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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________
FORM 10-Q
____________
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2001
Commission File Number: 000-25291
____________
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)
5964 W. Las Positas Blvd., Pleasanton, California 94588
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (925) 490-3900
____________
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 September 30, 2001, 16,380,964 shares of the Registrant's Common Stock,
par value $0.001 per share, were issued and outstanding.
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1
TUT SYSTEMS, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000 .......... 3
Condensed Consolidated Statements of Operations for the three months and nine months ended .... 4
September 30, 2001 and September 30, 2000
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, ....... 5
2001 and September 30, 2000
Notes to Unaudited Condensed Consolidated Financial Statements ................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ......... 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk .................................... 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................................................. 36
Item 2. Changes in Securities and Use of Proceeds ..................................................... 36
Item 3. Defaults Upon Senior Securities ............................................................... 36
Item 4. Submission of Matters to a Vote of Security Holders ........................................... 36
Item 5. Other Information ............................................................................. 36
Item 6. Exhibits and Reports on Form 8-K .............................................................. 36
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)
September 30, December 31,
2001 2000
---- ----
ASSETS
Current assets:
Cash and cash equivalents ................................................................. $ 41,234 $ 47,307
Short-term investments .................................................................... 15,211 55,307
Accounts receivable, net of allowance for doubtful accounts of $6,956 and
$21,167 in 2001 and 2000, respectively .................................................. 2,559 6,124
Inventories, net .......................................................................... 11,449 36,285
Prepaid expenses and other ................................................................ 2,126 3,526
--------- ---------
Total current assets ................................................................. 72,579 148,549
Property and equipment, net .................................................................. 8,955 10,578
Intangibles and other assets (including restricted cash of $1,604 and
$3,248 in 2001 and 2000, respectively) .................................................... 7,590 46,461
--------- ---------
Total assets ......................................................................... $ 89,124 $ 205,588
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................................... $ 2,738 $ 9,446
Accrued liabilities ....................................................................... 11,802 27,129
Deferred revenue .......................................................................... 1,191 1,054
--------- ---------
Total current liabilities ............................................................ 15,731 37,629
Deferred revenue, net of current portion ..................................................... 750 1,454
Other liabilities ............................................................................ 317 332
--------- ---------
Total liabilities .................................................................... 16,798 39,415
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock, $0.001 par value, 100,000 shares authorized, 16,381 and
15,911 shares issued and outstanding in 2001 and 2000, respectively ..................... 16 16
Additional paid-in capital ................................................................ 301,152 298,332
Deferred compensation ..................................................................... (34) (1,041)
Notes receivable from stockholders ........................................................ (288) (555)
Accumulated other comprehensive income (loss) ............................................. (135) 6
Accumulated deficit ....................................................................... (228,385) (130,585)
--------- ---------
Total stockholders' equity ........................................................... 72,326 166,173
--------- ---------
Total liabilities and stockholders' equity ........................................... $ 89,124 $ 205,588
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Revenues:
Product ............................................. $ 3,753 $ 27,922 $ 10,897 $ 64,431
License and royalty ................................. 214 645 679 1,624
--------- --------- --------- ---------
Total revenues ................................. 3,967 28,567 11,576 66,055
--------- --------- --------- ---------
Cost of goods sold:
Product ............................................. 14,615 15,064 38,905 35,435
--------- --------- --------- ---------
Total cost of goods sold ....................... 14,615 15,064 38,905 35,435
--------- --------- --------- ---------
Gross (loss) margin .................................... (10,648) 13,503 (27,329) 30,620
--------- --------- --------- ---------
Operating expenses:
Sales and marketing ................................. 2,767 5,559 10,093 15,163
Research and development ............................ 3,028 4,950 11,802 12,181
General and administrative .......................... 1,616 3,361 7,770 8,077
Restructuring costs ................................. -- -- 2,092 --
In-process research and development ................. -- -- 1,160 800
Impairment of intangible assets ..................... 29,859 -- 32,551 --
Amortization of intangible assets ................... 2,561 2,528 7,774 5,088
Noncash compensation expense ........................ 60 114 182 342
--------- --------- --------- ---------
Total operating expenses ....................... 39,891 16,512 73,424 41,651
--------- --------- --------- ---------
Loss from operations ................................... (50,539) (3,009) (100,753) (11,031)
Interest expense ....................................... (4) (10) (17) (459)
Interest income ........................................ 701 2,408 2,857 5,464
Other income, net ...................................... 10 -- 113 --
--------- --------- --------- ---------
Loss before income taxes ............................... (49,832) (611) (97,800) (6,026)
Income tax expense ..................................... -- -- -- 1
--------- --------- --------- ---------
Net loss ............................................... $ (49,832) $ (611) $ (97,800) $ (6,027)
========= ========= ========= =========
Net loss per share, basic and diluted (Note 3) ......... $ (3.05) $ (0.04) $ (6.01) $ (0.42)
========= ========= ========= =========
Shares used in computing net loss per share,
basic and diluted (Note 3) ............................. 16,353 15,751 16,286 14,519
========= ========= ========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
----------------------------
2001 2000
--------- ---------
Cash flows from operating activities:
Net loss ......................................................................... $ (97,800) $ (6,027)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation ................................................................... 2,699 1,550
Noncash interest income and amortization of discounts on investments ........... (206) (3,425)
Provision for allowance for doubtful accounts .................................. 761 208
Provision for excess and obsolete inventory .................................... 33,302 1,475
Impairment of intangible assets ................................................ 32,551 --
Amortization of intangible assets and noncash compensation expense ............. 8,741 7,520
Write-off of in-process research and development ............................... 1,160 800
Gain (loss) on sale or disposal of other assets ................................ 56 (103)
Change in operating assets and liabilities:
Accounts receivable ......................................................... 2,804 (19,809)
Inventories ................................................................. (7,823) (15,140)
Prepaid expenses and other assets ........................................... 4,137 (9,222)
Accounts payable and accrued liabilities .................................... (23,983) 10,559
Deferred revenue ............................................................ (567) (559)
--------- ---------
Net cash used in operating activities ..................................... (44,168) (32,173)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment ............................................... (1,049) (7,961)
Purchases of short-term investments .............................................. (7,002) (155,108)
Purchases of other assets ........................................................ (1,186) (4,501)
Proceeds from maturities of short-term investments ............................... 47,285 58,831
Proceeds from sale of other assets ............................................... -- 128
Acquisition of businesses, net of cash acquired and purchased research and
development .................................................................... (169) (1,788)
--------- ---------
Net cash provided by (used in) investing activities ....................... 37,879 (110,399)
--------- ---------
Cash flows from financing activities:
Payment on lines of credit ....................................................... -- (1,529)
Proceeds from issuances of common stock, net ..................................... 216 145,576
Other ............................................................................ -- (612)
--------- ---------
Net cash provided by financing activities ................................. 216 143,435
--------- ---------
Net increase (decrease) in cash and cash equivalents ................................ (6,073) 863
Cash and cash equivalents, beginning of period ...................................... 47,307 13,405
--------- ---------
Cash and cash equivalents, end of period ............................................ $ 41,234 $ 14,268
========= =========
Noncash financing activities:
Common stock issued in connection with ActiveTelco acquisition in 2001 and
FreeGate and Xstreamis acquisitions in 2000, respectively ...................... $ 2,944 $ 41,118
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
NOTE 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 that enable high-speed data access over the copper
infrastructure of telephone companies, as well as the copper telephone wires in
residential and commercial multi-tenant buildings. The Company's products
incorporate high-bandwidth access multiplexers, associated modems and routers,
ethernet extension products and integrated network management software.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of presentation
The accompanying condensed consolidated financial statements as of
September 30, 2001 and December 31, 2000 and for the three months and nine
months ended September 30, 2001 and 2000 are unaudited. The unaudited interim
condensed consolidated 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 as of September 30, 2001 and
December 31, 2000, its results of operations for the three and nine months ended
September 30, 2001 and 2000 and its cash flows for the nine months ended
September 30, 2001 and 2000. These condensed consolidated financial statements
and the accompanying notes are unaudited and should be read in conjunction with
the Company's audited financial statements included in the Company's Annual
Report on Form 10-K, filed with the Securities and Exchange Commission on April
2, 2001. The balance sheet as of December 31, 2000 was derived from audited
financial statements but does not include all disclosures required by generally
accepted accounting principles. The results for the three months and nine months
ended September 30, 2001 are not necessarily indicative of the expected results
for any other interim period or the year ending December 31, 2001.
Concentrations
The Company operates in one business segment, designing, developing and
marketing advanced communications products that enable high-speed data access in
residential and commercial multi-tenant buildings. The market for high-speed
data access products is characterized by rapid technological developments,
frequent new product introductions, changes in end-user requirements and
constantly evolving industry standards. The Company's future success depends on
its ability to develop, introduce and market enhancements to its existing
products, to introduce new products in a timely manner that meet customer
requirements and to respond effectively to competitive pressures and
technological advances. Further, the emergence of new industry standards,
whether formally adopted by official standards committees or informally through
widespread use of such standards by telephone companies or other service
providers, could require the Company to redesign its products.
Currently, the Company relies on contract manufacturers and certain single
source suppliers of materials for certain product components. As a result,
should the Company's current manufacturers or suppliers not produce and deliver
inventory for the Company to sell on a timely basis, operating results could be
adversely impacted.
From time to time, the Company maintains a substantial portion of its cash
and cash equivalents in money market accounts with one financial institution.
The Company invests its excess cash in debt instruments of the U.S. Treasury,
governmental agencies and corporations with strong credit ratings. The Company
has established guidelines relating to diversification and maturities in order
to maintain the safety and liquidity of these assets. To date, the Company has
not experienced any significant losses on its cash equivalents or short-term
investments. However, at September 30, 2001, the Company held an investment in
commercial paper issued by Southern California Edison Company. This investment
is included in short-term investments at a carrying value of approximately $9.0
million, which matured in January 2001 and is currently in default. The Company
believes that the net realizable value of this investment cannot be practicably
determined as of September 30, 2001.
6
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting and
reporting standards for derivative instruments and hedging activities. It
requires an entity to recognize all derivatives as either assets or liabilities
in the balance sheet and measure those instruments at fair value. The Company
adopted SFAS No. 133 (as amended by SFAS No. 138) as required by SFAS No. 137,
"Deferral of the Effective Date of the FASB Statement No. 133," effective
January 1, 2001. To date, the Company has not engaged in derivative and hedging
activities. Accordingly the adoption of SFAS No. 133 did not have a material
impact on the financial statements.
In June 2001, the Emerging Issues Task Force ("EITF") issued EITF Issue No.
00-25, "Vendor Income Statement Characterization of Consideration Paid to a
Reseller of the Vendor's Products." EITF Issue No. 00-25 addresses whether
consideration from a vendor to a reseller is (a) an adjustment of the selling
prices of the vendor's products and, therefore, should be deducted from revenue
when recognized in the vendor's income statement or (b) a cost incurred by the
vendor for assets or services received from the reseller and, therefore, should
be included as a cost or expense when recognized in the vendor's income
statement. The Company will adopt EITF Issue No. 00-25 effective January 1,
2002. The adoption of EITF Issue No.00-25 is not expected to have a material
impact on the Company's financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes Accounting Principles Board
("APB") Opinion No. 17, "Intangible Assets." It addresses how intangible assets
that are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition. This Statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. The Company will adopt SFAS
No. 142 effective January 1, 2002. The adoption of SFAS No. 142 is not expected
to have a material impact on the Company's financial statements.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS No. 144 applies to all long-lived assets
(including discontinued operations) and consequently amends APB Opinion No. 30,
"Reporting the Results of Operations, Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS No. 144 develops one accounting model for
long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that
long-lived assets that are to be disposed of by sale be measured at the lower of
book value or fair value less cost to sell. Additionally SFAS No. 144 expands
the scope of discontinued operations to include all components of an entity with
operations that (1) can be distinguished from the rest of the entity and (2)
will be eliminated from the ongoing operations of the entity in a disposal
transaction. SFAS No. 144 is effective for the Company for all financial
statements issued in 2002. The adoption of SFAS No. 144 is not expected to have
a material impact on the Company's financial statements.
Reclassifications
Certain reclassifications have been made to prior period balances in order
to conform to the current period presentation.
7
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
NOTE 3 -- NET LOSS PER SHARE:
Basic and diluted net loss per share are computed using the weighted
average number of common shares outstanding. Stock options and restricted common
stock subject to repurchase were not included in the computation of diluted net
loss per share because the effect would be antidilutive.
The calculation of net loss per share follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
-------- ------- -------- -------
Net loss per share, basic and diluted:
Net loss ...................................................................... $(49,832) $ (611) $(97,800) $(6,027)
======== ======= ======== =======
Net loss per share, basic and diluted ......................................... $ (3.05) $ (0.04) $ (6.01) $ (0.42)
======== ======= ======== =======
Shares used in computing net loss per share, basic and diluted ................ 16,353 15,751 16,286 14,519
======== ======= ======== =======
Antidilutive securities not included in net loss per share calculations ....... 1,975 2,748 1,975 2,748
======== ======= ======== =======
NOTE 4 -- COMPREHENSIVE LOSS:
Accumulated other comprehensive loss includes unrealized gains and losses
and foreign currency translation adjustments that have been previously excluded
from net loss and reflected instead in stockholders' equity. The following table
sets forth the calculation of comprehensive loss:
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
-------- -------- -------- --------
Net loss ........................................... $(49,832) $ (611) $(97,800) $ (6,027)
-------- -------- -------- --------
Unrealized gains (losses) .......................... (77) 177 (122) 177
Foreign currency translation adjustments (4) (15) (19) (15)
-------- -------- -------- --------
Net change in other comprehensive loss ............. (81) 162 (141) 162
-------- -------- -------- --------
Total comprehensive loss ........................... $(49,913) $ (449) $(97,941) $ (5,865)
======== ======== ======== ========
NOTE 5 -- ACQUISITIONS:
a) ActiveTelco
On January 11, 2001, the Company acquired ActiveTelco, Inc. ("ActiveTelco")
for approximately $4,850, consisting of an aggregate of 321 shares of the
Company's Common Stock and 19 options to purchase shares of the Company's Common
Stock, acquisition related expenses consisting primarily of legal and other
professional fees, assumed ActiveTelco convertible notes in the amount of $650
plus accrued interest and other assumed liabilities of approximately $1,100.
This transaction was treated as a purchase for accounting purposes. ActiveTelco
provided an Internet telephony platform that enabled Internet and
telecommunications service providers to integrate and deliver Web-based
telephony applications such as unified messaging, long-distance service,
voicemail and fax delivery, call forwarding, call conferencing and callback
services.
8
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
The allocation of the purchase price was based on the estimated fair value
of goodwill of $3,248, assembled workforce of $442, and in-process research and
development of $1,160. The amount allocated to intangibles was determined based
on an appraisal using established valuation techniques. The purchased in-process
technology was expensed upon acquisition because technological feasibility had
not been established and no future alternative uses existed. The in-process
technology percentage of completion was estimated to be 75%. The value of this
in-process technology was determined by estimating the costs to develop the
purchased in-process technology into a commercially viable product, estimating
the resulting net cash flows from the sale of the product resulting from the
completion of the in-process technology and discounting the net cash flows back
to their present value. Research and development costs to bring in-process
technology from ActiveTelco to technological feasibility are not expected to
have a material impact on the Company's future results of operations or cash
flows.
b) ViaGate
On September 14, 2001, the Company acquired certain assets of ViaGate
Technologies, Inc. ("ViaGate") for $550 in cash and assumed liabilities of $46
for certain capital leases. The allocation of the purchase price was based on
the fair market value of the assets at the date of acquisition of property and
equipment of $5, and the estimated fair value of completed technology and
patents of $591.
NOTE 6 -- BALANCE SHEET COMPONENTS:
September 30, December 31,
2001 2000
----- ----
Short-term investments:
Commercial paper ................................ $ 9,000 $ 37,564
Corporate bonds ................................. 3,129 12,637
US government agency notes ...................... 3,082 5,106
-------- --------
$ 15,211 $ 55,307
======== ========
Inventories, net:
Finished goods .................................. $ 52,803 $ 43,151
Raw materials ................................... 3,488 6,889
-------- --------
56,291 50,040
Less: reserves .................................. (44,842) (13,755)
-------- --------
$ 11,449 $ 36,285
======== ========
Intangibles and other assets:
Goodwill(2) ..................................... $ 10,949 $ 34,298
Completed technology and patents(2) ............. 6,467 10,580
Assembled workforce(2) .......................... 1,816 3,300
-------- --------
19,232 48,178
Less: accumulated amortization .................. (14,680) (7,648)
-------- --------
Net intangibles(1) .............................. 4,552 40,530
Other(3) ........................................ 3,038 5,931
-------- --------
$ 7,590 $ 46,461
======== ========
Accrued liabilities:
Provision for loss on purchase commitments ...... $ 5,901 $ 19,042
Compensation .................................... 983 2,571
Other ........................................... 4,918 5,516
-------- --------
$ 11,802 $ 27,129
======== ========
_______________
(1) Net intangible assets of $4,552 is comprised entirely of completed
technology and patents, net of accumulated amortization.
9
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
(2) The Company recorded an impairment of intangible assets of $29,859 in the
third quarter of 2001 and an impairment of completed technology and patents
in the first quarter of 2001. Also, see Note 9, Restructuring Costs,
Impairment of Certain Intangible Assets and Provision for Inventory.
(3) Included in other assets is restricted cash of $1,604 (see Note 7) and
$3,248 as of September 30, 2001 and December 31, 2000, respectively.
NOTE 7 -- COMMITMENTS AND CONTINGENCIES:
Lease obligations
The Company leases office, manufacturing and warehouse space under
noncancelable operating leases that expire in 2007. In connection with business
combinations in 1999 and 2000, the Company assumed operating leases that expire
in December 2001 and August 2002.
The lease for the Pleasanton facility expires in April 2007, with an option
to renew for five years. Under the terms of the lease agreement, the Company was
required to issue a letter of credit in the amount of $1,850. The letter of
credit is reduced annually, beginning July 1, 2001, by approximately $250,
provided that we are not in default under the terms of the lease agreement.
Pursuant to these terms, our letter of credit was reduced from $1,850 to $1,600
in the third quarter of 2001. The letter of credit is collateralized by
restricted funds in the amount of $1,604, which are included in intangibles and
other assets as of September 30, 2001.
Purchase commitments
At September 30, 2001, the Company had noncancellable commitments to
purchase finished goods inventory totaling $2,032 in aggregate.
Contingencies
On July 12, 2001, a putative shareholder class action lawsuit, entitled
Yusty et al. v. Tut Systems, Inc., et al., Civil Action No. C-01-2659-JCS was
filed in the United States District Court for the Northern District of
California against Tut Systems and certain of its current and former officers.
Similar actions have been filed by other plaintiffs, including Streicher v. Tut
Systems, Inc., et al., Civil Action No. C-01-02757-MEJ, Huelsman v. Tut Systems,
Inc., et al., Civil Action No. C-01-2894, Waltershied v. Tut Systems, Inc., et
al., Civil Action No. C-01-2983, Atlas v. Tut Systems, Inc., et al., Civil
Action No. C-01-02999 and Lefkowitz v. Tut Systems, Inc., et al., Civil Action
No. C-01-3053. The complaints have been related. The complaints were filed on
behalf of a purported class of people who purchased Tut Systems stock during the
period between July 20, 2000 and January 31, 2001, seeking unspecified damages.
The complaints allege that the Company and certain of its current and former
officers made false and misleading statements about the Company's business
during the putative class period. Specifically, the complaints allege violations
of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Plaintiffs
have moved for consolidation and for appointment of lead plaintiff and lead
counsel.
On August 3, 2001, a complaint, Arrow Electronics, Inc. v. Tut Systems,
Inc., Case No. CV 800433, was filed in the Superior Court of the State of
California for the County of Santa Clara against Tut Systems. The Complaint was
filed by a supplier of Tut Systems and alleges causes of action for breach of
contract and for money on common counts. The Complaint seeks damages in the
amount of $10,469. There has been no discovery to date and no trial has yet been
scheduled. The Company denies liability and intends to defend itself vigorously.
The Company is also subject to legal proceedings, claims and litigation
arising in the ordinary course of business. The Company's management does not
expect that the ultimate costs to resolve these matters will have a material
adverse effect on the Company's consolidated financial position, results of
operations, or cash flows.
10
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
NOTE 8 -- SEGMENT INFORMATION:
The Company currently targets its sales and marketing efforts to both
public and private service providers and users across two related markets. The
Company currently operates in a single business segment because there is only
one measurement of profitability for its operations. Revenues are attributed to
the following countries based on the location of customers:
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------ ------ ------ ------
United States ............. $1,512 $22,549 $4,839 $39,876
International:
Denmark ................ 28 * 552 *
Japan .................. 1,758 * 4,838 *
Korea .................. * 498 * 12,791
All other countries .... 669 5,520 1,347 13,388
------ ------- ------- -------
$3,967 $28,567 $11,576 $66,055
====== ======= ======= =======
___________
* Revenue attributable to this country was less than 10% of total revenue and
any revenue attributable to this country is included in the "All other
countries" line.
It is impracticable for the Company to compute product revenues by product
type for the three and nine months ended September 30, 2001 and 2000.
Two customers, Kanematsu Computer System Ltd. and RIKEI Corporation,
accounted for 28% and 15%, respectively, of the Company's revenue for the three
months ended September 30, 2001 and for 21% and 16%, respectively, of the
Company's revenue for the nine months ended September 30, 2001. Two customers
Reflex Communications, Inc. and CAIS, Inc. accounted for 24% and 16%,
respectively, of the Company's revenue for the three months ended September 30,
2000. In addition, three customers, TriGem InfoComm Inc., Reflex Corporation,
Inc. and Darwin Networks, Inc. accounted for 19%, 13% and 12%, respectively, of
the Company's revenue for the nine months ended September 30, 2000.
NOTE 9 -- RESTRUCTURING COSTS, IMPAIRMENT OF CERTAIN INTANGIBLE ASSETS AND
PROVISION FOR INVENTORY:
Restructuring Costs
On April 23, 2001, the Company announced a restructuring program which
included a workforce reduction, closure of excess facilities, and disposal of
certain of its fixed assets. As a result of this restructuring program, the
Company recorded restructuring costs of $2,092. The following information
relates to restructuring costs which were recorded during the quarter ended June
30, 2001.
Workforce reduction. The restructuring program resulted in the reduction of
approximately 28% of the Company's employees, and the Company recorded a
workforce reduction charge of approximately $1,235 relating primarily to
severance and fringe benefits. In addition, the number of temporary and contract
workers employed by the Company was significantly reduced.
11
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(in thousands, except per share amounts)
Closure of excess facilities and disposal of fixed assets. The Company
recorded costs of restructuring of $785 relating to closure of excess
facilities. The closure of excess facilities included the closure of certain
satellite facilities due to workforce reductions and the Company's effort to
reduce operating expenses as a result of the restructuring. This cost of
restructuring is primarily comprised of non-cancelable lease and operating
costs. Other fixed assets retired as a result of the workforce reductions
totaled $72.
Cash expenditures relating to workforce reductions were paid in the three
months ended June 30, 2001. Amounts related to the closure of excess facilities
were accrued at June 30, 2001 and will be paid over the respective lease terms
through August 2002.
Also, see Note 11 Subsequent Events, regarding the Company's workforce
reduction that occurred in October 2001.
Impairment of Certain Intangible Assets
The Company evaluates the recoverability of its long-lived assets, goodwill
related to those assets, and enterprise goodwill in accordance with Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121").
SFAS 121 requires recognition of impairment of long-lived assets upon the
occurence of certain events and in the event that the net book value of such
assets exceeds the future undiscounted cash flows attributable to such assets.
The Company assesses the impairment of long-lived assets and related
goodwill periodically in accordance with the provisions of SFAS No. 121. An
impairment review is performed whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors considered
important which could trigger an impairment review include, but are not limited
to, significant underperformance relative to expected historical or projected
future operating results, significant changes in the manner of use of the
acquired assets of the strategy for the overall business, significant negative
industry or economic trends, a significant decline in the stock price for a
sustained period, and the market capitalization relative to net book value.
When management determines that the carrying value may not be recoverable
based upon the existence of one or more of the above indicators of impairment,
any impairment measured is based on a projected discounted cash flow method
using a discount rate commensurate with the risk inherent in the Company's
current business model.
Based on the impairment review performed during the third quarter of 2001,
the Company recorded a $29.9 million impairment charge to reduce goodwill and
other intangible assets. The charge was determined based upon estimated
discounted future cash flows using a discount rate of 20%. The assumptions
supporting future cash flows, including the discount rate, were determined using
management's best estimates. The underlying factors contributing to the decline
in expected future cash flows include a continued slowdown in the
telecommunications market, and more recently, the indefinite postponement of
capital expenditures, especially within the hospitality industry.
In addition, in the first quarter of 2001, the Company recorded a $2.7
million impairment charge to reduce completed technology and patents. This
resulted from the Company's decision not to pursue further incorporation of the
related OneGate product and other intellectual property acquired from FreeGate
into the design of future products.
12
TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(in thousands, except per share amounts)
Provision for Inventory
The Company recorded a provision for inventory totaling $18.5 million in
the first quarter of 2001, related to the costs of raw materials and finished
goods in excess of what the Company reasonably expected to sell in the
foreseeable future as of the first quarter of 2001. The Company recorded an
additional provision for inventory totaling $11.4 million during the third
quarter of 2001, related to the costs of raw materials and finished goods in
excess of revised protections of what the Company reasonably expected to sell in
the foreseeable future as of the third quarter of 2001. In accordance with the
Company's policy, declines in expected future revenue resulted in inventory
levels for certain products in excess of demand in the foreseeable near term.
NOTE 10 -- TENDER OFFER:
On May 14, 2001, the Company made an offer to exchange all stock options
outstanding under the Company's 1992 Stock Plan, 1998 Stock Plan and the 1999
Nonstatutory Stock Option Plan to purchase approximately 1,456 shares of the
Company's Common Stock, par value $0.001 per share, held by eligible employees
for new stock options that will be granted under the Company's 1998 Stock Plan
or the 1999 Nonstatutory Stock Option Plan, upon the terms and subject to the
conditions set forth in the Offer to Exchange. An "eligible employee" refers to
all employees of Tut Systems, Inc. and its U.S. subsidiaries who are employees
at the time the new stock options are granted, except all executive officers,
vice-presidents, members of the Board of Directors and employees receiving
Workers' Adjustment and Retraining Notification Act pay are not eligible to
participate in the offer. The number of shares of Common Stock subject to the
new stock options will be equal to the number of shares of Common Stock subject
to the unexercised stock options tendered by such eligible employees and
accepted for exchange and cancelled. The new stock options will be reissued at a
date at least six months and two days later than the date of cancellation. This
stock option exchange program required the filing of a tender offer statement.
Employees receiving such an offer were requested to read the Company's Form 10-Q
for the quarter ended March 31, 2001, a related offering memorandum and other
pertinent information before making any decision with respect to the offer.
Accounting and other regulatory concerns prevent or limit the Company's ability
to issue additional stock options to these employees during the period between
cancellation and reissuance.
This offer expired on June 8, 2001. Pursuant to the offer, the Company
accepted, for cancellation, stock options to purchase approximately 1,056 shares
of the Company's Common Stock. Subject to the terms and conditions of the offer,
the Company will grant new stock options to purchase shares of the Company's
Common Stock on December 13, 2001 to those employees who are employed at the
Company at that time in exchange for the stock options surrendered in the offer.
Based on those individuals who are employed at the Company as of October 30,
2001, we anticipate that the December 13, 2001 grant will total approximately
851 shares of the Company's Common Stock.
NOTE 11 -- SUBSEQUENT EVENTS:
On October 8, 2001, the Company further reduced its workforce by
approximately 11%. The restructuring charges related to terminating employees
are estimated to be approximately $0.2 million, which will be recorded in the
fourth quarter of 2001.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with the Condensed Consolidated
Financial Statements and the related Notes included elsewhere in this Quarterly
Report on Form 10-Q. This discussion contains, in addition to historical
information, forward-looking statements that involve risks and uncertainties
including but not limited to statements regarding customer and geographic mix,
gross margins, operating costs and expenses. Our 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 our Annual Report on
Form 10-K, as filed with the SEC on April 2, 2001, those discussed in our other
reports and filings with the SEC and those discussed under "Risk Factors"
elsewhere in this Quarterly Report on Form 10-Q. We disclaim any obligation to
update information contained in any forward-looking statement.
Overview
We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access to multi-tenant
buildings. We use our proprietary FastCopper technology to deliver
cost-effective, scalable and easy to deploy solutions that exploit the
underutilized bandwidth of copper telephone wires within these buildings. Our
collection of FastCopper technologies includes HomeRun, which was selected as
the initial specification for a home networking standard promoted by the
HomePNA, and LongRun, a proprietary extension of HomeRun providing superior
performance at longer distances. These technologies are deployed through our
Expresso high-bandwidth access multiplexers and associated routers. In addition
to our Expresso access multiplexers are our products that provide service
providers with enhanced capabilities such as subscriber management, bandwidth
management, IP address management, and network address translation. In the first
half of 2001, we introduced our IntelliPOP product line with our proprietary
Signature Switch technology. Our proprietary Signature Switch technology is
designed to allow service providers to manage and guarantee bandwidth and
service performance across applications such as IP telephony, VPN networking,
videoconferencing, video-on-demand, file transfer and Internet access, and to
efficiently configure IntelliPOP for the delivery of these services according to
the unique market requirements of multi-tenant building owners and end-user
subscribers on an individual or collective basis. Our systems and related
services are designed with the specific requirements of the multi-tenant unit,
or MTU, market in mind and enable service providers in this market to increase
their revenue by providing additional services and increase customer retention
through bundled service offerings. With the recent introduction of our
IntelliPOP 8000 series, our products now include a highly-scalable, carrier
class, full service gateway built on standards-based asynchronous transfer mode
("ATM"), Internet Protocol ("IP") telephony and very high speed DSL ("VDSL")
based technologies that enable service providers to leverage the power of fiber
optic networks.
We commenced operations in August 1991. Through the third quarter of 1998,
substantially all of our revenue was derived from the sale of our XL Ethernet
LAN extension products to the corporate and university segments of the
multi-tenant commercial unit or MCU market. In early 1997, we introduced the
first products in our Expresso product line aimed at service provider markets.
During the first quarter of 1998, we began licensing our HomeRun technology to
certain leading semiconductor, computer hardware and consumer electronics
manufacturers for incorporation into integrated circuits and consumer products
including PCs, peripherals, modems and other Internet appliances. In the third
and fourth quarters of 1998, we commenced selling our Expresso GS products,
which are configured for local loop applications, and Expresso MDU products,
which incorporate our HomeRun technology to a broader range of service
providers, primarily those serving apartment complexes, hotels, university
dormitories and military complexes in the multi-dwelling unit or MDU market. In
the first quarter of 1999, we commenced selling Expresso MDU products
incorporating our LongRun technology and Expresso MDU Lite into additional
segments of the MDU market. During the fourth quarter of 1999, we commenced
selling our Expresso SMS 2000 and companion Expresso OCS system providing
subscriber management, bandwidth management, credit card billing and other
functions to the MDU market. In the first half of 2001, we commenced selling our
new IntelliPOP product. We recently introduced our first optical-input,
chassis-based product suitable for the neighborhood dwelling units or NDU
market.
We generate revenue primarily from the sale of hardware products and, to a
lesser extent, through the licensing of our HomeRun technology and the sale of
our software products. We generally recognize product revenue when
14
persuasive evidence of an arrangement exists, delivery has occurred, the fee is
fixed or determinable, and collectibility is probable. Revenue from service
obligations included in product revenues is deferred and generally recognized
ratably over the period of the obligation. We also maintain accruals and
allowances for all cooperative marketing and other programs. Estimated sales
returns and warranty costs are based on historical experience and are recorded
at the time revenue is recognized. Our products generally carry a one year
warranty from the date of purchase.
License and royalty revenue consists of nonrefundable up-front license
fees, some of which may offset initial royalty payments, and royalties.
Currently, the majority of our license and royalty revenue is comprised of
non-refundable license fees paid in advance. Such revenue is 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 revenue is expected to consist primarily of royalties based
on products sold by our licensees. We do not expect that such license and
royalty revenue will constitute a substantial portion of our revenue in future
periods. With the introduction of our IntelliPOP product line, we expect that
revenue from the sale of software products and maintenance fees will constitute
a substantial portion of revenue in future periods.
We may incur sales price reductions on some of our products to remain
competitive and to reduce our relatively high levels of inventory. Although we
have historically been able to offset most price declines with reductions in our
manufacturing costs, there can be no assurance that we will be able to offset
further price declines with cost reductions. Also, market developments,
including the writedown of significant amounts of inventory by competitors and
products resold as a result of bankruptcies within the industry, may put
increased pressure on the sales price of our existing inventories. In addition,
some of our licensees may sell products based on our technology to our
competitors or potential competitors. There can be no assurance that our 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 our
products.
Sales to customers outside of the United States accounted for approximately
58.2% and 39.6% of revenue for the nine months ended September 30, 2001 and
2000, respectively. On average, we expect international sales to represent
approximately 50% or more of our revenue in future periods. However, actual
results, both geographically and in absolute dollars, may vary from quarter to
quarter depending on the timing of orders placed by customers. To date, all
international sales have been denominated in U.S. dollars.
We expect to continue to evaluate product line expansion and new product
opportunities, engage in research, development and engineering activities and
focus on cost-effective design of our products. Accordingly, we will continue to
make significant expenditures on research and development activities as a
percentage of overall operating expenses.
In February 2000, we acquired FreeGate Corporation ("FreeGate") for
approximately $25.5 million, consisting of 510,931 shares of our Common Stock,
19,707 options to acquire shares of our Common Stock, and acquisition related
expenses consisting primarily of investment advisory, legal, other professional
fees and other assumed liabilities. This transaction was treated as a purchase
for accounting purposes. FreeGate was located in Sunnyvale, California. FreeGate
designed, developed and marketed Internet server appliances combining the
functions of IP routing, firewall security, network address translation, secure
remote access via VPN networking, and email and web servers on a compact,
PC-based platform.
In April 2000, we acquired certain assets of OneWorld Systems, Inc.
("OneWorld") for approximately $2.4 million in cash. This transaction was
treated as a purchase of assets for accounting purposes.
In May 2000, we acquired Xstreamis Limited ("Xstreamis"), formerly
Xstreamis, plc, for $19.6 million, consisting of 439,137 shares of our Common
Stock, 10,863 options to acquire shares of our Common Stock, $0.1 million in
cash and $0.6 million in acquisition related expenses consisting primarily of
legal and other professional fees. This transaction was treated as a purchase
for accounting purposes. Xstreamis was located in the United Kingdom. Xstreamis
provided policy-driven traffic management for high-performance, multimedia
networking solutions including routing, switching and bridging functions.
15
In January 2001, we acquired ActiveTelco, Inc. ("ActiveTelco") for
approximately $4.9 million, consisting of an aggregate of 321,343 shares of our
Common Stock and 18,657 options to purchase shares of our Common Stock and
acquisition related expenses consisting primarily of legal and other
professional fees, assumed ActiveTelco convertible notes in the amount of $0.7
million plus accrued interest and other assumed liabilities of approximately
$1.1 million. This transaction was treated as a purchase for accounting
purposes. ActiveTelco was located in Fremont, California. ActiveTelco provided
an Internet telephony platform that enabled Internet and telecommunications
service providers to integrate and deliver Web-based telephony applications such
as unified messaging, long-distance service, voicemail and fax delivery, call
forwarding, call conferencing and callback services.
In September 2001, we acquired certain assets, including some intellectual
property rights, from ViaGate Technologies, Inc. ("ViaGate") for approximately
$0.6 million in cash. This transaction was treated as a purchase of assets for
accounting purposes. The acquired patents and technology of ViaGate provide a
highly scalable, carrier-class, full service gateway built on standards-based
ATM, IP and VDSL technology.
While we expect to derive benefits from sales of product lines that are
designed, developed and marketed as a result of these acquisitions, there can be
no assurance that we will be able to complete the development and commercial
deployment of certain of these products. In January 2001, we decided to abandon
future sales of the existing OneGate product that we acquired in the FreeGate
acquisition. In April 2001, as part of our cost reduction efforts, we decided
not to pursue further incorporation of the related OneGate and other
intellectual property acquired from FreeGate into the design of future products.
As a result, we took a writedown for abandonment of the related completed
technology and patents of $2.7 million in the first quarter of 2001. During the
impairment review for the third quarter of 2001, we evaluated the present value
of future expected cash flows to determine the fair value of purchased
intangibles. This evaluation resulted in a writedown of $29.9 million of
goodwill and other intangible assets. The underlying factors contributing to the
decline in expected future cash flows include a continued decline in the
telecommunications industry and the indefinite postponement of capital
expenditures, especially within the hospitality industry.
In January 2001 and April 2001, we reduced our total workforce by 10% and
28%, respectively, in an effort to control overall operating expenses in
response to recent declines and expected slower growth in our sales. In April
2001, we also implemented plans to close several of our satellite offices. We
incurred restructuring charges of $2.1 million related to the April 2001
restructuring plan. In October 2001, we again reduced our total workforce by 11%
in an effort to further control overall operating expenses, which is expected to
result in restructuring charges of approximately $0.2 million.
We have incurred net operating losses to date and, as of September 30,
2001, had an accumulated deficit of $228.4 million. Our ability to generate
income from operations will be primarily dependent on increases in sales volume,
reductions in manufacturing costs and the growth of high-speed data access
solutions in the service provider and MTU markets. In view of our limited
history of product revenue from new markets, our reliance on growth in
deployment of high-speed data access solutions and the unpredictability of
orders and subsequent revenue, we believe that period-to-period comparisons of
our financial results are not necessarily meaningful and should not be relied
upon as an indication of future performance. Failure to generate significant
revenue from existing or new products, whether due to lack of market acceptance,
competition, technological change or otherwise, or the inability to reduce
manufacturing costs, will harm our business, financial condition and results of
operations.
16
Results of Operations
The following table sets forth items from our statements of operations as a
percentage of total revenue for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2001 2000 2001 2000
--------- -------- -------- --------
Total revenues ............................... 100.0% 100.0% 100.0% 100.0%
Total cost of goods sold ..................... 368.4 52.7 336.1 53.6
--------- -------- -------- --------
Gross (loss) margin ....................... (268.4) 47.3 (236.1) 46.4
--------- -------- -------- --------
Operating expenses:
Sales and marketing ....................... 69.8 19.5 87.2 23.0
Research and development .................. 76.3 17.3 102.0 18.4
General administrative .................... 40.7 11.8 67.1 12.2
Restructuring costs ....................... -- -- 18.1 --
In-process research and development ....... -- -- 10.0 1.2
Impairment of intangibles ................. 752.7 -- 281.2 --
Amortization of intangibles ............... 64.6 8.8 67.2 7.7
Noncash compensation expense .............. 1.5 0.4 1.6 0.5
--------- -------- -------- --------
Total operating expenses ............. 1,005.6 57.8 634.4 63.1
--------- -------- -------- --------
Loss from operations ......................... (1,274.0) (10.5) (870.5) (16.7)
Interest expense ............................. (0.1) -- (0.1) (0.7)
Interest income .............................. 17.7 8.4 24.7 8.3
Other income, net ............................ 0.3 -- 1.0 --
--------- -------- -------- --------
Loss before income taxes ..................... (1,256.1) (2.1) (844.9) (9.1)
Income tax expense ........................... -- -- -- --
--------- -------- -------- --------
Net loss ..................................... (1,256.1)% (2.1)% (844.9)% (9.1)%
========= ======== ======== ========
Three and Nine Months Ended September 30, 2001 and 2000
Revenue. We generate revenue primarily from the sale of hardware products
and, to a lesser extent, through the licensing of our HomeRun technology and
from the sale of software products. Our total revenue decreased to $4.0 million
and $11.6 million for the three and nine months ended September 30, 2001,
respectively from $28.6 million and $66.1 million for the three and nine months
ended September 30, 2000, respectively. The decreases in 2001, when compared to
the same periods in 2000, were primarily due to decreased sales of our Expresso
MDU products. The market for our products was markedly different in the first
nine months of 2001 as compared to the first nine months of 2000. During the
fourth quarter of 2000, our revenue growth slowed substantially due to (i)
several key customers who, in the latter part of the fourth quarter, experienced
a rapid deterioration in their ability to obtain additional capital and, as a
result, severely curtailed or halted their purchases of our product, and (ii)
reduced sales volume in the Korean market. These developments were not unique to
us and have continued in conjunction with a general downturn in the
telecommunications market throughout the first nine months of 2001, affecting
our ability to generate comparatively similar levels of sales. In certain
instances, these developments have made collection of receivables less certain.
License and royalty revenue decreased to $0.2 million and $0.7 million for the
three and nine months ended September 30, 2001, respectively, from $0.6 million
and $1.6 million for the three and nine months ended September 30, 2000,
respectively. The decreases in 2001 when compared to the same periods in 2000
were primarily due to decreases in royalty payments, as a result of recent
economic conditions affecting the telecommunications market.
Cost of Goods Sold/Gross (Loss) 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.
Excluding the reserves for excess and obsolete inventory of $18.5 million taken
in the first quarter of 2001 and $11.4 million taken in the third quarter of
2001, our cost of goods sold decreased to $3.2 million and $9.0 million for the
three and nine months ended September 30, 2001, respectively, from $15.1 million
and $35.4 million for the three and nine months ended September 30, 2000,
respectively. The decreases in 2001, when compared to the same periods in 2000,
were primarily due to decreased sales of our Expresso MDU products. Gross margin
before
17
such reserves as a percentage of revenue, decreased to 19.6% and 22.4% of
revenue for the three and nine months ended September 30, 2001, respectively,
from 47.3% and 46.4% of revenue for three and nine months ended September 30,
2000, respectively. The decreases in gross margin, before such reserves as a
percentage of revenue in the first nine months of 2001 were due primarily to
sales price reductions on some of our Expresso MDU products in response to
competitive pricing pressures and to a lesser extent to fixed manufacturing
costs that could not be reduced proportionately in relation to the decreased
revenue in the first nine months of 2001. During the first quarter of 2001, we
recorded a reserve for excess and obsolete inventory of $18.5 million. This
reserve was primarily related to the costs of raw materials and finished goods
in excess of what we reasonably expected to sell in the foreseeable future as of
the first quarter of 2001. During the third quarter of 2001, we recorded an
additional reserve for excess inventory of $11.4 million. This reserve is
primarily related to the costs of raw materials and finished goods in excess of
revised projections of what we reasonably expect to sell in the foreseeable
future. Market developments over the past year, including the writedown of
significant amounts of inventory by competitors and products resold as a result
of bankruptcies within the industry, continued slowdown in the
telecommunications market and more recently, the indefinite postponement of
capital expenditures, especially within the hospitality industry, have
contributed to substantial uncertainties related to the value of these
inventories. The charge was included in cost of goods sold resulting in an
overall negative gross margin of (268.4)% and (236.1)% for the three and nine
months ended September 30, 2001, respectively.
Sales and Marketing. Sales and marketing expense primarily consists of
personnel costs, including commissions and costs related to customer support,
travel, trade shows, promotions, and outside services. Our sales and marketing
expenses decreased to $2.8 million and $10.1 million for the three and nine
months ended September 30, 2001, respectively, from $5.6 million and $15.2
million for the three and nine months ended September 30, 2000, respectively.
The decreases in 2001, when compared to the same periods in 2000, were primarily
due to our scaling back of our marketing programs as a cost saving measure in
light of the current market conditions and, to a lesser degree, to reduced
commission expense on lower revenue in the first nine months of 2001. Sales and
marketing expenses decreased in absolute dollars in the third quarter of 2001,
as compared to the second quarter of 2001, and we expect these expenses to
continue to decrease in the fourth quarter of 2001 as a result of our workforce
reduction in April 2001 and our continued focus on cost saving measures.
Research and Development. Research and development expense primarily
consists 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. Our research and
development expenses decreased to $3.0 million and $11.8 million for the three
and nine months ended September 30, 2001, respectively, from $5.0 million and
$12.2 million the three and nine months ended September 30, 2000, respectively.
The decreases in 2001, when compared to the same periods in 2000, were primarily
a result of our workforce reduction in April 2001 and our continued focus on
cost saving measures, including the scale-back, postponement or abandonment of
research and development efforts on certain of our product lines. The slight
decrease year over year for the nine month period was mostly offset by the
higher headcount in the first nine months of 2001 due to the fiscal 2000
acquisitions of FreeGate, OneWorld assets and Xstreamis, all of which were not a
part of Tut in the entire first nine months of 2000 and the first quarter of
2001 acquisition of ActiveTelco. Additionally, in the first nine months of 2001,
we amortized $0.8 million of deferred compensation and notes receivable related
to restricted stock granted to certain FreeGate, OneWorld and ActiveTelco
employees to research and development. Approximately $0.3 million of the
remaining deferred compensation and notes receivable have been recorded as a
reduction of equity in the balance sheet. We intend to recognize the expense
ratably over the remaining period in which the repurchase rights on this
restricted stock lapse, currently estimated at one and ten months for each of
OneWorld and ActiveTelco, respectively. All of the deferred compensation and
notes receivable for FreeGate have been fully amortized as of September 30,
2001. Research and development expenses decreased in absolute dollars in the
third quarter of 2001 as compared to the second quarter of 2001 as a result of
our cost saving measures. We expect research and development activities to
represent a significant percentage of our overall fixed operating expenses in
the fourth quarter of 2001.
General and Administrative. General and administrative expense primarily
consists of personnel costs for administrative officers and support personnel,
legal, accounting, insurance and consulting fees. Our general and administrative
expenses decreased to $1.6 million and $7.8 million for the three and nine
months ended September 30, 2001, respectively, from $3.4 million and $8.1
million for the three and nine months ended September 30, 2000, respectively.
The decreases in 2001, when compared to the same periods in 2000, were primarily
a result of our
18
workforce reduction in April 2001, recovery of bad debt and our continued focus
on cost saving measures. The increase year over year for the nine month period
was mostly offset by the higher insurance and professional fees in the first
nine months of 2001 when compared to the first nine months of 2000. General and
administrative expenses decreased in absolute dollars in the third quarter of
2001 when compared to the second quarter of 2001, primarily due to significant
headcount reductions, reduced consulting expenses, reduced bad debt expenses and
a strong focus on cost cutting measures. We anticipate these expenses will
increase in the fourth quarter of 2001 due to the fact that we do not expect bad
debt recovery in the fourth quarter of 2001. In the second and third quarters,
this bad debt recovery represented $0.8 million and $1.0 million respectively.
The anticipated increase will be offset by the October 2001 reduction in our
general and administrative headcount and our continued focus on cost saving
measures in the fourth quarter of 2001.
Restructuring Costs. On April 23, 2001, we announced a restructuring
program which included a workforce reduction, closure of excess facilities, and
disposal of certain fixed assets. As a result of this restructuring program, we
recorded restructuring costs of $2.1 million in the second quarter of 2001.
These restructuring costs were comprised of $1.2 million in workforce reduction
charges relating primarily to severance and fringe benefits, $0.8 million
relating to closure of excess facilities and $0.1 million in other fixed assets
retired as a result of the workforce reductions. There were no such expenses
incurred in the three month period ended September 30, 2001 or the three and
nine month periods ended September 30, 2000. In October 2001, we again reduced
our total workforce by 11% in an effort to further control overall operating
expenses, which is expected to result in restructuring costs during the fourth
quarter of 2001 of approximately $0.2 million.
In-Process Research and Development. Amounts expensed as in-process
research and development for the nine months ended September 30, 2001 and 2000
were $1.2 million and $0.8 million, respectively, and were related to in-process
research and development purchased from ActiveTelco and FreeGate, respectively.
There were no such expenses incurred for the three months ended September 30,
2001 and 2000.
In-Process Research and Development, ActiveTelco. Amounts expensed as
in-process research and development were $1.2 million for the nine months
ended September 30, 2001 and were related to in-process research and
development purchased from ActiveTelco during the first quarter of 2001.
The purchased in-process technology was expensed upon acquisition because
technological feasibility had not been established and no future
alternative uses existed. The in-process technology percentage of
completion was estimated to be 75%. The value of this in-process technology
was determined by estimating the costs to develop the purchased in-process
technology into a commercially viable product, estimating the net cash
flows from the sale of the product after the completion of the in-process
technology and discounting the net cash flows back to their present value
using a risk-weighted discount rate of 30%. Research and development costs
to bring in-process technology from ActiveTelco to technological
feasibility are not expected to have a material impact on our future
results of operations or cash flows.
In-Process Research and Development, FreeGate. Amounts expensed as
in-process research and development were $0.8 million for the nine months
ended September 30, 2000 and were related to in-process research and
development purchased from FreeGate during the first quarter of 2000. The
purchased in-process technology was expensed upon acquisition because
technological feasibility had not been established and no future
alternative uses existed. The in-process technology percentage of
completion was estimated to be 75%. The value of this in-process technology
was determined by estimating the costs to develop the purchased in-process
technology into a commercially viable product, estimating the net cash
flows from the sale of the product after the completion of the in-process
technology and discounting the net cash flows back to their present value
using a risk-weighted discount rate of 30%. In April 2001, as part of our
cost reduction efforts, we decided not to pursue further incorporation of
the related OneGate and other intellectual property acquired from FreeGate
into the design of future products.
Impairment of Intangibles. Based on the impairment review performed during the
third quarter of 2001, we recorded a $29.9 million impairment charge to reduce
goodwill and other intangible assets. The charge was determined based upon
estimated discounted future cash flows using a discount rate of 20%. The
assumptions supporting future cash flows, including the discount rate, were
determined using management's best estimates. The underlying factors
contributing to the decline in expected future cash flows include a continued
slowdown in the telecommunications market, and more recently, the indefinite
postponement of capital expenditures, especially
19
within the hospitality industry. In the first quarter of 2001, we recorded a
$2.7 million impairment charge to reduce completed technology and patents. This
resulted from our decision not to pursue further incorporation of the related
OneGate product and other intellectual property acquired from FreeGate into the
design of future products. Total impairment of intangibles was $29.9 million and
$32.6 million for the three and nine months ended September 30, 2001. There were
no such impairments for the three and nine months ended September 30, 2000.
Amortization of Intangibles. Amortization of intangibles is comprised of
the amortization of intangible assets related to the purchase acquisitions of
Vintel, FreeGate, OneWorld assets, Xstreamis and ActiveTelco. These intangible
assets consisted primarily of assembled workforce, completed technology and
patents, and goodwill, and each are amortized over their estimated useful lives
of three, five and five years, respectively. Amortization of intangibles was
$2.6 million and $7.8 million for the three and nine months ended September 30,
2001, respectively, compared to $2.5 million and $5.1 million for the three and
nine months ended September 30, 2000, respectively. The increases in 2001, when
compared to the same periods in 2000, relate to the amortization of intangibles
during the three and nine months ended September 30, 2001 related to the Vintel,
FreeGate, OneWorld assets, Xstreamis and ActiveTelco acquisitions. The first
nine months of 2000 include only the amortization of intangibles related to the
November 1999 acquisition of Vintel and partial amortization of intangibles
related to the February 2000 acquisition of FreeGate, the April 2000 acquisition
of OneWorld assets and the May 2000 acquisition of Xstreamis. We expect a
significant decrease in amortization of intangibles due to the impairment of
these intangibles of $2.7 million recorded in the first quarter of 2001 and
$29.9 million recorded in the third quarter of 2001.
Noncash Compensation Expense. Noncash compensation expense for the three
and nine months ended September 30, 2001 and 2000 consisted of the recognition
of expense related to certain employee stock option grants, based on the
difference between the deemed fair value of our Common Stock and the stock
option exercise price at the date of grant. Our noncash compensation expense was
$0.06 million and $0.2 million for the three and nine months ended September 30,
2001, respectively, as compared to $0.1 million and $0.3 million for the three
and nine months ended September 30, 2000, respectively. As of September 30,
2001, we have recognized all of the expenses related to these employee stock
options.
Interest Expense. Interest expense consisted of interest expense associated
with our leases in the first half of 2001 and our credit facilities in the first
half of 2000. Our interest expense was nominal for the three and nine months
ended September 30, 2001, and was nominal for the three months ended September
30, 2000. Our interest expense was $0.5 million for the nine months ended
September 30, 2000. The decrease in the nine months ended September 30, 2001,
when compared to the same period in 2000, was primarily due to our paying off
the principal owed on our credit facilities in June 2000.
Interest Income. Interest income consisted of interest income on our cash,
investments and notes receivable balances, offset by the amortization of
premiums paid on investments. Our interest income decreased to $0.7 million and
$2.9 million for the three and nine months ended September 30, 2001,
respectively, from $2.4 million and $5.5 million for three and nine months ended
September 30, 2000, respectively. The decreases in 2001, when compared to the
same periods in 2000, were primarily due to lower interest income on lower
average cash and investment balances.
Other Income, Net. Other income, net consisted of gain (loss) on the
disposal of fixed assets, sale of other assets and foreign exchange gains
(losses). Our other income, net was nominal for the three months ended September
30, 2001 and was $0.1 million for the nine months ended September 30, 2001.
Liquidity and Capital Resources
In March 2000, we completed our secondary offering and issued 2,500,000
shares of our Common Stock at a price of $60.00, and we received approximately
$141.7 million in cash, net of underwriting discounts, commissions and other
offering costs.
As of September 30, 2001, we had cash, cash equivalents, and short-term
investments of $56.4 million, compared to $102.6 million as of December 31,
2000.
20
The net decrease in cash and cash equivalents of $6.1 million during the
nine months ended September 30, 2001 resulted primarily from short-term
investments of $47.3 million that matured and $0.2 million in proceeds from the
issuance of our Common Stock related to stock options and purchases of stock
through our stock purchase plan. The increases in cash and cash equivalents from
these sources were offset by uses in operating activities of $44.2 million,
purchases of short-term investments of $7.0 million, $1.0 million for the
purchase of property and equipment, the purchase of other assets of $1.2
million, which includes the acquisition of certain ViaGate assets for $0.6
million, and $0.2 million in acquisition costs related to ActiveTelco.
The net increase in cash and cash equivalents of $0.9 million during the
nine months ended September 30, 2000 resulted primarily from net proceeds of our
secondary offering of $141.7 million, $58.8 million in proceeds from short-term
investments that matured, $3.9 million in proceeds from the issuance of our
Common Stock related to stock options and purchases of stock through our stock
purchase plan and $0.1 million in proceeds from the sale of other assets. The
increases in cash and cash equivalents from these sources were offset by
purchases of short-term investments of $155.1 million, uses in operating
activities of $32.2 million, the purchase of other assets of $4.5 million, which
includes the acquisition of OneWorld assets for $2.4 million, $8.0 million for
the purchase of property and equipment, $1.8 million in acquisition costs for
FreeGate and Xstreamis, $1.5 million to repay borrowings under a credit facility
and $0.6 million for other financing activities.
In the first quarter of 2000, we entered into a lease for administrative
and engineering facilities in Pleasanton, California. Under the terms of the
lease, we were required to issue a letter of credit in the amount of $1.9
million. The letter of credit is reduced annually, beginning July 1, 2001, by
approximately $0.3 million, provided that we are not in default under the terms
of the lease agreement. Pursuant to these terms, our letter of credit was
reduced from $1.9 million to $1.6 million in the third quarter of 2001. The
letter of credit is collateralized by restricted funds in the amount of $1.6
million, which are included in intangibles and other assets as of September 30,
2001.
For future periods, we generally anticipate a decrease in working capital
expenditures on a period-to-period basis primarily as a result of making
substantial payments towards purchase commitments for inventory and general
decreases in our operational costs due to our recent workforce reductions.
We believe that our cash, cash equivalents and short-term investment
balances will be sufficient to satisfy our cash requirements for at least the
next 12 months.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. It requires an
entity to recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value. We adopted SFAS No.
133 (as amended by SFAS No. 138) as required by SFAS No. 137, "Deferral of the
Effective Date of the FASB Statement No. 133," effective January 1, 2001. To
date, we have not engaged in derivative and hedging activities, and accordingly
the adoption of SFAS No. 133 did not have a material impact on our financial
statements.
In June 2001, the EITF issued EITF Issue No. 00-25, "Vendor Income
Statement Characterization of Consideration Paid to a Reseller of the Vendor's
Products." EITF Issue No. 00-25 addresses whether consideration from a vendor to
a reseller is (a) an adjustment of the selling prices of the vendor's products
and, therefore, should be deducted from revenue when recognized in the vendor's
income statement or (b) a cost incurred by the vendor for assets or services
received from the reseller and, therefore, should be included as a cost or
expense when recognized in the vendor's income statement. We will adopt EITF
Issue No. 00-25 effective January 1, 2002. The adoption of EITF Issue No. 00-25
is not expected to have a material impact on our financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets." It addresses how intangible assets that are acquired
individually or with a group of other assets (but not those acquired in a
business combination) should be accounted for in financial statements upon their
acquisition. This Statement also addresses how goodwill and other intangible
assets should be accounted for after
21
they have been initially recognized in the financial statements. We will adopt
SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 142 is not
expected to have a material impact on our financial statements.
On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS No. 144 applies to all long-lived assets
(including discontinued operations) and consequently amends APB Opinion No. 30,
"Reporting the Results of Operations, Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." SFAS No. 144 develops one accounting model for
long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that
long-lived assets that are to be disposed of by sale be measured at the lower of
book value or fair value less cost to sell. Additionally SFAS No. 144 expands
the scope of discontinued operations to include all components of an entity with
operations that (1) can be distinguished from the rest of the entity and (2)
will be eliminated from the ongoing operations of the entity in a disposal
transaction. SFAS No. 144 is effective for all of our financial statements
issued in 2002. The adoption of SFAS No. 144 is not expected to have a material
impact on our financial statements.
22
Risk Factors
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, TOGETHER WITH ALL
OF THE OTHER INFORMATION INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q, BEFORE
MAKING AN INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE
NOT THE ONLY ONES FACING US. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY
KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS
OPERATIONS. THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS "FORWARD-LOOKING"
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH BELOW AND ELSEWHERE IN THIS
QUARTERLY REPORT ON FORM 10-Q.
We have a history of losses and expect future losses.
We have incurred substantial net losses and experienced negative cash flow
each quarter since our inception. We incurred net losses of $97.8 million for
the nine months ended September 30, 2001 and $74.1 million for the year ended
December 31, 2000. As of September 30, 2001, we had an accumulated deficit of
$228.4 million. We expect that we will continue to incur losses in the fourth
quarter of 2001, and we will likely incur losses in future periods as well.
We may never achieve profitability and if we do so, we may not be able to
maintain profitability. We have spent substantial amounts of money on the
development of our Expresso products, HomeRun technology, IntelliPOP product and
software products. We intend to continue decreasing and closely maintaining
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. Our ability
to increase revenue or achieve profitability in the future will primarily depend
on our ability to increase sales of our Expresso products (including selling
excess Expresso inventories), successfully launch our IntelliPOP product, reduce
manufacturing costs, sell excess component parts obtained as a result of
canceled purchase commitments and successfully introduce and sell enhanced
versions of our existing and new products.
A number of factors could cause our quarterly and annual financial results
to be worse than expected, which could result in a decline in our stock price.
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:
. availability of capital in the network infrastructure industry;
. market acceptance of our products;
. competitive pressures, including pricing pressures from our partners and
competitors, particularly in light of recent announcements from
competitors that they plan to take significant writedowns in inventory,
which could lead to a general excess of competitive products in the
marketplace;
. 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 that we offer;
. changes in the pricing policies of our suppliers;
23
. the availability and cost of key components; and
. the timing of personnel hiring.
We anticipate that average selling prices for our products will decrease in
the near future due to increased competitive price pressures in certain
geographical regions. In addition, 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. Decreasing the average selling prices of our
products could cause us to experience decreased revenue despite an increase in
the number of units sold. We cannot assure you that we will be able to sustain
our gross margins (even at the anticipated reduced levels), improve our gross
margins by offering new products or increased product functionality, or 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 price of our Common Stock would
likely further decline.
Purchases by past customers have decreased dramatically, and we must establish a
new base of customers.
Many of our past customers have significantly reduced or, in some cases,
have no access to capital and are experiencing significant financial
difficulties, including bankruptcy. Two customers, Kanematsu Computer System
Ltd. and RIKEI Corporation, accounted for 28% and 15%, respectively, of the
Company's revenue for the three months ended September 30, 2001 and for 21% and
16%, respectively, of the Company's revenue for the nine months ended September
30, 2001. Two customers, Reflex Communications, Inc. and CAIS, Inc. accounted
for 24% and 16%, respectively, of the Company's revenue for the three months
ended September 30, 2000, and three customers, TriGem InfoComm, Inc., Reflex
Corporation, Inc. and Darwin Networks, Inc. accounted for 19%, 13% and 12%,
respectively, of the Company's revenue for the nine months ended September 30,
2000. In order to meet our revenue targets, we must continue to acquire new
customers and increase sales to our existing customers. Our strategy of
targeting larger, more established customers may result in longer sales cycles
and delayed revenue. Sales to larger accounts could also result in increased
competition from larger and better established competitors.
We are currently engaged in a securities class action lawsuit and a lawsuit with
one of our suppliers, either of which, if it results in an unfavorable
resolution, could adversely affect our business, results of operations or
financial condition.
On July 12, 2001, a putative shareholder class action lawsuit, entitled
Yusty et al. v. Tut Systems, Inc., et al., Civil Action No. C-01-2659-JCS was
filed in United States District Court for the Northern District of California
against us and certain of our current and former officers. Similar actions have
been filed by other plaintiffs, including Streicher v. Tut Systems, Inc., et
al., Civil Action No. C-01-02757-MEJ, Huelsman v. Tut Systems, Inc., et al.,
Civil Action No. C-01-2894, Waltersheid v. Tut Systems, Inc., et al, Civil
Action No. C-01-2983, Atlas v. Tut Systems, Inc., et al., Civil Action No.
C-01-2999 and Lefkowitz v. Tut Systems, Inc., et al., Civil Action No.
C-01-3053. The complaints have been related. The complaints were filed on behalf
of a purported class of people who purchased our stock during the period between
July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints
allege that we and certain of our current and former officers made false and
misleading statements about our business during the putative class period.
Specifically, the complaints allege violations of Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934. Plaintiffs have moved for consolidation and
for appointment of lead plaintiff and lead counsel. An unfavorable resolution of
this litigation could have a material adverse effect on our business, results of
operations, or financial condition.
On August 3, 2001, a complaint, Arrow Electronics, Inc. v. Tut Systems,
Inc., Case No. CV 800433, was filed in the Superior Court of the State of
California for the County of Santa Clara against Tut Systems. The Complaint was
filed by one of our suppliers and alleges causes of action for breach of
contract and for money on common counts. The Complaint seeks damages in the
amount of $10,469,088. There has been no discovery to date and no trial has yet
been scheduled. We deny liability and intend to defend ourselves vigorously. An
unfavorable resolution of this litigation could have a material adverse effect
on our business, results of operations, or financial condition.
24
We must reduce our inventory and future purchase commitments.
Changes in our business have resulted in the accumulation of a substantial
inventory of finished goods and components. In addition, announcements of
large-scale inventory writedowns by competitors indicate that the risk of
inexpensive competitive products coming into the marketplace has increased
significantly. We have provided for losses related to the cancellation of
purchase commitments and further allowances for excess and obsolete finished
goods inventories and related raw materials. However, we must sell existing
finished goods inventory and delay or sell finished goods inventory from future
purchase commitments as well as sell component inventory resulting from
deliveries on already canceled purchase commitments. Failure to decrease our
current and future inventory and/or to sell component parts may require that we
take additional charges related to slow moving or obsolete inventory and
components. If we are unable to sell a substantial amount of both the finished
goods and the component inventories, our expected cash position for the fourth
quarter of 2001 and throughout the year 2002 could be negatively impacted.
We face substantial risk in launching our new IntelliPOP products.
We launched our new IntelliPOP product in the first half of 2001 and
recently introduced our IntelliPOP 8000 series product in the fourth quarter of
2001. Risks associated with the launch include delays in shipping, software
bugs, delays in product hardware and software testing, and production delays in
building the products. The complexity of the products requires additional
customer support resources. Since the products include major software
components, we are selling software maintenance agreements. Accordingly, revenue
associated with such maintenance agreements will be deferred and recognized over
the life of the underlying support of the products. The launch of our IntelliPOP
products may also cause customers to delay purchases of our existing products.
In addition, the introduction of new, more complex products, coupled with a
search for larger, more established customers may result in longer sales cycles
and delayed revenue.
Our ability to attract and retain our personnel may be negatively impacted by
the drop in our stock price.
The drop in our stock price has resulted in most of our outstanding
employee stock options being "under water" or priced substantially above the
current market price. In response to the drop in our stock price, on May 14,
2001, we offered our employees the opportunity to tender their existing stock
options for cancellation pursuant to a stock option exchange program and have
such stock options reissued at a date at least six months and two days later
than the date of cancellation. Accounting and other regulatory concerns prevent
or limit our ability to issue additional stock options to these employees during
the period between cancellation and reissuance. In the interim, those employees
who participated in the stock option exchange offer have, and will continue to
have, fewer or, in certain cases, no stock options until the lapsing of six
months and two days from the date of such cancellation. Further, for those
employees who did not participate in the stock option exchange offer, such
employees have stock options that are priced substantially above the current
market price. In both cases, our employees may feel that they are receiving
inadequate compensation. If adverse market conditions persist, the
attractiveness of our stock option offerings and the success of our employee
stock plans may be negatively impacted and, as a result, diminish our ability to
attract and retain qualified personnel.
Changes in the capital markets may negatively impact our business.
Due to increased volatility in equity markets and tightening of lending in
the credit markets, we believe that we are exposed to a greater risk that
customers will alter their payment practices to conserve capital. These changes
may lead to increases in outstanding accounts receivable as a percentage of
revenue, longer payback periods and increased risk of default. During the latter
part of the fourth quarter of 2000, several key customers experienced a rapid
deterioration in their ability to obtain additional capital to fund their
businesses and declared their inability to make timely payments on their
accounts and, as of the date of this report, have not been able to demonstrate
the wherewithal to pay their existing account balances. During 2001, a
significant number of these customers commenced bankruptcy proceedings. We
factor these increased risks into our assessment of our customers' wherewithal
to pay, and these considerations will likely result in longer revenue deferrals
than we have previously experienced. We also believe that certain of our
customers will alter their deployment plans to meet the constraints imposed by
changes in the capital markets. If we are not able to increase sales in other
customer segments or our
25
sales are otherwise delayed, we may experience volatility in expected sales
growth patterns which would increase the risk of declining sales growth in any
particular quarter.
Difficulties in forecasting product sales could negatively impact our business.
We base our expense levels in part on our expectations concerning future
revenue. These expense levels are relatively fixed in the short-term. Orders for
our products, however, 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 that typically last 60 to 90 days. In the case of IntelliPOP, those
evaluations may increase to six months. If orders forecasted for a specific
customer for a particular quarter do not occur in that quarter, our revenue for
that quarter may be less than our forecast. If we 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 the reduced revenue would have a
direct impact on our results of operations for that quarter. Further, we
purchase components and outsource the manufacturing of 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. Conversely, if orders are less than our
forecasts, we may have difficulty in canceling future purchase and manufacturing
commitments in a timely manner, which may result in greater than expected
inventory levels and exposure to losses related to slow moving and obsolete
inventory.
We depend on contract manufacturers to manufacture all of our products and rely
on them to deliver high-quality products in a timely manner.
We do not manufacture our products. We 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 harm our ability to meet our scheduled product deliveries to customers. In
addition, we believe that current market conditions have placed additional
financial strain on our contract manufacturers. 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
harm our business, operating results and financial condition. In addition, we
have canceled certain finished goods and component orders which may have a
negative impact on our ability to diversify our product manufacturing across a
larger base of contract manufacturers. 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 harm our business, operating results or
financial condition.
We depend on contract manufacturers to source all of our raw materials and
component products and rely on them to deliver these raw materials and
products in a timely manner.
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 neither we nor our contract
manufacturers have any 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 key components from current sources, we could experience
difficulties in obtaining alternative sources or in altering product designs to
use alternative components. Resulting delays and reductions in product shipments
could damage customer relationships and could harm our business, financial
condition or results of operations. In addition, any increases in component
costs that are passed on to our customers could reduce demand for our products.
26
We rely on third parties to test substantially all of our products and a failure
to adequately control quality could harm our business.
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 cost of
manufacturing, assembling or testing our products and could harm our business,
financial condition and results of operation. Moreover, defects in products that
are not discovered in the quality assurance process could damage customer
relationships and result in product returns or liability claims, each of which
could harm 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 the 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 supplies 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 and the switching integrated circuit
supplies used in the majority of our products are purchased from Texas
Instruments. Our products are also dependent on various sole source offerings
from Broadcom, Dallas Semiconductor, Metalink US, Motorola, Flextronics
Semiconductor, SaRonix, Siemens and Wind River Systems. 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 which could cause us to redesign our products
or could disrupt our operations and harm our business, financial condition and
results of operation in any given period.
Our market is subject to rapid technological changes and if we do not address
these changes, our products will become obsolete, harming our business and
ability to compete.
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, may negatively affect the development of the market for our
products. We cannot assure you that we will be able to respond quickly and
effectively to technological change. If we do not address these technological
changes and challenges by regularly introducing new products, our product line
will become obsolete, which would harm our business, financial condition and
results of operations.
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 harm our operating results by unexpectedly decreasing
sales, increasing our inventory levels of older products and exposing us to
greater risk of product obsolescence.
27
Our success depends on continued market acceptance of our Expresso products and
the successful launch of our IntelliPOP products.
We must devote a substantial amount of human and capital resources in order
to maintain commercial acceptance of our Expresso products and IntelliPOP
products and to expand offerings of these products in the MDU and MCU markets
and to further penetrate these markets. Historically, the majority of our
Expresso products has been sold into the MDU market. Our future success depends
on the ability to continue to penetrate this market and to expand our
penetration into the MCU market. Our success also depends on our ability to
educate existing and potential customers and end-users about the benefits of our
Fast Copper and Signature Switch technologies, our LongRun and IntelliPOP
products, and about the development of new products to meet changing and
expanding demands of service providers, MTU owners and corporate customers. The
success of our Expresso and IntelliPOP products will also depend on the ability
of our service provider customers to market and sell high-speed data services to
end-users. We cannot assure you that our IntelliPOP or our Expresso products
will achieve or maintain broad commercial acceptance within the MDU market, MCU
market, or in any other market we enter.
The market in which we operate is highly competitive, and we may not be able to
compete effectively.
The market for multi-service broadband access systems is intensely
competitive, and we expect that this market will become increasingly competitive
in the future. Our most immediate competitors include Cisco Systems, Copper
Mountain, Elastic Networks 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 and
related software products. Also, many of these competitors have recently
announced significant changes in their business plans and operations, some of
which, such as major writedowns of inventory, could have a negative impact on
our ability to sustain our current pricing or to sell current levels of
inventory. In addition, the market in which we compete is characterized by
increasing consolidation, and we cannot predict with certainty how industry
consolidation will affect us or our competitors.
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. These competitors 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 HomeRun licensees may sell products based on our HomeRun
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 harm our business, financial condition and
results of operations.
Our copper-wire based solutions face severe competition from other technologies,
and the commercial acceptance of any competing solutions could harm our business
and ability to compete.
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. These competing
solutions provide fast access, high reliability and cost-effective solutions for
some users. Because many of our products are based on the use of copper
telephone wire, and because 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 that
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
copper telephone 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 harm our business, financial
condition and results of operations.
28
Manufacturing or design defects in our products could harm 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 revenue,
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 to the development of 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 harm our business,
financial condition and results of operations.
Changing industry standards may reduce the demand for our products, which will
harm our business.
We will not be competitive unless we continually introduce new products and
product enhancements that address changing industry standards. The emergence of
new industry standards, whether through adoption by official standards
committees or through widespread use of such standards by telephone companies or
other service providers, could require the 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
harm 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
harm our business, financial condition and results of operations. In addition,
selection of competing technologies as standards by standards setting bodies
such as the HomePNA 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 selection could be interpreted by the press and
others as having a negative impact on our business which could negatively impact
our stock price.
We may not be able to effectively integrate our recent acquisitions into our
existing business.
In 2001 and 2000, we completed five acquisitions. We may need to
overcome significant issues in order to realize any benefits from these
transactions. These issues include:
. integrating the operations of the geographically dispersed businesses
acquired into our own operations;
. incorporating acquired technology, rights and products into our products
and services;
. developing new products and services that utilize the assets of all
entities;
. the potential disruption of our ongoing business and the distraction of
our management; and
. the potential impairment of relationships with employees, suppliers and
customers.
We may engage in future acquisitions of companies, technologies or products and
the failure to integrate any future acquisitions could harm our business.
As a part of our business strategy, we expect to make additional
acquisitions of, or significant investments in, complementary companies,
products or technologies. 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;
. the 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;
29
. 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 personnel.
We cannot assure you that we will be able to successfully integrate any
business, products, technologies or personnel that we may acquire in the future,
and our failure to do so could harm our business, operating results and
financial condition.
Failure to effectively manage operations in light of our changing revenue base
could adversely affect our business.
In the past, we have rapidly and significantly expanded our operations and
anticipate that, in the future, expansion in certain areas of our business may
be required to expand our customer base and exploit market opportunities. In
particular, we expect to face numerous challenges in the implementation of our
business strategy to focus on the larger, more established customers such as
ILECs and PTTs in both domestic and international markets. In addition, the
volatility in our business has placed a significant strain on our managerial and
operational resources. In January 2001, we reduced our workforce by 10%, in
April 2001 by an additional 28%, and in October 2001 by 11% in an effort to
control overall operating expenses in response to recent declines in and
expected slowing of our sales growth.
To exploit the market for our products, we must develop new and enhanced
products while implementing and managing effective planning and operating
processes. To manage our operations, 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 operations effectively, our business, financial condition and results of
operations could be harmed.
We depend on international sales for a significant portion of our revenue, which
could subject our business to a number of risks.
Sales to customers outside of the United States accounted for approximately
58.2% and 39.6% of revenue for the nine month periods ended September 30, 2001
and 2000, respectively. 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 continue to
account for a significant portion of our revenue. However, 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
of the United States could harm our business, financial condition and results of
operations.
30
We also expend product development and other resources in order to meet
regulatory and technical requirements of foreign countries. We depend on
sales of our products in these foreign markets to recoup the costs
associated with developing products for these markets.
Fluctuations in currency exchange rates may harm our business.
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 currently engage in foreign
currency hedging transactions. However, as we expand our current international
operations, we may allow payment in foreign currencies and, as a result, our
exposure to foreign currency transaction losses may increase. To reduce this
exposure, we may purchase forward foreign exchange contracts or use other
hedging strategies. However, we cannot assure you that any currency hedging
strategy would be successful in avoiding exchange related losses.
If we fail to protect our intellectual property, or if others use our
proprietary technology without authorization, our competitive position may
suffer.
Our future success and ability to compete depends 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 20 United States patents and have 18
United States patent applications pending. However, we cannot assure you that
patents will be issued with respect to pending or future patent applications
that we have filed or plan to file or that our 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, in which we strictly
limit access to and distribution of our software, and further limit the
disclosure and use of our 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. Our competitors may also
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 the laws of the United
States.
We may be subject to intellectual property infringement claims that are costly
to defend and could harm our business and ability to compete.
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 the 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 harm 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
harm our business, results of operations and financial condition.
If our products do not comply with complex government regulations, our products
may not be sold, preventing us from increasing our revenue or achieving
profitability.
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
31
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 harm 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 revenue
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 harm the sale of
products by us to these customers.
Our success depends on our ability to provide adequate customer support.
Our ability to achieve our planned sales growth and to retain current and
future customers will depend in part on 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. As our systems and products become more complex, we
believe our ability to provide adequate customer support will be increasingly
important to our success. 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, and we believe that the introduction of IntelliPOP will add a
significant layer of complexity to the demands on our customer support
organizations. 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 harm our business, financial condition or results of operations.
If we lose key personnel or are unable to hire additional qualified personnel
as necessary, we may not be able to manage our business successfully.
We depend on the performance of Salvatore D'Auria, our President, Chief
Executive Officer and Chairman of the Board, and on other senior management and
technical personnel with experience in the data communications,
telecommunications and high-speed data access industries. The loss of any one of
them could harm our ability to execute our business strategy. Additionally, we
do not have employment contracts with any of our executive officers. 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 stock price has fluctuated and is likely to continue to fluctuate, and you
may not be able to resell your shares at or above their purchase price.
The 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;
32
. 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 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 with severe
drops in recent months. These fluctuations have often been unrelated or
disproportionate to the operating performance of these technology companies.
These market and industry factors may harm our stock price, regardless of our
operating results.
Our stock may be delisted from the Nasdaq National Market.
At the closing of the Nasdaq National Market on October 30, 2001, the
minimum bid price of a share of our Common Stock was $1.07. Since the second
quarter of 2001, the minimum closing bid price of our Common Stock has dropped
below $1.00 per share on a number of occasions. Nasdaq corporate governance
rules require that all shares listed on the Nasdaq National Market maintain a
minimum bid price at closing of $1.00 per share. Our failure to maintain such a
minimum bid price for a period of thirty or more consecutive trading days could
result in the Nasdaq governing board taking action to remove our shares from the
Nasdaq National Market. Since September 11, 2001, the Nasdaq has issued a
moratorium suspending delisting actions against all companies whose shares are
listed on the Nasdaq National Market until January 1, 2002. However, there is no
assurance that, after January 1, 2002, the minimum bid price of our Common Stock
will meet or exceed and continue to meet or exceed the $1.00 per share minimum
bid price required by Nasdaq or that we will otherwise meet the requirements of
Nasdaq for continued inclusion for trading on the Nasdaq National Market. The
delisting of our Common Stock as well as the threat of delisting of our Common
Stock may negatively impact the value of our shares because shares that trade on
the over-the-counter market (rather than the Nasdaq National Market) are
typically less liquid and, therefore, trade with larger variations between the
bid and asking price.
Our charter, bylaws, retention and change of control plans and Delaware law
contain provisions that could delay or prevent a change in control.
Certain provisions of our charter and bylaws and our retention and change
of control plans (the "Plans") 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. The provisions of the charter and bylaws and the
Plans could limit the price that certain investors may 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
stockholders. 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. The Plans provide for severance
payments and accelerated stock option vesting in the event of termination of
employment following a change of control. The provisions of the charter and
bylaws, and the Plans, 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.
33
Future sales of our Common Stock could 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 harm
the market price of our Common Stock. These sales also may 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 September 30, 2001,
we had 16,380,964 shares outstanding. Of these shares, 16,051,633 shares of our
Common Stock are currently available for sale in the public market, some of
which are subject to volume and other limitations under securities laws.
Our facilities are located near known earthquake fault zones, and the occurrence
of an earthquake or other natural disaster could cause damage to our facilities
and equipment which could require us to curtail or cease operations.
Our facilities are located in the San Francisco Bay Area near known
earthquake fault zones and are vulnerable to damage from earthquakes. In October
1989, a major earthquake that caused significant property damage and a number of
fatalities struck this area. We are also vulnerable to damage from other types
of disasters, including fire, floods, power loss, communications failures and
similar events. If any disaster were to occur, our ability to operate our
business at our facilities could be seriously, or completely, impaired. The
insurance we maintain may not be adequate to cover our losses resulting from
disasters or other business interruptions.
We rely on a continuous power supply to conduct our operations, and California's
current energy crisis could disrupt our operations and increase our expenses.
California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below 1.5%,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. We currently do not have
backup generators or alternate sources of power in the event of a blackout, and
our current insurance does not provide coverage for any damages we, or our
customers, may suffer as a result of any interruption in our power supply. If
blackouts interrupt our power supply, we would be temporarily unable to continue
operations at our facilities. Any such interruption in our ability to continue
operations at our facilities could damage our reputation, harm our ability to
retain existing customers and to obtain new customers, and could result in lost
revenue, any of which could substantially harm our business and results of
operations.
We are, and continue to be affected by poor general economic conditions that
have resulted in significantly reduced sales levels and, if such adverse
economic conditions continue or worsen, our business, operating results and
financial condition could be negatively impacted.
The continued poor economic conditions in the world economy, which have
become particularly acute since the events on September 11, 2001, and the
industry-wide downturn in the telecommunications market, have affected, and may
continue to affect, our sales throughout 2001. As a result, we may experience a
material adverse impact on our business, operating results and financial
condition. Comparatively lower sales have resulted in operating expenses
increasing as a percentage of revenue for the three and nine month periods
ending on September 30, 2001, when compared to the same periods for 2000.
Although we have taken actions, throughout the first three quarters of 2001 to
create revenue opportunities and reduce operating expenses, a prolonged
continuation or worsening of sales trends may force us to take additional
actions and charges in order to reduce our operating expenses. If we are unable
to reduce operating expenses at a rate and level consistent with future adverse
sales trends or if we incur significant special charges associated with such
expense reductions that are disproportionate to sales, our business, operating
results and financial condition could be negatively impacted.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to changes in interest rates primarily from our investments
in certain held-to-maturity securities. Under our current policies, we do not
use interest rate derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in interest rates along the
entire interest rate yield curve would not materially affect the fair value of
interest sensitive financial instruments at September 30, 2001.
At September 30, 2001, we held an investment in commercial paper issued by
Southern California Edison Company. This investment is included in short-term
investments at a carrying value of approximately $9.0 million which matured in
January 2001 and is currently in default. We believe that the net realizable
value of this investment cannot be practicably determined as of September 30,
2001.
We have no investments, nor are any significant sales, expenses, or other
financial items denominated in foreign country currencies. All of our
international sales are denominated in U.S. dollars. An increase in the value of
the U.S. dollar relative to foreign currencies could make our products more
expensive and, therefore, reduce the demand for our products.
35
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 12, 2001, a putative shareholder class action lawsuit, entitled
Yusty et al. v. Tut Systems, Inc., et al., Civil Action No. C-01-2659-JCS was
filed in United States District Court for the Northern District of California
against us and certain of our current and former officers. Similar actions have
been filed by other plaintiffs, including Streicher v. Tut Systems, Inc., et
al., Civil Action No. C-01-02757-MEJ, Huelsman v. Tut Systems, Inc., et al.,
Civil Action No. C-01-2894, Waltersheid v. Tut Systems, Inc., et al., Civil
Action No. C-01-2983, Atlas v. Tut Systems, Inc., et al., Civil Action No.
C-01-2999 and Lefkowitz v. Tut Systems, Inc., et al., Civil Action No C-01-3053.
The complaints have been related. The complaints were filed on behalf of a
purported class of people who purchased our stock during the period between July
20, 2000 and January 31, 2001, seeking unspecified damages. The complaints
allege that we and certain of our current and former officers made false and
misleading statements about our business during the putative class period.
Specifically, the complaints allege violations of Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934. Plaintiffs have moved for consolidation and
for appointment of lead plaintiff and lead counsel. An unfavorable resolution of
this litigation could have a material adverse effect on our business, results of
operations, or financial condition.
On August 3, 2001, a complaint, Arrow Electronics, Inc. v. Tut Systems,
Inc., Case No. CV 800433, was filed in the Superior Court of the State of
California for the County of Santa Clara against Tut Systems. The Complaint was
filed by one of our suppliers and alleges causes of action for breach of
contract and for money on common counts. The Complaint seeks damages in the
amount of $10,469,088. There has been no discovery to date and no trial has yet
been scheduled. We deny liability and intend to defend ourselves vigorously. An
unfavorable resolution of this litigation could have a material adverse effect
on our business, results of operations, or financial condition.
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
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
2.1 Agreement and Plan of Reorganization dated as of October 15,
1999, by and among the Company, Vintel Acquisition Corp., and
Vintel Communications, Inc.(3)
2.2 Agreement and Plan of Reorganization dated as of June 8, 1999,
by and among the Company, Public Port Acquisition Corporation,
and Public Port, Inc.(2)
2.3 Agreement and Plan of Reorganization dated as of November 16,
1999, as amended, by and among the Company, Fortress Acquisition
Corporation and FreeGate Corporation.(4)
2.4 Asset Purchase Agreement by and between the Company and
OneWorld Systems, Inc. dated as of February 3, 2000.(5)
2.5 Amendment No. 1 to Asset Purchase Agreement by and between the
Company and OneWorld Systems, Inc. dated as of February 17,
2000.(5)
36
2.6 Agreement for the sale and purchase of the entire share capital
of Xstreamis plc, by and among the Company, the shareholders of
Xstreamis plc and Philip Corbishley.(6)
2.7 Agreement and Plan of Reorganization dated as of December 21,
2000, by and among the Company, ActiveTelco Incorporated,
ActiveTelco Acquisition Corporation, and, with respect to
Article VII only, Azeem Butt, as shareholder representative, and
U.S. Bank Trust, as escrow agent.(7)
3.1 Second Amended and Restated Certificate of Incorporation of the
Company.(1)
3.2 Bylaws of the Company, as currently in effect.(1)
4.1 Specimen Common Stock Certificate.(1)
10.25 Indemnification Agreement by and between the Company and Alida
Rincon, effective as of March 3, 2000.(8)
10.26 Indemnification Agreement by and between the Company and Marilyn
Lobel, effective as of April 17, 2001.(8)
11.1 Calculation of net loss per share (contained in Note 3 of Notes
to Condensed Consolidated Financial Statements).
___________
(1) Incorporated by reference to our Registration Statement on Form S-1
(File No. 333-60419) as declared effective by the Securities and Exchange
Commission on January 28, 1999.
(2) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999.
(3) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999.
(4) Incorporated by reference to our Current Report on Form 8-K dated February
14, 2000.
(5) Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1999.
(6) Incorporated by reference to our Current Report on Form 8-K dated May 26,
2000 as filed June 9, 2000.
(7) Incorporated by reference to our Current Report on Form 8-K dated January
18, 2001.
(8) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001.
(b) Reports on Form 8-K.
The Company did not file any reports on Forms 8-K during the quarter ended
September 30, 2001.
37
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: October 31, 2001
/s/ MARILYN LOBEL
-----------------------------------
Marilyn Lobel
Vice President, Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized
Officer)
38
INDEX TO EXHIBITS
Exhibit
-------
Number Description
------ -----------
2.1 Agreement and Plan of Reorganization dated as of October 15, 1999, by
and among the Company, Vintel Acquisition Corp., and Vintel
Communications, Inc.(3)
2.2 Agreement and Plan of Reorganization dated as of June 8, 1999, by and
among the Company, Public Port Acquisition Corporation, and Public
Port, Inc.(2)
2.3 Agreement and Plan of Reorganization dated as of November 16, 1999, as
amended, by and among the Company, Fortress Acquisition Corporation
and FreeGate Corporation.(4)
2.4 Asset Purchase Agreement by and between the Company and OneWorld
Systems, Inc. dated as of February 3, 2000.(5)
2.5 Amendment No. 1 to Asset Purchase Agreement by and between the Company
and OneWorld Systems, Inc. dated as of February 17, 2000.(5)
2.6 Agreement for the sale and purchase of the entire share capital of
Xstreamis plc, by and among the Company, the shareholders of Xstreamis
plc and Philip Corbishley.(6)
2.7 Agreement and Plan of Reorganization dated as of December 21, 2000, by
and among the Company, ActiveTelco Incorporated, ActiveTelco
Acquisition Corporation, and, with respect to Article VII only, Azeem
Butt, as shareholder representative, and U.S. Bank Trust, as escrow
agent.(7)
3.1 Second Amended and Restated Certificate of Incorporation of the
Company.(1)
3.2 Bylaws of the Company, as currently in effect.(1)
4.1 Specimen Common Stock Certificate.(1)
10.25 Indemnification Agreement by and between the Company and Alida
Rincon, effective as of March 3, 2000.(8)
10.26 Indemnification Agreement by and between the Company and Marilyn
Lobel, effective as of April 17, 2001.(8)
11.1 Calculation of net loss per share (contained in Note 3 of Notes to
Condensed Consolidated Financial Statements).
_______________
(1) Incorporated by reference to our Registration Statement on Form S-1 (File
No. 333-60419) as declared effective by the Securities and Exchange
Commission on January 28, 1999.
(2) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999.
(3) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999.
(4) Incorporated by reference to our Current Report on Form 8-K dated February
14, 2000.
(5) Incorporated by reference to our Annual Report on Form 10-K for the year
ended December 31, 1999.
(6) Incorporated by reference to our Current Report on Form 8-K dated May 26,
2000 as filed June 9, 2000.
(7) Incorporated by reference to our Current Report on Form 8-K dated January
18, 2001.
39
(8) Incorporated by reference to our Quarterly Report on Form 10-Q for the
quarter ended June 30, 2001.
40