14 and $2.61 as of December 31, 1998 and 1999, respectively.
(n) Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. FreeGate is required to adopt SFAS No. 133
in fiscal 2001. SFAS No. 133 establishes methods of accounting for derivative
financial instruments and hedging activities related to those instruments as
well as other hedging activities. To date, the Company has not entered into any
derivative financial instruments or hedging activities.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the SEC. SAB 101
F-10
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. Management
believes that the impact of SAB 101 will not have a material effect on the
financial position or results of the operations of the Company.
2. BALANCE SHEET COMPONENTS
(a) Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity
of 90 days or less to be cash equivalents. Cash equivalents as of December 31,
1998 and 1999, consisted of money market funds totaling $5,961,043 and nil,
respectively.
(b) Inventory
Inventory consisted of the following as of December 31, 1998 and 1999 (in
thousands)
December
31,
---------
1998 1999
---- ----
Finished goods................................................... $400 $164
Raw materials.................................................... 97 46
---- ----
$497 $210
==== ====
(c) Property and Equipment
Property and equipment consisted of the following as of December 31, 1998 and
1999 (in thousands):
December 31,
--------------
1998 1999
------ ------
Property and equipment, net:
Computer equipment and purchased software................ $1,007 $1,158
Office equipment......................................... 229 229
------ ------
1,236 1,387
Less: Accumulated depreciation and amortization.......... (575) (993)
------ ------
$ 661 $ 394
====== ======
Computer equipment and purchased software as of December 31, 1998 and 1999,
included equipment under capital leases of approximately $1,037,000 and
$1,191,000 respectively, and related accumulated amortization of approximately
$283,000 and $847,000, respectively.
(d) Accrued liabilities
Accrued liabilities consisted of the following as of December 31, 1998 and
1999 (in thousands):
December
31,
---------
1998 1999
---- ----
Accrued compensation............................................ $146 $119
Accrued warranty................................................ 64 149
Legal and professional fees..................................... 135 199
Other........................................................... 345 267
---- ----
$690 $734
==== ====
F-11
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. STOCKHOLDERS' EQUITY
(a) Convertible preferred stock
The rights, preferences, and privileges of the holders of Series A, B, C, and
D convertible preferred stock are as follows:
. The holders of Series D convertible preferred stock shall be entitled to
receive dividends, at a rate of $0.18 per share, per annum in preference
to holders of Series A, B, and C convertible preferred stock payable when
and if declared by the Company's Board of Directors. The holders of
Series A, B, and C convertible preferred stock are entitled to receive
dividends at the rate of $0.0075, $0.045, and $0.102, per share,
respectively, per annum, payable when and if declared by the Company's
Board of Directors in preference and priority to any payments of
dividends to holders of the Company's common stock. The dividend rights
are not cumulative.
. The holders of Series D convertible preferred stock have a liquidation
preference of $3.00 per share in preference to the holders of Series A,
B, and C convertible preferred stock. Subject to Series D rights, the
holders of Series A, B, and C convertible preferred stock have a
liquidation preference of $0.12, $0.75, and $1.70 per share,
respectively. After payment of the liquidation preference, all remaining
assets of the Company shall be distributed among holders of convertible
preferred stock and common stock pro rata on an "as-if-converted" basis.
Distributions to holders of convertible preferred stock are limited to an
aggregate of $0.24, $1.50, $3.40, and $6.00 per share to holders of
Series A, B, C, and D convertible preferred stock, respectively. After
payment of the maximum liquidation distribution to holders of convertible
preferred stock, any remaining assets of the Company will be distributed
pro rata to holders of common stock.
. Each share of convertible preferred stock is convertible into one share
of common stock. Conversion will occur automatically upon an initial
public offering with a price of not less than $4.50 per share and
proceeds in excess of $30,000,000.
. Holders of Series A, B, C, and D convertible preferred stock vote equally
with shares of common stock on an "as-if-converted" basis.
. Holders of Series A, B, C, and D convertible preferred stock possess
certain registration rights and the right to participate in future
financings.
No dividends have been declared or paid on convertible preferred stock or
common stock since inception of the Company.
(b) Common stock
During 1996, the Company issued 6,000,000 shares of common stock to the
Company's founders in exchange for certain rights and services. The fair value
assigned to the rights and services was equivalent to the fair value of the
common stock on the issuance date as determined by the Board of Directors. Upon
issuance, the Company had the right to repurchase 50% of these shares at $0.005
per share. Subject to continued employment of the founders, the repurchase
right expired in December 1996 for 25% of the shares and, for the remaining
shares, expired ratably over 36 months through December 1999. Under certain
circumstances, the shares may immediately vest upon a change in control of the
Company.
Stock issued to the founders, as well as stock issued upon exercise of stock
options under the 1996 Stock Option Plan, is subject to vesting. The Company
reserves the right of first refusal to purchase all vested shares of common
stock. All unvested shares of common stock may be repurchased by the Company at
the original issuance price upon an employee's termination of employment. The
repurchase right expires when the Company's stock becomes publicly traded or
upon a change in control of the Company. As of December 31, 1998 and 1999,
2,017,832 and 2,579,419 shares of outstanding common stock, respectively, are
unvested and, therefore, subject to repurchase by the Company.
F-12
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
By decision of the Board of Directors in November 1999, however, these
options will vest immediately on the closing date of the merger of the Company.
(c) 1996 Stock Option Plan
The Company's 1996 Stock Option Plan (the "Plan") authorizes the granting of
incentive and nonstatutory common stock options to employees and nonemployees
at exercise prices no less than 85% of the fair market value of the common
stock on the grant date, as determined by the Board of Directors. The options
may be exercised immediately upon issuance and generally have a term of 10
years. The common stock issued upon the exercise of stock options vests 25%
after one year of service and thereafter ratably over 36 months of service.
Upon termination of service, an employee's unvested shares may be repurchased
by the Company at the option exercise price. Approximately 5,000,000 shares of
common stock have been reserved for issuance under the Plan.
(d) Accounting for stock-based compensation
Under APB Opinion No. 25, the Company has recorded no compensation costs
related to its stock option plan for the year ended December 31, 1999, because
the exercise price of each employee option equals or exceeds the market value
of the underlying common stock as of the grant date for each employee stock
option. Had compensation cost for the Company's plans been determined
consistent with the fair value approach enumerated in SFAS No. 123, the
Company's pro forma net loss would have been as follows (in thousands, except
per share amounts):
1998 1999
------- ------
Net loss attributable to common stockholders--as
reported............................................... $10,662 $8,176
Net loss attributable to common stockholders--pro
forma.................................................. 10,677 8,408
Net loss per share attributable to common stockholders--
as reported............................................ (1.73) (1.03)
Net loss per share attributable to common stockholders--
pro forma.............................................. (1.74) (1.06)
The fair value of employee options granted was estimated on the date of grant
using the minimum-value method. The fair value of nonemployee options granted
was estimated on the date of grant using the Black-Scholes option-pricing
model. There were no nonemployee options granted in 1998. The following
weighted-average assumptions were used in these calculations: risk-free
interest rate of approximately 5.3% and 6.1% for the years ended 1998 and 1999,
respectively; expected life of five years and ten years for the years ended
December 31, 1998 and 1999, respectively; no dividends and expected volatility
of 0% and 65% for employee and nonemployee options, respectively.
The weighted average fair values of options granted in 1998 and 1999 was
$0.07 and $0.24, respectively.
F-13
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
A summary of activity under the Company's option plan for the period from
January 1, 1998 to December 31, 1999, is presented below (in thousands, except
per share amounts):
Options
Outstanding
----------------
Weighted
Options Average
Available Exercise
for Grant Shares Price
--------- ------ --------
Balances as of January 1, 1998 ...................... 805 1,232 $0.15
Granted ........................................... (1,286) 1,286 0.30
Exercised ......................................... -- (444) 0.18
Canceled .......................................... 511 (511) 0.23
Unvested stock repurchased ........................ 790 -- 0.09
------ ------
Balances as of December 31, 1998..................... 820 1,563 0.24
Granted ........................................... (2,554) 2,554 0.46
Exercised ......................................... -- (941) 0.19
Canceled .......................................... 1,337 (1,337) 0.29
Unvested stock repurchased ........................ 400 -- 0.13
------ ------
Balances as of December 31, 1999..................... 3 1,839 $0.53
====== ======
In addition to the 1996 stock option plan, the Company granted options of
475,000 and 235,000 for the years ended December 31, 1998 and 1999,
respectively.
A breakdown of the Company's outstanding options as of December 31, 1999 is
presented below (in thousands, except per share data):
Outstanding Exercisable
-------------------------------------- ---------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise of Contractual Exercise of Exercise
Price Shares Life (Years) Price Shares Price
------------- ------ ------------ -------- ------ --------
$0.075 69 6.68 $0.075 69 $0.075
$0.170 71 7.55 $0.170 71 $0.170
$0.300 586 9.31 $0.300 586 $0.300
$0.700 1,113 9.92 $0.700 1,113 $0.700
----- -----
$0.075-$0.700 1,839 9.51 $0.529 1,839 $0.529
===== =====
F-14
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
(e) Warrants
Warrants outstanding are as follows (in thousands, except per share amounts):
Warrants Outstanding
------------------------------
Weighted Average
Shares Exercise Price Amount
------ ---------------- ------
Balance at December 31, 1997................. 75 $1.03 $ 77
Warrants granted............................. 14 1.70 25
--- ------
Balance at December 31, 1998................. 89 1.14 102
Warrants granted............................. 337 3.00 1,012
--- ------
Balance at December 31, 1999................. 426 $2.61 $1,114
=== ======
The Company issued warrants in 1996 and 1997 for the purchase of 52,668
shares of Series B convertible preferred stock and 22,058 shares of Series C
convertible preferred stock, respectively. The Series B convertible preferred
stock warrants will expire on the later of June 17, 2003, or three years from
the effective date of an initial public offering. The Series C preferred stock
warrants will expire on the later of September 1, 2004, or three years from the
effective date of an initial public offering. In addition, the warrants expire
immediately upon either of the following:
. An initial public offering whereby the per share sale price to the public
is $3.40 or higher, or if requested by the underwriter.
. A merger or sale of substantially all of the Company's assets.
In connection with a credit facility, the Company issued warrants in 1998 for
the purchase of 14,706 shares of Series C convertible stock at an exercise
price of $1.70 per share. The fair value of the preferred stock warrants at the
date of grant was $1.17 and will expire on the later of February 1, 2005 or
three years from the effective date of an initial offering. In addition, the
warrants expire immediately upon either of the following:
. An initial public offering whereby the per share sale price to the public
is $4.50 or higher,or if requested by the underwriter.
. A merger or sale of substantially all of the Company's assets.
In connection with a capital lease, the Company issued warrants in 1999 for
the purchase of 8,333 shares of Series D convertible preferred stock at an
exercise price of $3.00 per share. The fair value of the Series D convertible
preferred stock warrants at the date of grant was $2.07. The Company determined
the fair value of Series D warrants using the Black-Scholes model with the
following assumptions: risk free interest rate of 6.1%; expected life of seven
years; volatility of 65%; and no dividend yield. The Series D preferred stock
warrants will expire on the later of January 1, 2006 or three years from the
effective date of an initial public offering. In addition, the warrants expire
immediately upon either of the following:
. An initial public offering whereby the per share sale price to the public
is $3.40 or higher, or if requested by the underwriter.
. A merger or sale of substantially all of the Company's assets.
In connection with short-term note payable agreements entered into during
1999, the Company issued 329,079 Series D preferred stock warrants at a price of
$3.00 per share. The fair value of preferred stock warrants at the date of the
grant was $0.67. The Company determined the fair value of the Series D warrants
using the Black-Scholes model with the following assumptions: risk free interest
rate of 6.1%; expected life of seven years; volatility of 65% and no
F-15
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
dividend yield. The warrants are immediately exercisable and expire on the
earliest of (i) September 23, 2000; (ii) the effective date of the Company,
completing an initial public offering; (iii) on a sale or transfer by the
Company of all or substantially all of its assets; or (iv) the acquisition of
the Company by another entity.
4. INCOME TAXES
Income tax expense for the years ended December 31, 1998 and 1999, consisted
of state income tax. The difference between the statutory income tax rate of
34% and the Company's effective tax rate is primarily due to the valuation
allowance provided for deferred tax assets. The Company has provided a
valuation allowance due to the uncertainty of generating future taxable income
that would allow for the realization of such deferred tax assets.
The types of temporary differences that give rise to significant portions of
the deferred tax assets and liabilities as of December 31, 1998 and 1999 are as
follows (in thousands):
December 31,
-----------------
1998 1999
------- --------
Deferred tax assets:
Accruals and reserves................................. $ 356 $ 422
Deferred start-up costs............................... 667 643
Deferred revenue...................................... 141 54
Research credit carryforwards......................... 722 957
Net operating loss carryforwards...................... 7,406 9,549
Fixed assets.......................................... 9 9
------- --------
Total gross deferred tax assets..................... 9,301 11,634
Less: Valuation allowance............................. (9,301) (11,634)
------- --------
Total deferred tax assets $ -- $ --
======= ========
The change in valuation allowance for the years ended December 31, 1998 and
1999, was $5,038,000 and $2,333,000 respectively.
The Company has net operating loss carryforwards for federal and state tax
purposes of approximately $24,000,000 and $20,500,000, respectively. The
federal carryforwards expire from 2010 to 2018. The state net operating loss
carryforwards expire in 2003. The Company also has tax credit carryforwards of
approximately $591,000 and $366,000 for federal and state tax purposes,
respectively, which expire from 2001 to 2003.
The Internal Revenue Code of 1986, and applicable state tax laws, impose
substantial restrictions on the ability of the Company to utilize net operating
loss and tax credit carryforwards in the event of an ownership change, as
defined. During 1997, the Company underwent an ownership change, and, as a
result, the federal and state tax losses and tax credit carryovers incurred
through that date are subject to an annual limitation.
5. COMMITMENTS AND CONTINGENCIES
Lease Obligations
The Company leases certain equipment and its facilities under various
noncancelable operating leases. In addition, the Company has entered into
capital lease arrangements for certain office and computer equipment.
F-16
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
Future minimum lease payments under operating and capital leases as of
December 31, 1999, are as follows (in thousands):
Years Ending December 31, Capital Leases Operating Leases
------------------------- -------------- ----------------
2000....................................... $359 $469
2001....................................... 230 482
2002....................................... 71 352
----- ------
Total minimum lease payments............... 660 $1,303
======
Less: Amount representing interest......... (58)
-----
Present value of minimum lease payments.... 602
Less: Current portion...................... (323)
-----
Long-term lease obligations.............. $ 279
=====
Rent expense was $452,184 and $467,439 for the years ended December 31, 1998
and 1999, respectively.
Notes payable
The Company entered into short-term note payable agreements with various
lenders on September 23, 1999 for $987,000. The notes bear interest of 10% and
are payable in full on March 23, 2000. The principal amount outstanding on
these notes at December 31, 1999 is $895,000.
6. SEGMENT INFORMATION
The Company has adopted the provisions of SFAS No. 131, Disclosure about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for reporting information about operating segments. The method for
determining what information to report is based on the way that management
organizes the operating segments within the Company for making operating
decisions and assessing financial performance. The Company's chief operating
decision-maker is considered to be the Company's Chief Executive Officer (CEO).
The consolidated financial information reviewed by the CEO is identical to the
information presented in the accompanying statements of operations. Therefore,
the Company operates in a single operating segment.
The CEO does not receive discrete financial information about individual
components of the Company's operations. The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information
about revenue by geographic region for purposes of making operating decisions
and assessing financial performance.
Information regarding product revenue and geographic areas for the years
ended December 31, 1998 and 1999 are as follows (in thousands):
1998 1999
------ ------
Product and service:
Product.................................................... $2,747 1,880
Maintenance................................................ 77 254
------ ------
$2,824 $2,134
====== ======
Geographic:
United States.............................................. $1,219 $1,605
Japan...................................................... 1,303 425
Canada..................................................... 266 40
Other...................................................... 36 64
------ ------
$2,824 $2,134
====== ======
F-17
FREEGATE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. SUBSEQUENT EVENTS
On November 16, 1999, the Company entered into a definitive merger agreement
with Tut Systems, Inc. in which the stockholders of the Company received
common stock of the acquiring company in exchange for all of the outstanding
shares of preferred stock, common stock, shares issuable under common stock
options, and shares issuable under warrants for common stock and preferred
stock. In accordance with the definitive agreement, the Company's stockholders
are to receive 510,931 shares of the acquirer's common stock and approximately
19,600 options to acquire Tut Systems, Inc. common stock. The acquirer has
also agreed to pay for all investment banking fees and related closing costs
of approximately $1,200,000. The acquisition closed on February 14, 2000.
F-18
Item 7(b) Pro Forma Financial Information:
TUT SYSTEMS, INC.
UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
The following unaudited pro forma combined financial statements for Tut
Systems, Inc. (the "Company") consist of the Unaudited Pro Forma Combined
Statement of Operations for the year ended December 31, 1999 and the Unaudited
Pro Forma Combined Balance Sheet as of December 31, 1999. This pro forma
financial information gives effect to Tut's acquisition of FreeGate
Corporation ("FreeGate") in a business combination to be accounted for as a
purchase, which was consummated on February 14, 2000. In exchange for the
acquisition of all of FreeGate's outstanding capital stock, Tut issued
FreeGate stockholders 510,931 shares of its common stock and reserved
approximately 19,600 additional shares for issuance upon the exercise of stock
options of FreeGate which will be converted into options to purchase shares of
Tut stock.
The unaudited pro forma combined balance sheet gives effect to this
acquisition as if it had occurred on December 31, 1999, by consolidating the
balance sheet of FreeGate with the balance sheet of Tut, at December 31, 1999.
The unaudited pro forma combined statement of operations gives effect to this
acquisition as if it had occurred on January 1, 1999, by consolidating the
results of operations of FreeGate for the year ended December 31, 1999 with the
results of operations of Tut for the year ended December 31, 1999.
The unaudited pro forma combined statement of operations is not necessarily
indicative of the operating results that would have been achieved had the
transactions been in effect as of the beginning of the periods presented and
should not be construed as being representative of future operating results.
The historical financial statements of the Company and FreeGate are included
elsewhere in this Prospectus and the unaudited pro forma combined financial
information presented herein should be read in conjunction with those financial
statements and related notes.
F-19
TUT SYSTEMS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
(in thousands)
December 31, 1999
--------------------------------------------
Tut FreeGate Adjustments Pro Forma
-------- -------- ----------- ---------
ASSETS
Current assets:
Cash and cash equivalents........ $ 13,405 $ 130 $ -- $ 13,535
Short-term investments .......... 18,831 -- -- 18,831
Accounts receivable, net ........ 11,742 403 -- 12,145
Inventories ..................... 8,401 210 -- 8,611
Prepaid expenses and other ...... 3,746 224 -- 3,970
-------- -------- -------- --------
Total current assets .......... 56,125 967 -- 57,092
Property and equipment, net ....... 3,476 394 -- 3,870
Intangible assets, net ............ 1,774 -- 25,409 (A) 27,183
Other assets ...................... 3,981 52 -- 4,033
-------- -------- -------- --------
Total assets .................. $ 65,356 $ 1,413 $ 25,409 $ 92,178
======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable ................ $ 5,859 $ 465 $ -- $ 6,324
Accrued expenses and other
payables ....................... 3,551 734 1,200 (A) 5,485
Lines of credit ................. 1,529 -- -- 1,529
Notes payable.................... -- 895 -- 895
Capital lease obligations ....... -- 323 -- 323
Deferred revenue ................ 770 418 -- 1,188
-------- -------- -------- --------
Total current liabilities ..... 11,709 2,835 1,200 15,744
Capital lease obligations, net of
current portion .................. -- 279 -- 279
Deferred revenue, net of current
portion .......................... 2,125 134 -- 2,259
-------- -------- -------- --------
Total liabilities ............. 13,834 3,248 1,200 18,282
-------- -------- -------- --------
Stockholders' equity (deficit):
Common stock .................... 12 -- 1 (A) 13
Additional paid in capital ...... 108,969 26,443 (26,443)(A) 132,417
23,448 (A)
Notes receivable from
stockholders ................... -- (275) -- (275)
Deferred stock compensation ..... (972) -- -- (972)
Accumulated deficit ............. (56,487) (28,003) 28,003 (A) (57,287)
(800)(A)
-------- -------- -------- --------
Total stockholders' equity
(deficit) .................... 51,522 (1,835) 24,209 73,896
-------- -------- -------- --------
Total liabilities and
stockholders' equity
(deficit)................... $ 65,356 $ 1,413 $ 25,409 $ 92,178
======== ======== ======== ========
The accompanying notes are an integral part of these unaudited combined
financial statements.
F-20
TUT SYSTEMS
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
(in thousands, except per share amounts)
Year Ended December 31, 1999
-------------------------------------------
Tut FreeGate Adjustments Pro Forma
-------- -------- ----------- ---------
Revenue:
Product .......................... $ 26,266 $ 2,134 $ -- $ 28,400
License and royalty .............. 1,541 -- -- 1,541
-------- ------- -------- ---------
27,807 2,134 -- 29,941
Cost of goods sold ................. 15,459 1,159 680(B) 17,298
-------- ------- -------- ---------
Gross margin ....................... 12,348 975 (680) 12,643
-------- ------- -------- ---------
Operating expenses:
Sales and marketing .............. 10,523 3,636 -- 14,159
Research and development ......... 7,618 3,899 -- 11,517
General and administrative ....... 4,429 1,406 -- 5,835
In-process research and
development ..................... 2,600 -- -- 2,600
Amortization of intangibles ...... 52 -- 4,602(B) 4,654
Noncash compensation expense ..... 455 221 -- 676
-------- ------- -------- ---------
Total operating expenses ....... 25,677 9,162 4,602 39,441
-------- ------- -------- ---------
Loss from operations ............... (13,329) (8,187) (5,282) (26,798)
Interest expense ................... (608) (62) -- (670)
Interest income .................... 2,203 76 -- 2,279
Other income, net .................. 1 -- -- 1
-------- ------- -------- ---------
Loss before income taxes ........... (11,733) (8,173) (5,282) (25,188)
Income tax expense ................. 1 3 -- 4
-------- ------- -------- ---------
Net loss ........................... (11,734) (8,176) (5,282) (25,192)
Dividend accretion on preferred
stock ............................. (235) -- -- (235)
-------- ------- -------- ---------
Net loss attributable to common
stockholders ...................... $(11,969) $(8,176) $ (5,282) $ (25,427)
======== ======= ======== =========
Net loss per share attributable to
common stockholders, basic and
diluted ........................... $ (1.12) $ (1.03) $ (2.26)
======== ======= =========
Shares used in computing net loss
per share attributable to common
stockholders, basic and diluted.... 10,729 7,964 511 11,240
======== ======= ======== =========
The accompanying notes are an integral part of these unaudited combined
financial statements.
F-21
TUT SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
(in thousands)
NOTE 1--BASIS OF PRESENTATION:
The pro forma financial information gives effect to Tut's acquisition of
FreeGate, consummated on February 14, 2000 in a business combination to be
accounted for as a purchase. All the outstanding common and preferred stock of
FreeGate was converted into shares of Tut common stock, and all outstanding
stock options to purchase shares of FreeGate common shares and options to be
issued to FreeGate stockholders and options holders.
The pro forma financial information has been prepared on the basis of
assumptions described in the following notes and include assumptions relating
to the allocation of the consideration paid for the assets and liabilities of
FreeGate based on preliminary estimates of their fair value. The actual
allocation of such consideration may differ from that reflected in the pro
forma financial statements after valuations after the closing of the FreeGate
acquisition have been completed. Tut does not expect that the final allocation
of the purchase price will differ materially from the preliminary allocation.
The Unaudited Pro Forma Combined Statement of Operations for the year ended
December 31, 1999 gives effect to this transaction as if it had taken place on
January 1, 1999. The Unaudited Pro Forma Combined Balance Sheet as of December
31, 1999 gives effect to the transaction as if it had taken place on December
31, 1999.
The pro forma financial information is not necessarily indicative of what the
actual financial results would have been had the transaction taken place on
January 1, 1999 and do not purport to indicative the results of future
operations.
NOTE 2--PURCHASE PRICE ALLOCATION:
The unaudited pro forma combined information reflects a total purchase price
of $24.7 million from 510,931 shares of common stock, approximately 19,600
options to acquire common stock and acquisition related expenses, consisting
primarily of investment advisory, legal and other professional fees. The
Company valued the options using the Black-Scholes option pricing model,
applying an average expected life of 4 years, a weighted average risk free
rate of 6%, an expected dividend yield of zero percent, a volatility of 80%
and a deemed fair value of common stock of $41.81.
The Company's allocation of aggregate purchase price to the tangible and
identifiable assets acquired in connection with this acquisition has been based
on a preliminary analysis by the Company and the goodwill, patents and current
technology are being amortized over an estimated useful life of five years and
assembled workforce is being amortized over an estimated useful life of three
years. The allocation is summarized below (in thousands):
Net liabilities assumed.......................................... $(1,560)
Current technology............................................... 2,900
In-process research and development.............................. 800
Assembled workforce.............................................. 1,500
Patents.......................................................... 500
Goodwill......................................................... 20,509
-------
Total purchase price........................................... $24,649
=======
FreeGate's liabilities assumed are derived as follows:
Total stockholders' deficit...................................... $(1,835)
Receivable from stockholders..................................... 275
-------
Total.......................................................... $(1,560)
=======
F-22
TUT SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION--(Continued)
(in thousands)
The amount allocated to in-process research and development represents the
purchased in-process technology for projects that, as of the date of the
acquisition, had not yet reached technological feasibility and had no
alternative future use. Based on preliminary assessments, the value of these
projects was determined by using the income approach, which discounts expected
future cash flows to present value. The discount rate used in the present value
calculations were typically derived from a weighted average cost of capital
analysis adjusted upwards to reflect additional risks inherent in the
development life cycle. These risk factors are reflected in the discount rate
used of 30%. Tut expects that the pricing model for products and intellectual
property licenses related to the acquisition of FreeGate will be considered
standard within the high-technology communications industry. Tut does not
expect, however, to achieve expense reductions as a result of integrating the
acquired in-process technology. Therefore, the valuation assumptions do not
include any anticipated cost savings. Tut expects that products incorporating
the acquired technology from this acquisition will be completed and begin to
generate cash flows over a six to nine month period after integration.
Development of these technologies, however, remains a significant risk due to
the remaining effort to achieve technical viability, rapidly changing customer
markets, uncertain standards for new products and significant competitive
threats from numerous companies. Efforts to develop the acquired technology into
commercially viable products consists principally of planning, designing and
testing activities necessary to determine that the product can meet market
expectations, including functionality and technical requirements. Failure to
bring these products to market in a timely manner could result in a loss of
market share, or a lost opportunity to capitalize on emerging markets, and could
harm our business and operating results.
The amounts allocated to in-process research and development will be charged
to the statement of operations in the period the acquisition is consummated.
NOTE 3--UNAUDITED PRO FORMA COMBINED NET LOSS PER SHARE:
The net loss per share and shares used in computing the net loss per share
for the year ended December 31, 1999 are based upon the Tut historical weighted
average common shares outstanding together with the shares issued in the
transaction as if such shares were issued January 1, 1999. Common stock
issuable upon the exercise of Tut stock options and warrants has been excluded
as the effect would be anti-dilutive. In addition to the shares used in
computing the net loss per share above, pro forma net loss per share is
calculated using the convertible preferred stock outstanding as if such shares
were converted to common stock at the time of issuance or January 1, 1999 for
the stock issued in the transaction.
NOTE 4--PURCHASE ADJUSTMENTS:
The following adjustments were applied to the combined financial statements:
(A) To reflect the issuance of shares in the acquisition and to record
estimated transaction costs and other assets and liabilities at their
fair values.
(B) To record amortization of goodwill and other intangibles.
The amount allocated to in-process research and development has not been
included in the unaudited pro forma combined statement of operations as it is
nonrecurring. This amount will be expensed in the period the acquisition is
consummated.
F-23
SIGNATURE
Pursuant to requirements of the Securities Exchange Act of 1934, Tut
Systems, Inc. has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TUT SYSTEMS, INC.
Dated: February 18, 2000 By: /s/ Nelson B. Caldwell
----------------------
Nelson B. Caldwell, Vice President and
Chief Financial Officer