UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
Commission File Number: 333-60419
TUT SYSTEMS, INC.
-----------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-2958543
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2495 Estand Way, Pleasant Hill, California 94523
------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (925) 682-6510
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ]No [ ]
As of August 4, 1999, 11,674,312 shares of the Registrant's Common Stock,
$0.001 par value per share, were issued and outstanding.
TUT SYSTEMS, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of June 30, 1999 and
December 31, 1998.............................................................. 1
Condensed Consolidated Statements of Operations for the three months and
six months ended June 30, 1999 and June 30, 1998............................... 2
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and June 30, 1998.......................................... 3
Notes to Unaudited Condensed Consolidated Financial Statements................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................... 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................. 21
Item 2. Changes in Securities.......................................................... 21
Item 3. Defaults Upon Senior Securities................................................ 21
Item 4. Submission of Matters to a Vote of Security Holders............................ 21
Item 5. Other Information.............................................................. 21
Item 6. Exhibits and Reports on Form 8-K............................................... 22
Part I. FINANCIAL INFORMATION
Item I. Consolidated Financial Statements
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
June 30, December 31,
1999 1998
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 23,131 $ 4,452
Short-term investments 21,862 -
Accounts receivable, net of allowance for doubtful accounts
of $230 and $115 in 1999 and 1998, respectively 4,418 3,194
Inventories 3,466 3,787
Prepaid expenses and other 1,846 499
---------- ---------
Total current assets 54,723 11,932
Property and equipment, net 1,907 1,790
Deferred offering costs - 955
Other assets 2,420 580
---------- ---------
Total assets $ 59,050 $ 15,257
========== =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND WARRANT, AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,055 $ 2,421
Accrued liabilities 1,520 1,758
Line of credit 1,414 -
Deferred revenue 700 580
---------- ---------
Total current liabilities 4,689 4,759
Lines of credit, net of current portion - 4,262
Deferred revenue, net of current portion 2,226 2,080
---------- ---------
Total liabilities 6,915 11,101
---------- ---------
Redeemable convertible preferred stock, $0.001 par value,
7,531 shares authorized, none and 6,355 shares issued and
outstanding in 1999 and 1998, respectively - 43,895
Redeemable convertible preferred stock warrant - 2,100
---------- ---------
- 45,995
---------- ---------
Stockholders' equity (deficit)
Convertible preferred stock, $0.001 par value,
5,000 shares authorized, none and 1,098 shares issued and
outstanding in 1999 and 1998, respectively - 1,567
Common stock, $0.001 par value, 100,000 shares authorized,
11,630 and 347 shares issued and outstanding in
1999 and 1998, respectively 12 -
Additional paid in capital 104,082 2,455
Deferred compensation (1,199) (1,427)
Accumulated deficit (50,760) (44,434)
---------- ---------
Total stockholders' equity (deficit) 52,135 (41,839)
---------- ---------
Total liabilities and stockholders' equity (deficit) $ 59,050 $ 15,257
========== =========
The accompanying notes are an integral part of these financial statements.
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended Six months ended
June 30, June 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues:
Product $ 4,735 $ 2,399 $ 8,308 $ 4,095
License and royalty 275 254 593 418
--------- --------- --------- --------
Total revenues 5,010 2,653 8,901 4,513
--------- --------- --------- --------
Cost of goods sold:
Product 2,921 1,370 5,160 2,382
License and royalty - 21 3 21
--------- --------- --------- --------
Total cost of goods sold 2,921 1,391 5,163 2,403
--------- --------- --------- --------
Gross margin 2,089 1,262 3,738 2,110
--------- --------- --------- --------
Operating Expenses:
Sales and marketing 2,456 2,097 4,857 3,928
Research and development 1,687 1,321 3,358 2,764
General and administrative 1,015 782 2,002 1,424
Noncash compensation expense 114 939 228 1,005
--------- --------- --------- --------
Total operating expenses 5,272 5,139 10,445 9,121
--------- --------- --------- --------
Loss from operations (3,183) (3,877) (6,707) (7,011)
Interest expense (139) (13) (315) (23)
Other income 627 110 1,016 234
--------- --------- --------- --------
Loss before income taxes (2,695) (3,780) (6,006) (6,800)
Income tax expense - 1 1 1
--------- --------- --------- --------
Net loss (2,695) (3,781) (6,007) (6,801)
Dividend accretion on preferred stock - 658 235 1,262
--------- --------- --------- --------
Net loss attributable to common stockholders $ (2,695) $ (4,439) $ (6,242) $ (8,063)
========= ========= ========= ========
Net loss per share attributable to common stockholders,
basic and diluted (Note 3) $ (0.23) $ (20.06) $ (0.64) $ (36.65)
========= ========= ========= ========
Shares used in computing net loss attributable to common
stockholders, basic and diluted (Note 3) 11,498 221 9,695 220
========= ========= ========= ========
The accompanying notes are an integral part of these financial statements
-2-
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six months ended
June 30,
---------------------------
1999 1998
----------- -----------
Cash flows from operating activities:
Net loss $ (6,007) $ (6,801)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 366 255
Provision for allowance for doubtful accounts 115 27
Provision for excess and obsolete inventory 353 -
Amortization of discounts on investments (99) (144)
Noncash compensation expense 228 1,005
Change in assets and liabilities:
Accounts receivable (1,339) (1,543)
Inventories (32) (346)
Prepaid expenses and other assets (2,232) 58
Accounts payable (1,366) (419)
Deferred revenue 266 942
Accrued liabilities (238) 150
---------- ----------
Net cash used in operating activities (9,985) (6,816)
---------- ----------
Cash flows from investing activities:
Purchase of property and equipment (483) (586)
Purchase of short-term investments (21,763) (1,950)
Proceeds from maturities of short-term investments - 4,000
Net cash acquired in business combination 76 -
---------- ----------
Net cash (used in) provided by investing activities (22,170) 1,464
---------- ----------
Cash flows from financing activities:
Payment on lines of credit (2,882) (200)
Proceeds from lines of credit 34 257
Proceeds from issuances of common and preferred stock, net 53,682 3,705
---------- ----------
Net cash provided by financing activities 50,834 3,762
---------- ----------
Net increase (decrease) in cash and cash equivalents 18,679 (1,590)
Cash and cash equivalents, beginning of period 4,452 5,395
---------- ----------
Cash and cash equivalents, end of period $ 23,131 $ 3,805
========== ==========
The accompanying notes are an integral part of these financial statements.
-3-
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(unaudited)
1. The Company:
Tut Systems, Inc. (the "Company") was founded in 1983 and began operations
in August 1991. The Company designs, develops and markets advanced
communications products which enables data to be transmitted at high speeds over
the copper wires used by telephone companies, as well as the copper telephone
wires found in homes, businesses and other buildings. The Company's products
incorporate our proprietary FastCopper technology which allows these products to
exploit the underutilized bandwidth, or capacity, of copper telephone wires.
2. Basis of Presentation:
The accompanying condensed consolidated financial statements as of June 30,
1999 and 1998 and for the six months ended June 30, 1999 and 1998 are unaudited.
The unaudited interim consolidated condensed financial statements have been
prepared on the same basis as the annual financial statements and, in the
opinion of management, reflect all adjustments, which include only normal
recurring adjustments, necessary to present fairly the Company's financial
position, results of operations and cash flows as of and for the six months
ended June 30, 1999 and 1998. These condensed consolidated financial statements
and notes thereto are unaudited and should be read in conjunction with the
Company's audited financial statements included in the Company's Prospectus,
filed with the Securities and Exchange Commission on January 28, 1999. The
balance sheet as of December 31, 1998 was derived from audited financial
statements, but does not include all required disclosures required by generally
accepted accounting principles. The results for the six months ended June 30,
1999 are not necessarily indicative of the expected results for any other
interim period or the year ending December 31, 1999.
-4-
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
3. Summary of Significant Accounting Policies:
Net Loss Per Share and Unaudited Pro Forma Net Loss Before Dividend
Accretion:
The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share." Under the provision of SFAS No. 128, basic and diluted
net loss per share is computed by dividing the net loss available to common
stockholders for the period by the weighted average number of common shares
outstanding during the period. Options, warrants and preferred stock were not
included in the computation of diluted net loss per share because the effect
would be antidilutive.
Three months ended Six months ended
June 30, June 30,
-------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net loss per share attributable to common stockholders,
basic and diluted:
Net loss attributable to common stockholders $ (2,695) $ (4,439) $ (6,242) $ (8,063)
======== ======== ======== ========
Net loss per share attributable to common stockholders,
basic and diluted $ (0.23) $ (20.06) $ (0.64) $ (36.65)
======== ======== ======== ========
Shares used in computing net loss attributable to common
stockholders, basic and diluted 11,498 221 9,695 220
======== ======== ======== ========
Antidilutive securities including options, warrants and
preferred stock not included in net loss per share
attributable to common stockholders calculations 1,094 9,171 1,094 9,171
======== ======== ======== ========
Pro forma net loss per share before dividend accretion has been computed as
described above except that it assumes the conversion of preferred stock
outstanding into common stock during the relevant periods.
Three months ended Six months ended
June 30, June 30,
-------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Pro forma net loss per share before dividend accretion:
Net loss attributable to common stockholders $ (2,695) $ (4,439) $ (6,242) $ (8,063)
Dividend accretion on redeemable convertible preferred
stock -- 658 235 1,262
-------- -------- -------- --------
Pro forma net loss before dividend accretion on redeemable
convertible preferred stock $ (2,695) $ (3,781) $ (6,007) $ (6,801)
======== ======== ======== ========
Shares used in computing net loss attributable to common
stockholders, basic and diluted 11,498 221 9,695 220
Adjustment to reflect the assumed conversion of preferred
stock -- 7,452 1,194 7,453
-------- -------- -------- --------
Shares used in computing pro forma net loss before
dividend accretion on preferred stock, basic and diluted 11,498 7,673 10,889 7,673
======== ======== ======== ========
Pro forma net loss per share, before dividend accretion,
basic and diluted $ (0.23) $ (0.49) $ (0.55) $ (0.89)
======== ======== ======== ========
-5-
TUT SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(unaudited)
3. Summary of Significant Accounting Policies, continued:
Impact of Recently Issued Accounting Standards:
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130). FAS 130 requires that all items that are to be required to be recognized
under accounting standards as components of comprehensive financial statements.
FAS 130 is effective for fiscal years beginning after December 15, 1997. To
date, the Company has not had any transactions that are required to be reported
in comprehensive income.
During June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information" (FAS 131). FAS 131 replaces FAS 14,
"Financial Reporting for Segments of a Business Enterprise" and changes the way
the public companies report segment information. FAS 131 is effective for
fiscal years beginning after December 15, 1997. The Company has determined that
it does not have any separately reportable business segments.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" (SOP 98-1). This standard requires
companies to capitalize qualifying computer software costs which are incurred
during the application development stage and amortize them over the software's
estimated useful life. SOP 98-1 is effective for fiscal years beginning after
December 15, 1998. The Company believes the adoption of SOP 98-1 will not have
a material impact on its financial statements and related disclosures.
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-5 "Reporting on the Costs of Start-Up
Activities" (SOP 98-5). This standard requires companies to expense the costs
of start-up activities and organization costs as incurred. In general, SOP 98-5
is effective for fiscal years beginning after December 15, 1998. The Company
believes the adoption of SOP 98-5 will not have a material impact on its results
of operations.
4. Initial Public Offering and Conversion of Redeemable Convertible Preferred
Stock and Warrant:
In January 1999, the Company completed its initial public offering and
issued 2,875 shares of its common stock at a price of $18.00 per share. The
Company received approximately $47.0 million in cash, net of underwriting
discounts, commissions and other offering costs. Additionally, prior to the
initial public offering, a warrant to purchase 667 shares of Series G
convertible preferred stock at an exercise price of $10.00 per share was
exercised for approximately $6.7 million. Simultaneously with the closing of the
initial public offering, all of the Company's convertible preferred stock and
redeemable convertible preferred stock was automatically converted into an
aggregate of 8,120 shares of common stock.
5. Royalty Obligation
The Company has acquired the rights, title and interests in two patents
from a founder and stockholder of the Company. Under a previous agreement, the
Company was required to pay on-going royalties based on the net sales price of
products sold utilizing the patented technology. In February 1999, the Company
paid the founder $2.5 million as a lump sum payment for all its future royalty
obligations. This payment, net of the current portion, is included in other
assets at June 30, 1999. The Company amortizes the amount ratably over five
years. This period represents the estimated life of the patented technology.
-6-
6. Inventories:
Inventories consist of the following: June 30, December 31,
1999 1998
------- -------
Finished goods $ 2,287 $ 1,856
Work in process 480 1,616
Raw material 699 315
------- -------
$ 3,466 $ 3,787
======= =======
7. Significant Customer and Geographic Information:
The Company structures its business activity in only one operating segment
which encompasses the design, development and marketing of advanced
communications products. Revenue by geographic region is as follows:
Three months ended Six months ended
June 30, June 30,
------------------------- -------------------------
1999 1998 1999 1998
------- ------- ------- -------
United States $ 4,209 $ 2,215 $ 7,252 $ 3,768
Foreign 801 438 1,649 745
------- ------- ------- -------
$ 5,010 $ 2,653 $ 8,901 $ 4,513
======= ======= ======= =======
For the three months and the six months ended June 30, 1999, no reseller
customers accounted for more than 10% of the Company's revenue. Two reseller
customers accounted for approximately 14% and 12%, respectively, of the
Company's revenue for the three months and the six months ended June 30, 1998.
8. Business Combinations:
In June 1999, the Company acquired PublicPort, Inc. ("PublicPort"), a
company that designs and develops subscriber management systems. The Company
issued 168,679 shares of its common stock for all of the outstanding common
stock of PublicPort.
The acquisition was accounted for as a pooling of interests. The
historical results of operations and financial position of PublicPort have not
been significant in relation to those of the Company. As such, historical
results of operations of the Company have not been restated to consolidate the
results of operations of PublicPort for periods prior to the acquisition date.
-7-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF DISCONTINUED OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Financial
Statements and the related Notes thereto included elsewhere in this Form 10-Q.
This discussion contains, in addition to historical information, forward-looking
statements that involve risks and uncertainties. The Company's actual results
could differ materially from the results discussed in the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed below, as well as those discussed in the
Company's Registration Statement on Form S-1. The Company disclaims any
obligation to update information contained in any forward-looking statement.
Overview
Tut Systems designs, develops and markets advanced communications products
which enable high-speed data access over the copper infrastructure of telephone
companies, as well as the copper telephone wires in homes, businesses and other
buildings. The Company's Expresso and XL products include high-bandwidth access
multiplexers, associated modems and routers, Ethernet extension products and
integrated network management software.
The Company generates revenues primarily from the sale of products and, to
a lesser extent, through the licensing of its HomeRun technology. The Company
generally recognizes revenues from product sales upon shipment. Estimated sales
returns and warranty costs, based on historical experience by product, are
recorded at the time revenues are recognized. License and royalty revenues
consist of non-refundable up-front license fees, some of which may offset
initial royalty payments, and royalties. Currently, license and royalty
revenues are comprised entirely of non-refundable license fees paid in advance.
Such revenues are recognized ratably over the period during which post-contract
customer support is expected to be provided or upon delivery and transfer of
agreed upon technical specifications in contracts where essentially no further
support obligations exist. Future license and royalty revenues are expected to
consist primarily of royalties based on products sold by the Company's
licensees. The Company does not expect that such license and royalty revenues
will constitute a substantial portion of the Company's revenues in future
periods.
Sales price reductions on some of the Company's products may be necessary
to remain competitive. Although the Company has been historically able to
offset most price declines with reductions in its manufacturing costs, there can
be no assurance that the Company will be able to offset further price declines
with cost reductions. In addition, certain of the Company's licensees may sell
products based on the Company's technology to competitors or potential
competitors of the Company. There can be no assurance that the Company's
HomeRun technology will be successfully deployed on a widespread basis or that
such licensing will not result in an erosion of the potential market for the
Company's products. See "Risk Factors."
Sales to customers outside of the United States accounted for approximately
18.5% of revenues in both 1998 and the first six months of 1999. The Company
expects sales to customers outside of the United States to increase in the
future. To date, substantially all sales have been denominated in U.S. dollars.
Tut Systems expects to continue to evaluate product line expansion and new
product opportunities, engage in extensive research, development and engineering
activities and focus on cost-effective design of its products. Accordingly, the
Company will continue to make significant expenditures on sales and marketing
and research and development activities.
In June 1999, the Company acquired PublicPort, Inc. ("PublicPort").
PublicPort designs and develops subscriber management systems which enable
businesses, such as the hospitality industry, to allow mobile computer users,
using laptop computers equipped with an Ethernet interface, to access the public
internet or private corporate networks without having to reconfigure their
laptop's network access software. The Company intends to continue additional
design and development and to market such products as part of its Expresso MDU
product line.
The Company has generated net operating losses to date and, as of June 30,
1999, had an accumulated deficit of $50.8 million. The ability of the Company
to generate income from operations will be primarily dependent on increases in
sales volume, reductions in certain manufacturing costs and the growth of high-
speed data access solutions in the service provider and multi-dwelling unit
("MDU") markets. In view of the Company's limited history of product revenues
from new markets, reliance on growth in deployment of high-speed data access
solutions and the unpredictability of orders and subsequent revenues, the
Company believes that period to period comparisons of its financial results are
not necessarily meaningful and should not be relied upon as an indication of
future performance. Failure to generate significant revenues
-8-
from new products, whether due to lack of market acceptance, competition,
technological change or otherwise, or the inability to reduce manufacturing
costs, will have a material adverse effect on the Company's business, financial
condition and results of operations.
Results of Operations
The following table sets forth certain items from the Company's statements
of operations as a percentage of total revenues for the periods indicated:
Three months ended Six months ended
June 30, June 30,
----------------------- --------------------------
1999 1998 1999 1998
----- ------- ------ ------
Total revenues 100.0% 100.0% 100.0% 100.0%
Total cost of goods sold 58.3 52.4 58.0 53.2
----- ------- ------ ------
Gross margin 41.7 47.6 42.0 46.8
Operating expenses:
Sales and marketing 49.0 79.0 54.6 87.0
Research and development 33.7 49.8 37.7 61.3
General administrative 20.3 29.5 22.5 31.6
Noncash compensation expenses 2.3 35.4 2.6 22.3
----- ------- ------ ------
Total operating expenses 105.3 193.7 117.4 202.2
----- ------- ------ ------
Loss from operation (63.6) (146.1) (75.4) (155.4)
Other income (expense), net 9.8 3.6 7.9 4.7
----- ------- ------ ------
Loss before income taxes (53.8) (142.5) (67.5) (150.7)
Income tax expense - - - -
----- ------- ------ ------
Net loss (53.8)% (142.5)% (67.5)% (150.7)%
===== ======= ====== ======
Three Months and Six Months Ended June 30, 1999 and 1998
Revenues. The Company generates revenues primarily from the sale of
products and, to a lesser extent, through the licensing of its HomeRun
technology. The Company's total revenues increased to $5.0 million and $8.9
million for the three months and the six months ended June 30, 1999,
respectively, from $2.7 million and $4.5 million, respectively, for the same
periods ended June 30, 1998. The increase in 1999 was primarily due to an
increase in sales of Expresso GS products and Expresso MDU products. Expresso
MDU products were introduced in the third quarter of 1998. License and royalty
revenues were $0.3 million and $0.6 million for the three months and the six
months ended June 30, 1999, respectively, compared to $0.3 million and $0.4
million, respectively, for the same periods of 1998. License and royalty
revenues to date consist primarily of the currently recognized portion of fees
from total license contracts of $4.4 million. Approximately $2.9 million and
$0.9 million of such fees were deferred at June 30, 1999 and 1998, respectively.
Cost of Goods Sold/Gross Margin. Cost of goods sold consists of raw
materials, contract manufacturing, personnel costs, test and quality assurance
for products, and cost of licensed technology included in the products. The
Company's cost of goods sold increased to $2.9 million and $5.2 million for the
three months and the six months ended June 30, 1999, respectively, from $1.4
million and $2.4 million, respectively, for the same periods ended June 30,
1998. The increase in 1999 was primarily due to increased production of the
Company's Expresso GS products and new production of its Expresso MDU products.
The Company's gross margin on an absolute basis increased to $2.1 million and
$3.7 million for the three months and the six months ended June 30, 1999,
respectively, up from $1.3 million and $2.1 million, respectively, for the same
periods ended June 30, 1998. Gross margin as a percentage of revenues decreased
to 41.7% and 42.0% of revenues for the three months and the six months ended
June 30, 1999, respectively, down from 47.6% and 46.8% of revenues,
respectively, for the same periods ended June 30, 1998. The decrease in gross
margin as a percent of revenues in 1999 was primarily due to the change in
product mix to include Expresso products which have lower average gross margins
than the XL products. Increased costs of raw materials and contract
manufacturing associated with initial Expresso MDU product introductions also
contributed to this decrease in gross margin.
-9-
Sales and Marketing. Sales and marketing expenses primarily consist of
personnel costs including commissions and costs related to customer support,
travel, trade-shows, promotions and outside services. The Company's sales and
marketing expenses increased to $2.5 million and $4.9 million for the three
months and the six months ended June 30, 1999, respectively from $2.1 million
and $3.9 million, respectively, for the same periods ended June 30, 1998. The
increase in 1999 was primarily due to increased hiring of sales and marketing
personnel, expansion of travel and attendance at trade shows, increases in
personnel related to customer support activities and expanded efforts in
international markets. The Company intends to increase sales and marketing
expenses as it adds personnel to support its domestic and international sales
and customer support efforts.
Research and Development. Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services, equipment and supplies
associated with enhancing existing products and developing new products.
Research and development costs are expensed as incurred. The Company's research
and development expenses increased to $1.7 million and $3.4 million for the
three months and the six months ended June 30, 1999, respectively, from $1.3
million and $2.8 million, respectively, for the same periods ended June 30,
1998. The increase in 1999 was primarily due to increased expenditures from
further development of the Expresso GS and Expresso MDU products, development of
HomeRun-related products, and enhancement of certain XL products. In June,
1999, the Company acquired PublicPort. The research and development expenses
of PublicPort were consolidated with the Company's expenses for the period
subsequent to the acquisition date and represented less than 3% of the expenses
for the quarter. The Company intends to increase investment in research and
development programs in future periods for the purpose of enhancing current
products for domestic and international markets, reducing the cost of current
products and developing new products.
General and Administrative. General and administrative expenses primarily
consist of personnel costs for administrative officers and support personnel,
and legal, accounting and consulting fees. The Company's general and
administrative expenses increased to $1.0 million and $2.0 million for the three
months and the six months ended June 30, 1999, respectively, from $0.8 million
and $1.4 million, respectively, for the same periods ended June 30, 1998. The
increase in 1999 was primarily due to increased costs related to the Company's
growth, including additions of administrative personnel. The Company intends to
increase general and administrative expenditures and infrastructure costs as the
Company expands its business.
Noncash Compensation Expense. Noncash compensation expense primarily
consists of expenses related to the grant of a warrant to purchase up to 666,836
shares of common stock in consideration for technology endorsement, marketing
and certain development support by Microsoft with respect to the Company's
HomeRun technology and related products. Noncash compensation expense also
consists of the recognition of expense related to certain employee stock option
grants, based on the difference between the deemed fair value of common stock
and the option exercise price at the date of grant. The Company's noncash
compensation expense was $0.1 million and $0.2 million for the three months and
the six months ended June 30, 1999, respectively, compared to $0.9 million and
$1.0 million, respectively, for the same periods of 1998. The decrease in 1999
is due to the initial expense of $0.9 million for noncash compensation
recognized in the three months ended June 30, 1998. The Company intends to
recognize $1.2 million in additional expenses related to employee stock options
ratably over the remaining vesting period of the related options. Such deferred
expense has been recorded as a reduction of equity in the balance sheet.
Other Income (Expense), Net. Other income (expense), net consists of
interest income on cash balances, offset by interest expense associated with
credit facilities. The Company's other income (expense), net was $0.5 million
and $0.7 million for the three months and the six months ended June 30, 1999,
respectively, and $0.1 million and $0.2 million for the same periods ended June
30, 1998. The increase in 1999 was primarily due to increased balances in cash,
cash equivalents and short-term investments following the Company's initial
public offering.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations primarily
through the sale of preferred equity securities for an aggregate of $46.0
million net of offering costs. In January, 1999 the Company completed its
initial public offering and issued 2,875,000 shares of its common stock at a
price of $18.00. The Company received approximately $47.0 million in cash, net
of underwriting discounts, commissions and other offering costs. The Company
also received approximately $6.7 million as a result of the exercise of a
warrant to purchase 666,836 shares of Series G convertible preferred stock at a
price of $10.00 per share.
-10-
The Company has a credit facility to borrow up to $7.5 million. The credit
facility is composed of two revolvers: a formula revolver of up to the lesser of
$3.0 million or 85% of qualified accounts receivable bearing interest at prime
plus 2.0% per annum; a non-formula revolver of up to $4.5 million bearing
interest at prime plus 3.5% per annum. The credit facility requires a minimum
monthly interest payment of $10,000. The term of the credit facility is 18
months ending on June 30, 2000 and is automatically renewed for additional terms
of one year unless 60 days' written notice is given by either party. The Company
has approximately $1.4 million borrowed against the credit facility as of June
30, 1999.
At June 30, 1999, the Company had cash, cash equivalents and short-term
investments of $45.0 million.
Net cash used by operating activities was $10.0 million for the six months
ended June 30, 1999, compared to $6.8 million for the same period of 1998. The
increase in 1999 was primarily due to the $2.5 million payment to purchase
certain intellectual property previously subject to ongoing royalties.
Net cash used in investing activities was $22.2 million for the six months
ended June 30, 1999, compared to $1.5 million of cash provided for the same
period of 1998. The increase in 1999 was primarily due to the purchase of
short-term investments.
On June 8, 1999, the Company acquired PublicPort as a wholly-owned
subsidiary. The Company issued 168,679 shares of common stock. The acquisition
has been accounted for as a pooling of interests resulting in a business
combination, net of cash acquired, of approximately $0.1 million.
Net cash provided by financing activities was $50.8 million for the six
months ended June 30, 1999, compared to $3.8 million for the same period of
1998. The increase in 1999 was primarily due to the Company's initial public
offering of 2,875,000 shares of its common stock for which the Company received
approximately $47.0 million in cash. Additionally, the Company received
approximately $6.7 million as a result of the exercise of a warrant to purchase
666,836 shares of Series G convertible preferred stock at an exercise price of
$10.00 per share. The Company used $2.9 million of cash to pay down its
borrowings under a credit facility entered into in 1998.
In future periods, the Company generally anticipates significant increases
in working capital on a period to period basis primarily as a result of planned
increased product sales and higher relative levels of inventory. The Company
will also continue to expend significant amounts on property and equipment
related to the expansion of systems infrastructure and office equipment to
support Company growth and lab and test equipment to support on-going research
and development operations.
During the six months ended June 30, 1999 and 1998, the Company incurred
non-cash expenses related to the amortization of stock compensation and other
non-cash items. The table below sets forth supplemental information concerning
the impact of certain non-cash items on losses from operations. The Statements
of Operations data has been derived from the Company's unaudited condensed
interim financial statements, which, in Management's opinion, have been prepared
on substantially the same basis as the audited annual financial statements
necessary for a fair presentation of the periods presented. The operating
results in any quarter are not necessarily indicative of the results that may be
expected for any future period.
-11-
Three months ended Six months ended
June 30, June 30,
---------------------------------- ---------------------------------
1999 1998 1999 1998
---------------- --------------- --------------- ---------------
Total revenues $ 5,010 $ 2,653 $ 8,901 $ 4,513
-------- -------- -------- --------
Gross margin 2,089 1,262 3,738 2,110
Operating expenses 5,272 5,139 10,445 9,121
-------- -------- -------- --------
Loss from operations $ (3,183) $ (3,877) $ (6,707) $ (7,011)
======== ======== ======== ========
Supplemental loss information (1):
Historical loss from operations $ (3,183) $ (3,877) $ (6,707) $ (7,011)
Add back certain non-cash charges:
Amortization of non-cash compensation (2) 114 939 228 1,005
Depreciation 190 133 366 255
-------- -------- -------- --------
Supplemental loss from operations excluding certain
non-cash charges $ (2,879) $ (2,805) $ (6,113) $ (5,751)
======== ======== ======== ========
(1) The accompanying supplemental financial information is presented for
informational purposes only and should not be considered as a substitute
for the historical financial information presented in accordance with
generally accepted accounting principles.
(2) Expense associated with the amortization of non-cash compensation consists
primarily of the recognition of expense related to certain employee stock
option grants, based on the difference between fair value of common stock
and the option exercise price at the date of grant.
The Company believes that its cash, cash equivalents and short-term
investment balances and funds available under its credit facility will be
sufficient to satisfy its cash requirements for at least the next 12 months.
Forward Looking Statements
The statements contained in this Report that are not historical facts are
"forward-looking statements" (as such term is defined in Section 27A of the
Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934),
which can be identified by the use of forward-looking terminology such as
"estimated," "projects," "anticipated," "expects," "intends," "believes," or the
negative thereof or other variations thereon or comparable terminology, or by
discussions of strategy that involve risks and uncertainties. These forward-
looking statements, such as the Company's plans to expand its existing network
or to commence service in new areas, estimates regarding the timing of launching
its service in new regions, statements regarding development of the Company's
business, future operating results, the Company's anticipated capital
expenditures, the effect of regulatory reform and regulatory litigation, the
Company's expectations as to its use of the capital resource and the
availability of additional financing, and other statements contained in this
Report regarding matters that are not historical facts, are only estimates or
predictions and cannot be relied upon. No assurance can be given that future
results will be achieved; actual events or results may differ materially as a
result of risks facing the company or actual results differing from the
assumption underlying such statements. Such risks and assumptions include, but
are not limited to, the Company's ability to successfully market its products to
current and new customers, generate customer demand for its products in the
particular regions where it plans to market products, access additional debt or
equity financing in the future, achieve acceptable pricing for its products,
respond to increasing competition, manage growth of the Company's operations, as
well as regulatory, legislative, and judicial developments that could cause
actual results to vary materially from the future results indicated, expressed
or implied in such forward-looking statements. All written and oral forward-
looking statements made in connection with this Report which are attributable to
the Company or persons acting on its behalf are expressly qualified in their
entirety by the "Risk Factors" and other cautionary statements and disclosures
regarding the Company's business included herein and in the Company's
Registration Statement on Form S-1 (Commission File No. 333-60419). The Company
disclaims any obligation to update information contained in any forward-looking
statement.
-12-
Risk Factors
We have a history of losses.
We have incurred substantial net losses and experienced negative cash flow
each fiscal quarter since our inception. We incurred net losses attributable to
common stockholders of $6.2 million for the six months ended June 30, 1999 and
$8.1 million for the six months ended June 30, 1998. As of June 30, 1999, we
had an accumulated deficit of $50.8 million. We expect that we will continue to
incur losses through 1999.
We cannot predict our future profitability.
We may never achieve or sustain profitability. We have spent substantial
amounts of money on the development of our Expresso products and our HomeRun
technology. We intend to continue increasing certain of our operating
expenditures, including our sales and marketing, research and development and
general and administrative expenditures. We cannot assure you that we will
generate a sufficient level of revenue to offset these expenditures, or that we
will be able to adjust spending in a timely manner to respond to any
unanticipated decline in revenue due to the fact that our expenditures for sales
and marketing, research and development, and general administrative functions
are, in the short term, relatively fixed. We derive approximately two-thirds of
our revenue from sales of our Expresso products and approximately one-third of
our revenue from sales of our XL products. Our ability to increase revenues or
achieve profitability in the future will primarily depend on our ability to
increase sales of our Expresso GS and Expresso MDU products, reduce
manufacturing costs, and successfully introduce and sell enhanced versions of
our existing products and new products. In particular, the success of our
Expresso MDU products depends, in part, on the widespread adoption of our
HomeRun technology as an embedded technology in integrated circuits and consumer
products.
Our operating results are likely to fluctuate in future periods and may fail to
meet the expectations of securities analysts or investors.
Our annual and quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future as a result of numerous factors, some
of which are outside of our control. These factors include:
. market acceptance of our products;
. competitive pressures, including pricing pressures from our partners and
competitors;
. the timing or cancellation of orders from, or shipments to, existing and new
customers;
. the timing of new product and service introductions by us, our customers, our
partners or our competitors;
. variations in our sales or distribution channels;
. variations in the mix of products offered by us;
. changes in the pricing policies of our suppliers;
. the availability and cost of key components; and
. the timing of personnel hiring.
We may also experience substantial period to period fluctuations in future
operating results and declines in gross margin as a result of the erosion of
average selling prices for high-speed data access products and services due to a
number of factors, including competition and rapid technological change. We
anticipate that average selling prices for our products will decrease over time
due to competitive pressures and volume pricing agreements. Decreasing average
selling prices could cause us to experience decreased revenues despite an
increase in the number of units sold. We cannot assure you that we will be able
to sustain or improve our gross margins in the future, or that we will be able
to offset future price declines with cost reductions.
As a result of these and other factors, it is possible that in some future
period our operating results will be below the expectations of securities
analysts and investors. In that event, the trading price of our common stock
would likely decline.
Difficulties in forecasting product sales could negatively impact our business.
We base our expense levels in part upon our expectations concerning future
revenue and these expense levels are relatively fixed in the short-term.
However, orders for our products may vary from quarter to quarter. In some
circumstances, customers may delay purchasing our current products in favor of
next-generation products. In addition, our new products are generally subject
to technical evaluations which typically last 60 to 90 days. If orders
forecasted for a specific customer for a particular quarter do not occur in that
quarter, our revenues for that quarter would be reduced. If we
-13-
have lower revenue in a quarter than expected, we may not be able to reduce our
spending in the short-term in response to this shortfall and reduced revenues
would have a direct impact on our results of operations for that quarter.
Further, we purchase components and contract manufacture our products based on
forecasts of sales. If orders for products exceed our forecasts, we may have
difficulty meeting customers orders in a timely manner which could damage our
reputation or result in lost sales.
Our market is subject to rapid technological change.
The markets for high-speed data access products are characterized by rapid
technological developments, frequent enhancements to existing products and new
product introductions, changes in end user requirements and evolving industry
standards. In addition, the market for high-speed data access products is
dependent in large part on the increased use of the Internet. Issues concerning
the use of the Internet, including security, lost or delayed packets, and
quality of service, remain unresolved and may negatively affect the development
of the market for our products. If we do not address these technological
changes and challenges by regularly introducing new products, our product line
will become obsolete which would have a material adverse effect on our business,
financial condition and results of operations. We cannot assure you that we
will be able to respond quickly and effectively to technological change.
Our success depends on our ability to continually introduce new products that
achieve broad market acceptance.
We must also continually improve the performance, features and reliability
of our products, particularly in response to competitive product offerings. To
remain competitive we need to introduce products in a timely manner that
incorporate or are compatible with these new technologies as they emerge. We
may have only a limited amount of time to penetrate certain markets, and we
cannot assure you that we will be successful in achieving widespread acceptance
of our products before competitors offer products and services similar or
superior to our products. Any delay in product introduction could adversely
affect our ability to compete and cause our operating results to be below our
expectations or the expectations of public market analysts or investors. In
addition, when we announce new products or product enhancements that have the
potential to replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. These actions could
materially adversely affect our operating results by unexpectedly decreasing
sales, increasing our inventory levels of older products and exposing us to
greater risk of product obsolescence.
Our success depends on continued market acceptance of our Expresso products.
We must devote a substantial amount of human and capital resources in order
to maintain commercial acceptance of our Expresso GS and Expresso MDU products
in the service provider and MDU markets and to further penetrate these markets.
Our success depends on our ability to educate existing and potential customers
and end users about the benefits of our FastCopper technology, including
HomeRun, and the development of new products to meet changing demands of service
providers, MDUs and corporate customers. The continued success of our Expresso
products will also depend on the ability of our customers to market and sell
high-speed data services to end users. We cannot assure you that our Expresso
products will achieve or maintain broad commercial acceptance by service
providers, MDUs and corporate customers or in any other market we enter.
Copper-wire based solutions face severe competition from other technologies.
The market for high-speed data access products and services is
characterized by several competing technologies, including fiber optic cables,
coaxial cables, satellites and other wireless facilities, that offer competing
solutions which provide fast access, high reliability and are cost-effective for
some users. Since all of our products are based on the use of copper telephone
wire, and since there are physical limits to the speed and distance over which
data can be transmitted over this wire, our products may not be a viable
solution for customers requiring service at performance levels beyond the
current limits of copper telephone wire. To the extent that telecommunications
service providers choose to install fiber optic cable or other transmission
media in the last mile, or to the extent that homes and businesses install other
transmission media within buildings, we expect that demand for our products
which are based on copper telephone wires will decline. Commercial acceptance
of any one of these competing solutions or any technological advancement or
product introduction that provides faster access, greater reliability, increased
cost-effectiveness or other advantages over technologies that utilize existing
telephone copper wires could decrease the demand for our products and reduce
average selling prices and gross margins associated with our products. The
occurrence of any one or more of these events could materially adversely affect
our business, financial condition and results of operations.
-14-
Manufacturing or design defects in our products could cause harm to our
reputation and business.
Any defect or deficiency in our products could reduce the functionality,
effectiveness or marketability of our products. These defects or deficiencies
could cause orders for our products to be canceled or delayed, reduce revenues,
or render our product designs obsolete. In that event, we would be required to
devote substantial financial and other resources for a significant period of
time in order to develop new product designs. We cannot assure you that we
would be successful in addressing any manufacturing or design defects in our
products or in developing new product designs in a timely manner, if at all.
Any of these events, individually or in the aggregate, could have a material
adverse effect on our business, financial condition and results of operations.
The markets in which we operate are highly competitive, and we may not be able
to compete effectively.
The markets for high-speed Internet and network access products are
intensely competitive, and expect that these markets will become increasingly
competitive in the future. Our most immediate competitors are: PairGain,
Paradyne, Cisco, Ascend Communications (recently acquired by Lucent
Technologies), Copper Mountain, and a number of other public and private
companies. Many of these competitors are offering, or may offer, technologies
and services that directly compete with some or all of our high-speed access
products.
Many of our competitors and potential competitors have substantially
greater name recognition and technical, financial and marketing resources than
we do, and we can give you no assurance that we will be able to compete
effectively in our target markets. As a result, they may be able to undertake
more extensive marketing campaigns, adopt more aggressive pricing policies and
devote substantially more resources to developing new products than we can. In
addition, our licensees may sell products based on our technology to our
competitors or potential competitors. This licensing may cause an erosion in
the potential market for our products. We cannot assure you that we will have
the financial resources, technical expertise or marketing, manufacturing,
distribution and support capabilities to compete successfully. This competition
could result in price reductions, reduced profit margins and loss of market
share, which could materially and adversely affect our business, financial
condition and results of operations.
We depend on third parties for increased market penetration of HomeRun.
We have established relationships with several strategic partners,
including our collaborative arrangement through the Home Phoneline Network
Alliance, or the Home PNA, with leading semiconductor, computer hardware and
consumer electronics manufacturers. We have also licensed our HomeRun
technology to members of the Home PNA and others. In this regard, the
widespread market acceptance of our HomeRun technology for home networking
applications is dependent on the development and marketing of HomeRun-enabled
integrated circuits and consumer products by our licensees and their customers.
We cannot assure you that our HomeRun technology will continue to be
successfully deployed on a widespread basis and future sales of products
containing our HomeRun technology cannot be predicted. The amount and timing of
resources which our licensees devote to developing and marketing HomeRun-enabled
products is not within our control. We cannot assure you that these licensees
will develop and market products as expected or that significant license and
royalty revenues will be forthcoming in the future. If any of our licensees
fails to develop, commercialize or market products incorporating HomeRun
technology, our revenues would not grow as expected and we may be required to
undertake unforeseen additional responsibilities or to devote additional
resources to development, commercialization or marketing of HomeRun, all of
which could have a material adverse effect on our business, financial condition
and results of operations.
Changing industry standards may adversely affect demand for our products and our
stock price.
We will not be competitive unless we continually introduce new products and
product enhancements that changing industry standards. The emergence of new
industry standards, whether through adoption by official standards committees or
widespread use by telephone companies or other service providers, could require
redesign of our products. If these standards become widespread and our products
are not in compliance, our customers and potential customers may not purchase
our products, which would materially adversely affect our business, financial
condition and results of operations. The rapid development of new standards
increases the risk that competitors could develop products that make our
products obsolete. Any failure by us to develop and introduce new products or
enhancements directed at new industry standards could have a material adverse
effect on our business, financial condition and results of operations. In
addition, selection of competing technologies as standards by standards setting
bodies such as the Home PNA could negatively affect our reputation in the market
regardless of whether our products are standard compliant or demand for our
products does not decline. This
-15-
selection could be interpreted by the press and others as having a negative
impact on our business which could negatively impact the market price of our
stock.
If a key distributor discontinues purchasing our product, our revenues may
decline and the price of our stock may fall.
In the first six months of 1999, we derived approximately 11.7% of our
revenues from combined sales to Tech Data, Rycom CCI, Inc. and Ingram Micro,
three independent distributors of our products. These independent distributors
are not contractually bound to purchase our products and therefore could
discontinue carrying our products at any time in favor of competitive products
or for any other reason. In addition, we remain subject to the risk of product
returns from these distributors and other customers. We expect that the sale of
our products to a limited number of distributors and value-added resellers,
including Tech Data, Rycom CCI Inc. and Ingram Micro, may continue to account
for a substantial percentage of revenues for the foreseeable future. Any
reduction, delay or loss of orders from Tech Data, Rycom CCI, Inc. or Ingram
Micro could have a material adverse effect on our revenues and on our business,
financial condition and results of operations.
We depend on contract manufacturers to manufacture all of our products.
We do not manufacture any of our products, but instead rely on contract
manufacturers to assemble, test and package our products. We cannot assure you
that these contract manufacturers and suppliers will be able to meet our future
requirements for manufactured products, components and subassemblies. Any
interruption in the operations of one or more of these contract manufacturers
would adversely affect our ability to meet our scheduled product deliveries to
customers. We also intend to regularly introduce new products and product
enhancements, which will require that we rapidly achieve volume production by
coordinating our efforts with those of our suppliers and contract manufacturers.
The inability of our contract manufacturers to provide us with adequate supplies
of high-quality products or the loss of a current contract manufacturer would
cause a delay in our ability to fulfill customer orders while we obtain a
replacement manufacturer and would have a material adverse effect on our
business, operating results and financial condition. In addition, our inability
to accurately forecast the actual demand for our products could result in
supply, manufacturing or testing capacity constraints. These constraints could
result in delays in the delivery of our products or the loss of existing or
potential customers, either of which could have a material adverse effect on our
business, operating results or financial condition.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. Components are purchased pursuant
to purchase orders based on forecasts, but we or our contract manufacturers have
no guaranteed supply arrangements with these suppliers. The availability of
many of these components is dependent in part on our ability to provide our
contract manufacturers and their suppliers with accurate forecasts of our future
needs. If we or our manufacturers were unable to obtain a sufficient supply of
components from current sources, we could experience difficulties in obtaining
alternative sources or in altering product designs to use alternative
components. Resulting delays or reductions in product shipments could damage
customer relationships and could adversely affect our business, financial
condition or results of operations. In addition, any increases in component
costs could increase the costs of our products and reduce demand for our
products.
We rely on third parties to test all of our products.
Substantially all of our products are assembled and tested by our contract
manufacturers. Although we perform random spot testing on manufactured
products, we rely on our contract manufacturers for assembly and primary testing
of our products. Any quality assurance problems could increase the costs of
manufacturing, assembling or testing of our products and could have a material
adverse effect on our business, financial condition and results of operation.
Moreover, defects in products which are not discovered in the quality assurance
process could damage customer relationships and result in product returns or
liability claims, each of which could have a materially adversely affect our
business, financial condition and results of operations.
We purchase several key components from single or limited sources and could lose
sales if these sources fail to fill our needs.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. In procuring components, our
contract manufacturers rely on some suppliers that are the sole source of those
components, and we are dependent upon supply from these sources to meet our
needs. For example, all of the field programmable gate array supplies used in
our products are purchased from Xilinx. Our Expresso products are also
dependent on various sole source offerings from Metalink US, Motorola, Oki
Semiconductor, Osicom Technologies.
-16-
RELTEC, SaRonix, and Wind River Systems. Certain of our XL products are
dependent on offerings from Globespan Semiconductor and Level One
Communications. If there is any interruption in the supply of any of the key
components currently obtained from a single or limited source, obtaining these
components from other sources could take a substantial period of time, could
cause us to redesign our products and could disrupt our operations and have a
material adverse effect on our business in any given period.
We may not be able to manage our growth effectively.
Our growth has placed, and in the future may continue to place, a
significant strain on our engineering, managerial, administrative, operational,
financial and marketing resources, and increased demands on our systems and
controls. To exploit the market for our products, we must develop new and
enhanced products while managing anticipated growth in sales by implementing
effective planning and operating processes. To manage our anticipated growth,
we must, among other things, continue to implement and improve our operational,
financial and management information systems, hire and train additional
qualified personnel, continue to expand and upgrade core technologies and
effectively manage multiple relationships with various customers, suppliers and
other third parties. We cannot assure you that our systems, procedures or
controls will be adequate to support our operations or that our management will
be able to achieve the rapid execution necessary to exploit fully the market for
our products or systems. If we are unable to manage our growth effectively
could have a material adverse effect on our business, financial condition and
results of operations.
We depend on international sales for a significant portion of our revenues.
Sales to customers outside of the United States accounted for approximately
18.5% of revenues in both 1998 and in the first six months of 1999. There are a
number of risks arising from our international business, including:
. longer receivables collection periods;
. increased exposure to bad debt write-offs;
. risk of political and economic instability;
. difficulties in enforcing agreements through foreign legal systems;
. unexpected changes in regulatory requirements;
. import or export licensing requirements;
. reduced protection for intellectual property rights in some countries; and
. currency fluctuations.
We expect sales to customers outside of the United States to increase in
the future and our success is dependent on increased international sales. We
can give you no assurance that foreign markets for our products will not develop
more slowly than currently anticipated. Any failure to increase sales to
customers outside the United States could materially adversely affect our
business, financial condition and results of operations.
We also expend product development and other resources in order to meet
regulatory and technical requirements of foreign countries. We are depending on
sales of our products in these foreign markets in order to recoup the costs
associated with developing products for these markets.
We are subject to fluctuations in currency exchange rates.
All of our foreign sales are invoiced in U.S. dollars. As a result,
fluctuations in currency exchange rates could cause our products to become
relatively more expensive for international customers and reduce demand for our
products. We anticipate that foreign sales will generally continue to be
invoiced in U.S. dollars. Accordingly, we do not plan to engage in foreign
currency hedging transactions. However, as we expand our current international
operations, we may allow payment in foreign currencies and exposure to losses in
foreign currency transactions may increase. We may choose to limit our exposure
through the purchase of forward foreign exchange contracts or other hedging
strategies. We cannot assure you that any currency hedging strategy would be
successful in avoiding exchange related losses.
Our limited ability to protect our intellectual property may adversely affect
our ability to compete.
Our future success and ability to compete is dependent in part upon our
proprietary technology. We rely on a combination of copyright, patent,
trademark and trade secrets laws and nondisclosure agreements to establish and
protect our proprietary technology. We currently hold 12 United States patents
and have 15 United States patent applications pending. However, we cannot
assure you that patents will be issued with respect to pending or future patent
applications or that our
-17-
patents will be upheld as valid or will prevent the development of competitive
products or that any actions we have taken will adequately protect our
intellectual property rights.
We generally enter into confidentiality agreements with our employees,
consultants, resellers, customers and potential customers, strictly limit access
to and distribution of our software, and further limit the disclosure and use of
other proprietary information. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy or otherwise obtain or use our
products or technology. We also cannot assure you that our competitors will not
independently develop technologies that are substantially equivalent or superior
to our technology. In addition, the laws of some foreign countries do not
protect our proprietary rights to the same extent as do the laws of the United
States.
We are also subject to the risk of adverse claims and litigation alleging
infringement of the intellectual property rights of others. We cannot assure
you that third parties will not assert infringement claims in the future with
respect to our current or future products. Any such assertion, regardless of
its merit, could require us to pay damages or settlement amounts and could
require us to develop non-infringing technology or acquire licenses to the
technology that is the subject of asserted infringement. This litigation or
potential litigation could result in product delays, increased costs or both.
In addition, the cost of any litigation and the resulting distraction of our
management resources could have a material adverse effect on our business,
results of operations or financial condition. We also cannot assure you that
any licenses of technology necessary for our business will be available or that,
if available, these licenses can be obtained on commercially reasonable terms.
Our failure to obtain these licenses could have a material adverse effect on our
business, results of operations and financial condition.
Our products must comply with complex government regulations or our products may
not be sold.
We and our customers are subject to varying degrees of federal, state and
local regulation. Our products must comply with various regulations and
standards defined by the Federal Communications Commission. The FCC has issued
regulations that set installation and equipment standards for communications
systems. Our products are also required to meet certain safety requirements.
For example, certain of our products must be certified by Underwriters
Laboratories in order to meet federal safety requirements relating to electrical
appliances to be used inside the home. In addition, certain products must be
Network Equipment Building Standard certified before they may be deployed by
certain of our customers. Any delay in or failure to obtain these approvals
could have a material adverse effect on our business, financial condition or
results of operations. Outside of the United States, our products are subject
to the regulatory requirements of each country in which our products are
manufactured or sold. These requirements are likely to vary widely. If we do
not obtain timely domestic or foreign regulatory approvals or certificates we
would not be able to sell our products where these regulations apply, which may
prevent us from sustaining our revenues or achieving profitability.
In addition, regulation of our customers may adversely impact our business,
operating results and financial condition. For example, FCC regulatory policies
affecting the availability of data and Internet services and other terms on
which telecommunications companies conduct their business, may impede our
penetration of certain markets. In addition, the increasing demand for
communications systems has exerted pressure on regulatory bodies worldwide to
adopt new standards, generally following extensive investigation of competing
technologies. The delays inherent in this governmental approval process may
cause the cancellation, postponement or rescheduling of the installation of
communications systems by our customers, which in turn may have a material
adverse effect on the sale of products by us to these customers.
Our success is dependent on our ability to provide adequate customer support.
Our ability to achieve our planned sales growth and retain current and
future customers will depend in part upon the quality of our customer support
operations. Our customers generally require significant support and training
with respect to our products, particularly in the initial deployment and
implementation stage. We have limited experience with widespread deployment of
our products to a diverse customer base, and we cannot assure you that we will
have adequate personnel to provide the levels of support that our customers may
require during initial product deployment or on an ongoing basis. In addition,
we rely on a third party for a substantial portion of our customer support
functions. Our failure to provide sufficient support to our customers could
delay or prevent the successful deployment of our products. Failure to provide
adequate support could also have an adverse impact on our reputation and
relationship with our customers, could prevent us from gaining new customers and
could have a material adverse effect on our business, financial condition or
results of operations.
Our success depends on our retention of certain key personnel and our ability to
hire additional key personnel.
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We depend on the performance of Matthew Taylor, our Chairman of the Board
and Chief Technical Officer, and Salvatore D'Auria, our President and Chief
Executive Officer, and on other senior management and technical personnel with
experience in the data communications, telecommunications and high-speed data
access industries, and the loss of any one of them could have a material adverse
effect on our ability to execute our business strategy. Additionally, we do not
have employment contracts with any of our executive officers and we only
maintain a "key person" life insurance policy on Matthew Taylor. We believe
that our future success will depend in large part upon our continued ability to
identify, hire, retain and motivate highly skilled employees, who are in great
demand. We cannot assure you that we will be able to do so.
Our failure or the failure of our key suppliers and customers to be year 2000
compliant could negatively impact our business.
Software that records only the last two digits of the calendar year may not
be able to distinguish whether "00" means 1900 or 2000. This may result in
software failures or the creation of erroneous results, which could adversely
impact our operations. The following are risks of the year 2000 issue:
. potential warranty or other claims from our customers or payment of
compensatory or other damages;
. loss or delay in market acceptance of our products or services;
. disruptions in systems we use to run our business;
. disruptions in systems used by our suppliers; and
. potential reduced spending by other companies on networking solutions as a
result of significant information systems spending on year 2000 remediation
We generally warrant and represent to our customers that our products are
free from year 2000 defects. Since all customer situations cannot be
anticipated, we may see an increase in warranty and other claims as a result of
the year 2000 transition. In addition, litigation regarding year 2000
compliance issues is expected to escalate. For these reasons, the impact of
customer claims could have a material adverse impact on our operating results or
financial condition.
Within the past twelve months, we have been upgrading components of our own
internal computer and related information and operational systems and continue
to assess the need for further system redesign. We believe we are taking the
appropriate steps to ensure year 2000 compliance. Based on information
currently available, we believe that the costs associated with year 2000
compliance, and the consequences of incomplete or untimely resolution of the
year 2000 problem, will not have a material adverse effect on our business,
financial condition and results of operations in any given year. However, even
if our internal systems are not materially affected by the year 2000 problem,
our business, financial condition and results of operations could be materially
adversely affected through disruption in the operation of the enterprises with
which we interact. We cannot assure you that third party computer products used
by us are year 2000 compliant. Further, even though we believe that our current
products are year 2000 compliant, we cannot assure you that under actual
conditions these products will perform as expected or that future products will
be year 2000 compliant. Any failure of our products to be year 2000 compliant
could result in the loss of or delay in market acceptance of our products and
services, increased service and warranty costs to us or payment by us of
compensatory or other damages which could have a material adverse effect on our
business, financial condition and results of operations.
We may engage in future acquisitions of companies, technologies or products.
As a part of our business strategy, we expect to make acquisitions of, or
significant investments in, complementary companies, products or technologies,
although no acquisitions or investments are currently pending. For example, in
June 1999, we acquired Public Port, Inc. Any future acquisitions would be
accompanied by the risks commonly encountered in acquisitions of companies.
These risks include:
. difficulties in assimilating the operations and personnel of the acquired
companies;
. diversion of management's attention from ongoing business concerns;
. our potential inability to maximize our financial and strategic position
through the successful incorporation of acquired technology and rights into
our products and services;
. additional expense associated with amortization of acquired intangible assets;
. maintenance of uniform standards, controls, procedures and policies; and
. impairment of existing relationships with employees, suppliers and customers
as a result of the integration of new management personnel.
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We cannot assure you that we will be able to successfully integrate any
business, products, technologies or personnel that we might acquire in the
future, and our failure to do so could materially adversely affect our business,
operating results and financial condition.
Our stock price has been and is likely to continue to be volatile.
The trading price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could fluctuate widely in response to
factors such as the following:
. actual or anticipated variations in operating results;
. announcements of technological innovations, new products or new services by us
or by our partners, competitors or customers;
. changes in financial estimates or recommendations by stock market analysts
regarding us or our competitors;
. conditions or trends in the telecommunications industry, including regulatory
developments;
. growth of the Internet;
. announcements by us of significant acquisitions, strategic partnerships, joint
ventures or capital commitments;
. additions or departures of key personnel;
. future equity or debt offerings or our announcements of these offerings; and
. general market and general economic conditions.
In addition, in recent years, the stock market in general, and the Nasdaq
National Market and the securities of Internet and technology companies in
particular, have experienced extreme price and volume fluctuations. These
fluctuations have often been unrelated or disproportionate to the operating
performance of these companies. These market and industry factors may
materially and adversely affect our stock price, regardless of our operating
results. In addition, trading prices of the stocks of many technology companies
are at or near historic highs and reflect price-earnings ratios substantially
above historic levels. These trading prices and price-earnings ratios may not
be sustained.
Our charter and bylaws and Delaware law contain provisions with certain anti-
takeover effects.
Certain provisions of our charter and bylaws may have the effect of making
it more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, control of us. These provisions could limit the
price that certain investors might be willing to pay in the future for shares of
our common stock. Our charter and bylaws provide for a classified board of
directors, eliminate cumulative voting in the election of directors, restrict
our stockholders from acting by written consent and calling special meetings,
and provide for procedures for advance notification of stockholder nominations
and proposals. In addition, our board of directors has the authority to issue
up to 5,000,000 shares of preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the shareholders. The issuance of
preferred stock, while providing flexibility in connection with possible
financings or acquisitions or other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of our
outstanding voting stock. These provisions, as well as Section 203 of the
Delaware General Corporation Law to which we are subject, could discourage
potential acquisition proposals, delay or prevent a change of control and
prevent changes in our management.
Future sales of our common stock may depress our stock price.
Sales of a substantial number of shares of our common stock in the public
market, or the appearance that these shares are available for sale, could
materially and adversely affect the market price of our common stock. These
sales also might make it more difficult for us to sell equity securities or
equity-related securities in the future at a time and price that we deem
appropriate. As of June 30, 1999, we had 11,630,049 shares outstanding. Of
these shares, 10,794,534 shares of common stock are currently available for sale
in the public market, some of which are subject to volume and other limitations
under securities laws. However, 835,515 shares are not currently available for
sale in the public market but will be as follows:
Date of Availability For Sale Number
----------------------------- ------
February 3, 1999 666,836 shares
June 8, 2000 168,679 shares
-20-
We have agreed, subject to certain conditions, to register on or prior to
October 31, 1999 the 168,679 shares which will otherwise become available for
sale on June 8, 2000. In addition, we have 55,000 shares underlying an
outstanding warrant that will be eligible for resale in the public market upon
expiration of the warrant holder's one-year holding period under Rule 144, which
will begin upon the date of exercise. However, to the extent that the warrant
holder effects a "cashless" exercise of our warrant, the underlying shares will
be eligible for sale in the public market beginning on December 21, 1999.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio. The Company places its
investments with high credit issuers in short-term securities with maturities of
three to twelve months. The portfolio includes only marketable securities with
active secondary or resale markets to ensure portfolio liquidity. The Company
has no investments denominated in foreign country currencies and therefore is
not subject to foreign exchange risk.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
None
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
None
Item 3. Defaults Upon Senior Securities
--------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Company's Annual Meeting of Stockholders was held on May 19, 1999 (the
"Annual Meeting"). At the Annual Meeting, stockholders voted on two matters:
(i) the election of three Class I directors for terms of three years expiring in
2002, and (ii) the ratification of the appointment of PricewaterhouseCoopers LLP
as the Company's independent auditors. The stockholders elected management's
nominees as the Class I directors in an uncontested election and ratified the
appointment of the independent auditors by the following votes, respectively:
(i) Election of Class I directors for terms expiring in 2001:
Votes For Votes Withheld
----------------- ------------------
Clifford H. Higgerson........................................... 7,423,351 14,968
Brion Applegate................................................. 7,423,351 14,968
David Spreng.................................................... 7,423,351 14,968
The Company's Board of Directors is currently comprised of nine members who
are divided into three classes with overlapping three-year terms.
(ii) Ratification of appointment of PricewaterhouseCoopers LLP as independent
auditors:
Votes For Votes Against Abstentions
- --------------------------- ---------------------- -------------------
7,423,351 4,561 4,025,066
Item 5. Other Information
-----------------
None
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Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits:
10.1 Agreement and Plan of Reorganization dated June 8, 1999, by and among
Registrant, PublicPort Acquisition Corporation, a Delaware corporation,
PublicPort, Inc., a Delaware corporation, and, with respect to Article
VII only, Dory E. Leifer as Stockholder Representative, and U.S. Bank
Trust, as Escrow Agent.
10.2 Tut Systems, Inc. Registration Rights Agreement dated June 8, 1999, by
and between Registrant and the Company Stockholders listed therein.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
A Current Report on Form 8-K was filed on July 23, 1999.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TUT SYSTEMS, INC.
Date: August 16, 1999
/s/ Nelson Caldwell
------------------------------------------
Nelson Caldwell
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer and Duly
Authorized Officer)
-23-
Exhibit Index
-------------
10.1 Agreement and Plan of Reorganization dated June 8, 1999, by and among
Registrant, Public Port Acquisition Corporation, a Delaware corporation,
PublicPort, Inc., a Delaware corporation, and, with respect to Article
VII only, Dory E. Leifer as Stockholder Representative, and U.S. Bank
Trust, as Escrow Agent.
10.2 Tut Systems, Inc. Registration Rights Agreement dated June 8, 1999, by
and between Registrant and the Company Stockholders listed therein.
27.1 Financial Data Schedule