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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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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 June 30, 2005



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



Commission File Number: 000-25291



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TUT SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 94-2958543                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification No.)
|                                                              | 
|6000 SW Meadows Rd, Suite 200Lake Oswego, Oregon              |  | 97035                              
|(Address of principal executive offices)                      |  | (Zip Code)                         



Registrants
telephone number, including area code: (971) 217-0400



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ̈No x



As of July 28, 2005, 33,249,267 shares of the Registrants common stock, par value $0.001 per share, were issued and outstanding.



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TUT SYSTEMS, INC.



FORM 10-Q



INDEX



|           |  |                                                                                                                    |  |   
|---------- |  | ------------------------------------------------------------------------------------------------------------------ |  | --
|PART I.    |  | FINANCIAL INFORMATION                                                                                              |  |   
|           |  |                                                                                                                   
|Item 1.    |  | Condensed Consolidated Financial Statements (unaudited):                                                           |  |   
|           |  |                                                                                                                   
|           |  | Condensed Consolidated Balance Sheets as of December 31, 2004 and June 30, 2005                                    |  | 3 
|           |  |                                                                                                                   
|           |  | Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2004 and June 30, 2005 |  | 4 
|           |  |                                                                                                                   
|           |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and June 30, 2005           |  | 5 
|           |  |                                                                                                                   
|           |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                     |  | 6 
|           |  |                                                                                                                   
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                              |  | 16
|           |  |                                                                                                                   
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                                         |  | 29
|           |  |                                                                                                                   
|Item 4.    |  | Controls and Procedures                                                                                            |  | 29
|           |  |                                                                                                                   
|PART II.   |  | OTHER INFORMATION                                                                                                  |  |   
|           |  |                                                                                                                   
|Item 1.    |  | Legal Proceedings                                                                                                  |  | 30
|           |  |                                                                                                                   
|Item 2.    |  | Unregistered Sales of Securities and Use of Proceeds                                                               |  | 30
|           |  |                                                                                                                   
|Item 3.    |  | Defaults Upon Senior Securities                                                                                    |  | 31
|           |  |                                                                                                                   
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                |  | 31
|           |  |                                                                                                                   
|Item 5.    |  | Other Information                                                                                                  |  | 31
|           |  |                                                                                                                   
|Item 6.    |  | Exhibits                                                                                                           |  | 32
|           | 
|Signatures |  | 34                                                                                                                



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PART I. FINANCIAL
INFORMATION



|ITEM 1. | CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|------- | -------------------------------------------



TUT SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                                          |  |                  |          |   |              |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                                          |  | December 31,2004 |          |   | June 30,2005 |  
|ASSETS                                                                                                                                    |  |                  |          |   |              |   |          |  
|Current assets:                                                                                                                           |  |                  |          |   |              |   |          |  
|Cash and cash equivalents                                                                                                                 |  | $                | 12,440   |   |              | $ | 10,362   |  
|Accounts receivable, net of allowance for doubtful accounts of $139 and $132 in 2004 and 2005, respectively                               |  |                  | 6,585    |   |              |   | 11,026   |  
|Inventories, net                                                                                                                          |  |                  | 3,994    |   |              |   | 4,825    |  
|Prepaid expenses and other                                                                                                                |  |                  | 1,137    |   |              |   | 1,762    |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total current assets                                                                                                                      |  |                  | 24,156   |   |              |   | 27,975   |  
|Property and equipment, net                                                                                                               |  |                  | 1,874    |   |              |   | 3,194    |  
|Goodwill                                                                                                                                  |  |                  |         |   |              |   | 1,672    |  
|Intangibles and other assets                                                                                                              |  |                  | 1,935    |   |              |   | 7,363    |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total assets                                                                                                                              |  | $                | 27,965   |   |              | $ | 40,204   |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                      |  |                  |          |   |              |   |          |  
|Current liabilities:                                                                                                                      |  |                  |          |   |              |   |          |  
|Line of credit                                                                                                                            |  | $                |         |   |              | $ | 5,000    |  
|Accounts payable                                                                                                                          |  |                  | 2,221    |   |              |   | 5,641    |  
|Accrued liabilities                                                                                                                       |  |                  | 2,324    |   |              |   | 3,404    |  
|Deferred revenue                                                                                                                          |  |                  | 226      |   |              |   | 448      |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total current liabilities                                                                                                                 |  |                  | 4,771    |   |              |   | 14,493   |  
|Note payable                                                                                                                              |  |                  | 3,816    |   |              |   | 3,967    |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total liabilities                                                                                                                         |  |                  | 8,587    |   |              |   | 18,460   |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Commitments and contingencies (Note 8)                                                                                                    |  |                  |          |   |              |   |          |  
|Stockholders equity:                                                                                                                     |  |                  |          |   |              |   |          |  
|Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding in 2004 and 2005, respectively               |  |                  |         |   |              |   |         |  
|Common stock, $0.001 par value, 100,000 shares authorized, 25,180 and 27,710 shares issued and outstanding in 2004 and 2005,
respectively |  |                  | 25       |   |              |   | 28       |  
|Additional paid-in capital                                                                                                                |  |                  | 315,006  |   |              |   | 325,302  |  
|Deferred compensation                                                                                                                     |  |                  |         |   |              |   | (74      | )
|Accumulated other comprehensive loss                                                                                                      |  |                  | (140     | ) |              |   | (164     | )
|Accumulated deficit                                                                                                                       |  |                  | (295,513 | ) |              |   | (303,348 | )
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total stockholders equity                                                                                                                |  |                  | 19,378   |   |              |   | 21,744   |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  
|Total liabilities and stockholders equity                                                                                                |  | $                | 27,965   |   |              | $ | 40,204   |  
|                                                                                                                                          |  |                  |          |   |              |   |          |  



The accompanying
notes are an integral part of these condensed consolidated financial statements.



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TUT SYSTEMS, INC.



CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                        |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                        |  | 2004                       |        |   | 2005                     |   |        | 2004 |  |   | 2005   |  
|Revenue                                                                 |  | $                          | 5,123  |   |                          | $ | 9,674  |      |  | $ | 11,299 |   |  | $ | 16,727 |  
|Cost of goods sold                                                      |  |                            | 3,447  |   |                          |   | 5,811  |      |  |   | 8,576  |   |  |   | 9,966  |  
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                                            |  |                            | 1,676  |   |                          |   | 3,863  |      |  |   | 2,723  |   |  |   | 6,761  |  
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                                                     |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Sales and marketing                                                     |  |                            | 1,932  |   |                          |   | 2,745  |      |  |   | 3,836  |   |  |   | 5,232  |  
|Research and development                                                |  |                            | 1,860  |   |                          |   | 3,216  |      |  |   | 3,682  |   |  |   | 5,337  |  
|General and administrative                                              |  |                            | 1,099  |   |                          |   | 1,965  |      |  |   | 2,216  |   |  |   | 3,124  |  
|Impairment of intangible assets                                         |  |                            |       |   |                          |   |       |      |  |   | 202    |   |  |   |       |  
|Amortization of intangible assets                                       |  |                            | 376    |   |                          |   | 400    |      |  |   | 772    |   |  |   | 775    |  
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                |  |                            | 5,267  |   |                          |   | 8,326  |      |  |   | 10,708 |   |  |   | 14,468 |  
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Loss from operations                                                    |  |                            | (3,591 | ) |                          |   | (4,463 | )    |  |   | (7,985 | ) |  |   | (7,707 | )
|Interest and other (expense), net                                       |  |                            | (44    | ) |                          |   | (54    | )    |  |   | (99    | ) |  |   | (128   | )
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                                |  | $                          | (3,635 | ) |                          | $ | (4,517 | )    |  | $ | (8,084 | ) |  | $ | (7,835 | )
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share, basic and diluted (Note 3)                          |  | $                          | (0.18  | ) |                          | $ | (0.17  | )    |  | $ | (0.40  | ) |  | $ | (0.31  | )
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing net loss per share, basic and diluted (Note 3) |  |                            | 20,396 |   |                          |   | 26,013 |      |  |   | 20,346 |   |  |   | 25,602 |  
|                                                                        |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



The accompanying
notes are an integral part of these condensed consolidated financial statements.



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TUT SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                                                                                                                     |  | Six Months EndedJune 30, |       
|                                                                                                                                                                                     |  | 2004                     |        |   | 2005 |  
|Cash flows from operating activities:                                                                                                                                                |  |                          |        |   |      |   |        |  
|Net loss                                                                                                                                                                             |  | $                        | (8,084 | ) |      | $ | (7,835 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                                                                                          |  |                          |        |   |      |   |        |  
|Depreciation                                                                                                                                                                         |  |                          | 650    |   |      |   | 490    |  
|Provision for doubtful accounts                                                                                                                                                      |  |                          | 13     |   |      |   | 7      |  
|Provision for excess and obsolete inventory and abandoned products                                                                                                                   |  |                          | 995    |   |      |   | 20     |  
|Impairment of intangibles                                                                                                                                                            |  |                          | 202    |   |      |   |       |  
|Amortization of intangibles                                                                                                                                                          |  |                          | 772    |   |      |   | 775    |  
|Deferred interest on note payable                                                                                                                                                    |  |                          | 140    |   |      |   | 151    |  
|Non cash compensation                                                                                                                                                                |  |                          |       |   |      |   | 221    |  
|Change in operating assets and liabilities, net of business acquired:                                                                                                                |  |                          |        |   |      |   |        |  
|Accounts receivable                                                                                                                                                                  |  |                          | 2,237  |   |      |   | (4,385 | )
|Inventories                                                                                                                                                                          |  |                          | (1,563 | ) |      |   | (318   | )
|Prepaid expenses and other assets                                                                                                                                                    |  |                          | (854   | ) |      |   | (7     | )
|Accounts payable and accrued liabilities                                                                                                                                             |  |                          | 340    |   |      |   | 3,127  |  
|Deferred revenue                                                                                                                                                                     |  |                          | (21    | ) |      |   | 122    |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Net cash used in operating activities                                                                                                                                                |  |                          | (5,163 | ) |      |   | (7,632 | )
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Cash flows from investing activities:                                                                                                                                                |  |                          |        |   |      |   |        |  
|Acquisition of Copper Mountain, net of cash acquired                                                                                                                                 |  |                          |       |   |      |   | 1,529  |  
|Purchase of property and equipment                                                                                                                                                   |  |                          | (762   | ) |      |   | (1,104 | )
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                                                                                                                                  |  |                          | (762   | ) |      |   | 425    |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Cash flows from financing activities:                                                                                                                                                |  |                          |        |   |      |   |        |  
|Proceeds from line of credit                                                                                                                                                         |  |                          |       |   |      |   | 5,000  |  
|Proceeds from issuances of common stock, net                                                                                                                                         |  |                          | 311    |   |      |   | 129    |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Net cash provided by financing activities                                                                                                                                            |  |                          | 311    |   |      |   | 5,129  |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                                                                                                                            |  |                          | (5,614 | ) |      |   | (2,078 | )
|Cash and cash equivalents, beginning of period                                                                                                                                       |  |                          | 14,370 |   |      |   | 12,440 |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                                                                                                                             |  | $                        | 8,756  |   |      | $ | 10,362 |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Supplemental schedule of noncash investing and financing activities:                                                                                                                 |  |                          |        |   |      |   |        |  
|The Company purchased all of the common stock of Copper Mountain for $11,729 (Note 5). In conjunction with the acquisition, liabilities were
assumed and assets acquired as follows: |  |                          |        |   |      |   |        |  
|Fair value of assets acquired:                                                                                                                                                       |  | $                        | 12,884 |   |      |   |        |  
|Liabilities assumed                                                                                                                                                                  |  |                          | 1,155  |   |      |   |        |  
|                                                                                                                                                                                     |  |                          |        |   |      |   |        |  
|Net assets acquired                                                                                                                                                                  |  | $                        | 11,729 |   |      |   |        |  



The accompanying
notes are an integral part of these condensed consolidated financial statements.



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TUT SYSTEMS, INC.



NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share amounts)



NOTE 1DESCRIPTION OF BUSINESS:



The Company designs, develops, and sells digital video processing systems
that enable telephony-based service providers to deliver broadcast quality digital video signals over their networks. The Company also offers video processing systems that enable private enterprise and government entities to transport video signals
over satellite, fiber, radio, or copper networks for surveillance, distance learning, and TV production applications. Additionally, the Company designs, develops and markets broadband transport and service management products that enable the
provisioning of high speed Internet access and other broadband data services over existing copper networks within hotels and private campus facilities.



Historically, the Company derived most of its sales from its broadband transport and service management products. In November 2002, the Company acquired
VideoTele.com, referred to in this report as VTC, from Tektronix, Inc. to extend its product offerings to include digital video processing systems. On June 1, 2005, the Company acquired Copper Mountain Networks, Inc., referred to in this report as
Copper Mountain, for its additional product and engineering resources to further address the Companys expanding video market opportunities. The Company does not expect significant future revenue from the sale of Copper Mountains
historical product line. Video-based products now represent a majority of the Companys sales.



The Company has incurred substantial losses and negative cash flows from operations since inception. For the six months ended June 30, 2005, the Company
incurred a net loss of $7,835 and negative cash flows from operating activities of $7,632, and has an accumulated deficit of $303,348 at June 30, 2005. Management believes that its cash and cash equivalents and availability under the credit facility
as of June 30, 2005, combined with the cash proceeds from the July 2005 common stock sale described in Note 10, are sufficient to fund its operating activities and capital expenditure needs for the next twelve months. However, in the event that the
Company does not meet its revenue and earnings expectations, the Company may require additional cash to fund operations. Failure to generate positive cash flow in the future could have a material adverse effect on the Companys ability to
achieve its intended business objectives.



NOTE 2SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES:



Basis of presentation



The accompanying condensed consolidated financial statements as of
December 31, 2004 and June 30, 2005 and for the three and six months ended June 30, 2004 and 2005 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted
accounting principles for interim financial information and, in the opinion of management, reflect all adjustments, which include normal recurring adjustments and purchase accounting adjustments in relation to the acquisition of Copper Mountain on
June 1, 2005, necessary to state fairly the Companys financial position as of December 31, 2004 and June 30, 2005, its results of operations for the three and six months ended June 30, 2004 and 2005 and its cash flows for the six months ended
June 30, 2004 and 2005. 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/A, filed with the Securities and Exchange Commission on May 2, 2005. The balance sheet as of December 31, 2004 was derived from audited financial statements but does not include all disclosures required by generally accepted accounting
principles. The results for the three and six months ended June 30, 2005 are not necessarily indicative of the expected results for any other interim period or the year ending December 31, 2005.



Revenue recognition



The Company generates revenue primarily from the sale of hardware products, including third-party products, through
professional services, and through the sale of its software products. The Company sells products through direct sales channels and through distributors. Generally, product revenue is generated from the sale of video processing systems and components
and the sale of broadband transport and service management products. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyers
specifications.



Product revenues



Product revenue is generated primarily from the sale of complete end-to-end
video processing systems generally referred to as turnkey solutions. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services and post-contract support. Sales of turnkey solutions
are classified as product revenue in the statement of operations.



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Product revenue is also generated from the sale of video processing component products, the sale of
broadband transport and service management products and the sale of certain legacy products acquired with the Copper Mountain merger. The Company sells these products through its own direct sales channels and also through distributors.



The Companys revenue recognition policies for turnkey solutions are
in accordance with SOP 97-2, Software Revenue Recognition, as amended, which is the authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP
97-2 requires that revenue recognized from software arrangements be allocated to each element of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or
other elements. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by
SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2,and was amended again in December 1998 by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments
deferred and then clarified, respectively, the specification of what was considered vendor specific objective evidence of fair value for the various elements in a multiple element arrangement.



In the case of software arrangements which require significant production,
modification or customization of software, which encompasses all of the Companys turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts.
The Company recognizes revenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the post contract support (or PCS) element, for which the Company has established vendor specific objective evidence of fair value (as
defined by SOP 97-2), revenue from turnkey solutions is generally recognized using the percentage-of-completion method, as stipulated by SOP 81-1. The percentage-of-completion method reflects the portion of the anticipated contract revenue that has
been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is
deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value of the arrangement prior to the time of delivery to the
customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. In connection with these contracts, we may perform the work prior to when the
revenue is billable pursuant to the contract. The termination clauses in most of our contracts provide for the payment for the fair value of products delivered and services performed in the event of an early termination. In connection with certain
of our contracts, we have recorded unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are
subject to billings in the subsequent accounting period. Management reviews unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence
which allows us to recognize such revenue. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are generally considered to be incidental to the arrangement in its entirety
because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.



For direct sales of video processing systems component products not included as part of turnkey solutions and the direct sale of broadband transport and
service management products, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured.



Management must make significant management judgments and estimates in
connection with the measurement of revenue in a given period. The Company follows specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, the Company assesses a number of factors, including
specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment
terms. Based on the results of the assessment, the Company may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. In order to recognize revenue, the Company
must also make a judgment regarding collectibility of the arrangement fee. Managements judgment of collectibility is applied on a customer-by-customer basis pursuant to the Companys credit review policy. The Company sells to customers
with which the Company has a history of successful collection and to new customers for which no similar history may exist. New customers are subject to a credit review process, which evaluates the customers financial position and ability to
pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are increased only after a successful collection history with the customer has been established. If it is determined from the
outset of an arrangement that collectibility is not probable based upon the Companys credit review process, no credit is extended and revenue is recognized on a cash-collected basis, after shipment has occurred or the revenue has been earned
under the percentage-of-completion method.



The Company also
maintains accruals and allowances for cooperative marketing and other programs, as necessary. Estimated sales returns and warranty costs are based on historical experience and are recorded at the time revenue is recognized, as necessary. The
Companys products generally carry a one year warranty from the date of purchase. To date, warranty costs have been insignificant to the overall financial statements taken as a whole.



Should changes in conditions cause the Company to determine that the criteria
for revenue recognition are not met for certain future transactions, revenue recognition for any reporting period could be adversely affected.



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Unbilled Receivables



Unbilled receivables (costs and estimated profit in excess of billings) may be recorded in connection with certain turnkey solution contracts. Unbilled
receivables are not billable at the balance sheet date but are recoverable over the remaining life of the contract through billings made in accordance with contractual agreements. Management reviews unbilled receivables and related contract
provisions to ensure the Company is justified in recognizing revenue prior to billing the customer and that there is objective evidence which allows the Company to recognize such revenue.



Inventories



Inventories are stated at the lower of cost or market. Cost is computed using standard cost which approximates actual cost on a first-in, first-out basis.
The Company records provisions to write down its inventory and firm, non-cancellable and unconditional purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the
estimated market value based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than those estimated by the Company, additional inventory provisions may be required.



Allowance for doubtful accounts



The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make payments. These estimated allowances are periodically reviewed and take into account customers payment history and information regarding customers creditworthiness that is
known to the Company. If the financial condition of any of the Companys customers were to deteriorate, resulting in their inability to make payments, the Company would need to make an additional allowance.



Accounting for long-lived assets



The Company periodically assesses the impairment of long-lived assets. 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 or 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 Companys 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.



During the six months ended June 30, 2004, the Company determined that certain of the technology acquired as part of the
purchase of the ViaGate Technologies, Inc. assets in September 2001 had become impaired. As a result, the Company incurred a loss of $202 to write-off the technology.



Future events could cause the Company to conclude that impairment indicators exist. Any resulting impairment loss could have
a material adverse impact on the Companys financial condition and results of operations.



Goodwill



Goodwill
represents the excess of the purchase price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed. Management tests for impairment of goodwill on an annual basis and at any other time if events occur
or circumstances change that would indicate that it is more likely than not that the fair value of the reporting unit has been reduced below its carrying amount.



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 or 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 Companys market capitalization relative to net book value.



The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount,
including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit is based on one or more fair value measures including present value techniques of estimated future cash flows and estimated amounts at which
the unit as a whole could be bought or sold in a current transaction between willing parties. If the carrying amount of the reporting unit exceeds the fair value, step two requires the fair value of the reporting unit to be allocated to the
underlying assets and



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liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied
fair value of that goodwill, an impairment loss equal to the excess is recorded in net earnings (loss).



Accounting for stock based compensation



The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, referred
to as APB No. 25 and Financial Accounting Standard Board Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensationan Interpretation of APB 25, referred to as FIN 44 and in compliance with the
disclosure provisions of Statement of Financial Accounting Standard No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure, Referred to as SFAS No. 148. Under APB No. 25, compensation expense is based on the
difference, if any, on the date of the grant, between the fair market value of the Companys stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 148 and the Emerging
Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services.



The Company amortizes stock-based compensation using the straight-line method
over the remaining vesting periods of the related options, which is generally four years. Pro forma information regarding net loss and net loss per share is presented and has been determined as if the Company had accounted for employee stock options
under the fair value method of SFAS No. 123, as amended by SFAS No. 148.



The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, to stock-based employee
compensation:



|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                                                                      |  | Three MonthsEnded June 30, |        |   | Six Months EndedJune 30, |  
|                                                                                                                                      |  | 2004                       |        |   | 2005                     |   |        | 2004 |  |   | 2005   |  
|Net loss  as reported                                                                                                                |  | $                          | (3,635 | ) |                          | $ | (4,517 | )    |  | $ | (8,084 | ) |  | $ | (7,835 | )
|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Stock based employee compensation expense included in net loss (net of tax)                                                           |  |                            |       |   |                          |   | 193    |      |  |   |       |   |  |   | 221    |  
|Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax
effects |  |                            | (593   | ) |                          |   | (878   | )    |  |   | (1,405 | ) |  |   | (1,269 | )
|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss  pro forma                                                                                                                  |  | $                          | (4,228 | ) |                          | $ | (5,202 | )    |  | $ | (9,489 | ) |  | $ | (8,883 | )
|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share  as reported                                                                                    |  | $                          | (0.18  | ) |                          | $ | (0.17  | )    |  | $ | (0.40  | ) |  | $ | (0.31  | )
|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted net loss per share  pro forma                                                                                      |  | $                          | (0.21  | ) |                          | $ | (0.20  | )    |  | $ | (0.47  | ) |  | $ | (0.35  | )
|                                                                                                                                      |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



The fair value of
options issued pursuant to the option plans and at the grant date were estimated using the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. Option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. The Company uses projected volatility rates, which are based upon historical volatility
rates trended into future years. Because employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in
managements opinion, the existing models do not necessarily provide a reliable single measure of the fair value of options.



The effects of applying pro forma disclosures of net loss and net loss per share are not likely to be representative of the pro forma effects on net
income (loss) and net earnings (loss) per share in the future years, as the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.



Recent accounting pronouncements



In December 2004, the FASB issued SFAS No. 123R (revised 2004),
Share-Based Payment, which amends FASB Statement No. 123 and will be effective for public companies first fiscal year beginning after June 15, 2005. Thus, the Company will adopt SFASR on January 1, 2006. The new standard will require the
Company to expense employee stock options and other share-based payments. The FASB believes the use of a binomial lattice model for option valuation is capable of more fully reflecting certain characteristics of employee share options compared to
the Black-Scholes options pricing model. The new standard may be adopted in one of three ways - the modified prospective transition method, a variation of the modified prospective transition method or the modified retrospective transition method.
The Company is currently evaluating the method of adoption and the effect that the adoption of SFAS 123R will have on its results of operations.



On March 29, 2005, the SEC issued Staff Accounting Bulletin 107, or SAB 107, which expresses the views of the SEC regarding the interaction between SFAS
No. 123R and certain SEC rules and regulations and provides the SECs views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based



9



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##### Table of Contents

payment transactions with non-employees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected
volatility and expected term), the accounting for certain redeemable financial instrument issues under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in
an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options
prior to adoption of SFAS No. 123R, and disclosures in Managements Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. The Company is currently evaluating the impact that SAB 107
will have on its results of operations and financial position when it is adopted in fiscal 2006.



In June 2005, the FASB issued FAS No. 154, Accounting Changes and Error Corrections  a replacement of APB No. 20 and FAS No. 3, which
replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in
accounting principle. This Statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative
effect of the change. When it is impracticable to determine the period-specific effects of an accounting change, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of
the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is
impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date
practicable. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. This
Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Its adoption is not expected to have a significant impact on the Companys financial position or results of
operations.



Reclassifications



Certain reclassifications have been made to prior period balances in order
to conform to the current period presentation.



NOTE 3NET LOSS PER
SHARE:



Basic and diluted net loss per share is computed
using the weighted average number of common shares outstanding. Options 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 EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                     |  | 2004                       |        |   | 2005                     |   |        | 2004 |  |   | 2005   |  
|Net loss per share, basic and diluted:                               |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                                             |  | $                          | (3,635 | ) |                          | $ | (4,517 | )    |  | $ | (8,084 | ) |  | $ | (7,835 | )
|                                                                     |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share, basic and diluted                                |  | $                          | (0.18  | ) |                          | $ | (0.17  | )    |  | $ | (0.40  | ) |  | $ | (0.31  | )
|                                                                     |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing net loss per share, basic and diluted       |  |                            | 20,396 |   |                          |   | 26,013 |      |  |   | 20,346 |   |  |   | 25,602 |  
|                                                                     |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Antidilutive options not included in net loss per share calculations |  |                            | 4,357  |   |                          |   | 5,206  |      |  |   | 4,357  |   |  |   | 5,206  |  
|                                                                     |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



NOTE 4COMPREHENSIVE LOSS:



Comprehensive loss includes net loss, unrealized gains
and losses on investments, 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 EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                           |  | 2004                       |        |   | 2005                     |   |        | 2004 |  |   | 2005   |  
|Net loss                                   |  | $                          | (3,635 | ) |                          | $ | (4,517 | )    |  | $ | (8,084 | ) |  | $ | (7,835 | )
|Unrealized losses on marketable securities |  |                            | (15    | ) |                          |   | 3      |      |  |   | 2      |   |  |   | (17    | )
|Foreign currency translation adjustments   |  |                            | (4     | ) |                          |   | (10    | )    |  |   | (12    | ) |  |   | (7     | )
|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Net change in other comprehensive loss     |  |                            | (19    | ) |                          |   | (7     | )    |  |   | (10    | ) |  |   | (24    | )
|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|Total comprehensive loss                   |  | $                          | (3,654 | ) |                          | $ | (4,524 | )    |  | $ | (8,094 | ) |  | $ | (7,859 | )
|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  



10



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##### Table of Contents

NOTE 5ACQUISITION



On January 7, 2005, the Company entered into an Agreement and Plan of Merger with CoSine Communications, Inc., referred to in this report as CoSine.
The Company received formal notice from CoSine on May 17, 2005, terminating the merger agreement. As a result, the Company incurred a one time charge of $1,209 to write off the related transaction costs.



On June 1, 2005, the Company acquired 100% of the outstanding common stock of
Copper Mountain for approximately $11,729. The purchase price consisted of 2,470 shares of the Companys common stock valued in aggregate at $9,817, warrants to purchase the Companys common stock valued at $58, acquisition related
expenses consisting of legal, insurance and other professional fees of $1,503 and employee severance costs of $351. The value of the Companys common stock was determined based on the average market price over the two day period before and
after the acquisition was announced on February 11, 2005. The results of operations of Copper Mountain have been included in the consolidated statement of operations from June 1, 2005. The Company acquired Copper Mountain for its additional product
and engineering resources, which are being refocused to address the Companys expanding video market opportunities. The Company believes that the acquisition of Copper Mountain will help to accelerate the Companys plan to address the
growing number of opportunities in the market for video processing systems. During the three months ended June 30, 2005, the Company recognized revenue of $1,528 from the sale of legacy Copper Mountains products in backlog. The Company will
honor Copper Mountains existing customer support agreements but does not expect significant future revenue from the sale of Copper Mountains historical product lines.



The Company determined the fair value of the acquired intangibles with the assistance of an independent third party
appraiser using established valuation techniques. The purchase price of $11,729 exceeded the fair value of the net assets acquired of $10,057, thereby resulting in goodwill of $1,672. The allocation of the purchase price was as follows:



|                                 |  |   |       
|-------------------------------- |  | - | ------
|Current assets                   |  | $ | 4,285 
|Property and equipment           |  |   | 706   
|Completed technology and patents |  |   | 6,221 
|Goodwill                         |  |   | 1,672 
|                                 |  |   |       
|Total assets acquired            |  |   | 12,884
|Liabilities                      |  |   | 1,155 
|                                 |  |   |       
|Total liabilities assumed        |  |   | 1,155 
|                                 |  |   |       
|Net assets acquired              |  | $ | 11,729
|                                 |  |   |       



Completed technology
and patents are being amortized over a weighted average life of five years. The goodwill of $1,672 will not be deductible for tax purposes.



The following unaudited pro forma consolidated information gives effect to the acquisition of Copper Mountain as if it had occurred on January 1, 2004 and
2005 by consolidating the results of operations of Copper Mountain with the results of operations of the Company for the three and six months ended June 30, 2004 and 2005.



|                                     |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------ |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                     |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                     |  | 2004                       |        |   | 2005                     |   |        | 2004 |  |   | 2005    |  
|Revenue                              |  | $                          | 7,228  |   |                          | $ | 9,822  |      |  | $ | 15,394  |   |  | $ | 17,192  |  
|Net loss                             |  | $                          | (9,742 | ) |                          | $ | (7,667 | )    |  | $ | (19,521 | ) |  | $ | (16,160 | )
|Basic and diluted net loss per share |  | $                          | (0.48  | ) |                          | $ | (0.29  | )    |  | $ | (0.96   | ) |  | $ | (0.63   | )



NOTE 6BALANCE SHEET
COMPONENTS:



|                                                                  |  |                  |        |   |              |   |        |  
|----------------------------------------------------------------- |  | ---------------- | ------ | - | ------------ | - | ------ | -
|                                                                  |  | December 31,2004 |        |   | June 30,2005 |  
|Accounts Receivable:                                              |  |                  |        |   |              |   |        |  
|Accounts receivable                                               |  | $                | 6,724  |   |              | $ | 8,314  |  
|Unbilled revenue                                                  |  |                  |       |   |              |   | 2,844  |  
|Allowance for doubtful accounts                                   |  |                  | (139   | ) |              |   | (132   | )
|                                                                  |  |                  |        |   |              |   |        |  
|                                                                  |  | $                | 6,585  |   |              | $ | 11,026 |  
|                                                                  |  |                  |        |   |              |   |        |  
|Inventories, net:                                                 |  |                  |        |   |              |   |        |  
|Finished goods                                                    |  | $                | 5,038  |   |              | $ | 4,359  |  
|Raw materials                                                     |  |                  | 184    |   |              |   | 1,531  |  
|Allowance for excess and obsolete inventory and abandoned product |  |                  | (1,228 | ) |              |   | (1,065 | )
|                                                                  |  |                  |        |   |              |   |        |  
|                                                                  |  | $                | 3,994  |   |              | $ | 4,825  |  
|                                                                  |  |                  |        |   |              |   |        |  
|Property and equipment:                                           |  |                  |        |   |              |   |        |  
|Computers and software                                            |  | $                | 1,811  |   |              | $ | 2,165  |  
|Test equipment                                                    |  |                  | 3,169  |   |              |   | 4,596  |  
|Office equipment                                                  |  |                  | 56     |   |              |   | 68     |  
|                                                                  |  |                  |        |   |              |   |        |  
|                                                                  |  |                  | 5,036  |   |              |   | 6,829  |  
|Less: accumulated depreciation                                    |  |                  | (3,162 | ) |              |   | (3,633 | )
|                                                                  |  |                  |        |   |              |   |        |  
|                                                                  |  | $                | 1,874  |   |              | $ | 3,194  |  
|                                                                  |  |                  |        |   |              |   |        |  
|Accrued liabilities:                                              |  |                  |        |   |              |   |        |  
|Professional Services                                             |  | $                | 872    |   |              | $ | 1,559  |  
|Compensation                                                      |  |                  | 1,164  |   |              |   | 1,398  |  
|Other                                                             |  |                  | 288    |   |              |   | 447    |  
|                                                                  |  |                  |        |   |              |   |        |  
|                                                                  |  | $                | 2,324  |   |              | $ | 3,404  |  
|                                                                  |  |                  |        |   |              |   |        |  



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The Company recorded a provision for inventory within cost of goods sold totaling $0 and $20 in the three
and six months ended June 30, 2005, respectively, and $21 and $995 in the three and six months ended June 30, 2004, respectively, 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 end of each respective quarter in the six months ended June 30, 2004. The Company also reduced inventory costs to market value in 2004 as of the end of each respective quarter in the six months ended June 30, 2004.



Intangible and other assets:



|                                 |  |                         |        |                         |   |        |                |  |   |      
|-------------------------------- |  | ----------------------- | ------ | ----------------------- | - | ------ | -------------- |  | - | -----
|                                 |  | As of December 31, 2004
|                                 |  | GrossCarryingAmount     |        | AccumulatedAmortization |   |        | NetIntangibles
|Intangible and other assets:     |  |                         |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                       | 7,922  |                         | $ | (6,460 | )              |  | $ | 1,462
|Contract backlog                 |  |                         | 247    |                         |   | (247   | )              |  |   |     
|Customer list                    |  |                         | 86     |                         |   | (27    | )              |  |   | 59   
|Maintenance contract renewals    |  |                         | 50     |                         |   | (22    | )              |  |   | 28   
|Trademarks                       |  |                         | 315    |                         |   | (97    | )              |  |   | 218  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  | $                       | 8,620  |                         | $ | (6,853 | )              |  |   | 1,767
|                                 |  |                         |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                         |        |                         |   |        |                |  |   | 168  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  |                         |        |                         |   |        |                |  | $ | 1,935
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 | 
|                                 |  | As of June 30, 2005    
|                                 |  | GrossCarryingAmount     |        | AccumulatedAmortization |   |        | NetIntangibles
|Intangible and other assets:     |  |                         |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                       | 14,143 |                         | $ | (7,202 | )              |  | $ | 6,941
|Contract backlog                 |  |                         | 247    |                         |   | (247   | )              |  |   |     
|Customer list                    |  |                         | 86     |                         |   | (33    | )              |  |   | 53   
|Maintenance contract renewals    |  |                         | 50     |                         |   | (27    | )              |  |   | 23   
|Trademarks                       |  |                         | 315    |                         |   | (120   | )              |  |   | 195  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  | $                       | 14,841 |                         | $ | (7,629 | )              |  |   | 7,212
|                                 |  |                         |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                         |        |                         |   |        |                |  |   | 151  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  |                         |        |                         |   |        |                |  | $ | 7,363
|                                 |  |                         |        |                         |   |        |                |  |   |      



During the six months
ended June 30, 2004, the Company determined that certain of the technology acquired as part of the purchase of the ViaGate Technologies, Inc. assets in September 2001 had become impaired. As a result, the Company incurred a loss of $202 to write-off
the technology.



The aggregate amortization expense for the
three months ended June 30, 2004 and 2005 was $376 and $400, respectively and $772 and $775 for the six months ended June 30, 2004 and 2005.



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Minimum future amortization expense as of June 30, 2005 is as follows:



|                  |  |   |      
|----------------- |  | - | -----
|Remainder of 2005 |  | $ | 893  
|2006              |  |   | 1,787
|2007              |  |   | 1,726
|2008              |  |   | 1,247
|2009              |  |   | 1,115
|2010              |  |   | 444  
|                  |  |   |      
|                  |  | $ | 7,212
|                  |  |   |      



NOTE 7INDEBTEDNESS



Line of Credit



On September 23, 2004, the Company entered into a revolving asset based
credit facility (credit facility), with Silicon Valley Bank (the Bank). This facility has a term of two years and expires on September 23, 2006. Borrowings under the credit facility are formula based and limited to the lesser
of $7.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate, 6.0% as of June 30, 2005, plus 0.5%. The rate may
increase by 1.0% if the Company does not meet certain financial covenants. The credit facility is collateralized by all of the Companys assets, and contains various financial covenants. The Company had $5.0 million in outstanding borrowings
under this credit facility at June 30, 2005. The maximum amount available based on the maximum percentages of eligible accounts receivable and inventory was $6,631. Subsequent to the end of the quarter, the Company repaid all the outstanding
borrowings under the credit facility.



Note Payable



As part of the Companys acquisition of VTC from Tektronix, Inc. in
November 2002, the Company issued a note payable to Tektronix, Inc. for $3,232, with repayment in sixty months, or November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is
added to the principal balance of the note. Thereafter, the Company will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and October 31 thereafter until the principal balance is due in full in November
2007. As of December 31, 2004 and June 30, 2005, this note payable balance, including accrued interest, was $3,816 and $3,967, respectively



NOTE 8COMMITMENTS AND CONTINGENCIES:



Lease obligations



The Company leases equipment and office, assembly and warehouse space under non-cancelable operating leases that expire from 2005 through 2008.



Minimum future lease payments under operating leases as of
June 30, 2005 are as follows:



|                  |  |   |    
|----------------- |  | - | ---
|Remainder of 2005 |  | $ | 395
|2006              |  |   | 347
|2007              |  |   | 181
|2008              |  |   | 19 
|                  |  |   |    
|                  |  | $ | 942
|                  |  |   |    



Purchase
commitments



The Company had non-cancelable commitments to
purchase finished goods inventory totaling $469 and $1,913 in aggregate at December 31, 2004 and June 30, 2005, respectively.



Contingencies



Whalen v. Tut Systems, Inc. et al



On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc.
et al.,Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was
filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from the Companys January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged actions by the
underwriters for the offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and under Section 10(b) and Rule 10b-5 of the
Securities Exchange Act of 1934, as amended, and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the Securities Act. The complaint also names as defendants the underwriters for the
Companys initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public



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##### Table of Contents

offerings and secondary offerings conducted in 1999 and 2000. Therefore, for pretrial purposes, the Whalen action is being coordinated with the
approximately 300 other suits before United States District Court Judge Shira Scheindlin of the Southern District of New York under the matter In Re Initial Public Offering Securities Litigation.The individual defendants in the Whalen
action, namely, Nelson Caldwell, Salvatore D Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, approving the parties October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the
Court issued an Opinion and Order denying the Companys motion to dismiss.



In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including the Company, was submitted to the Court on June 14, 2004 in the In Re Initial Public Offering Securities
Litigation. On February 15, 2005, the Court granted preliminary approval of the settlement, conditioned upon the parties modification of a proposed bar order with respect to potential contribution claims. The settlement is subject to a
number of conditions, most of which are outside of the Companys control, including approval by the Court. The underwriters named as defendants in the In Re Initial Public Offering Securities Litigation (collectively, the
underwriter-defendants), including the underwriters named in the Whalen suit, are not parties to the stipulation of settlement.



The stipulation of settlement provides that, in exchange for a release of claims against the settling issuer-defendants, the insurers of all of the
settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the underwriter-defendants. The ultimate amount, if any, that may be paid on behalf of the Company
will therefore depend on the final terms of the settlement, including the number of issuer-defendants that ultimately participate in the final settlement, and the amounts, if any, recovered by the plaintiffs from the underwriter-defendants and other
non-settling defendants.



In the event that all or
substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on behalf of the Company could range from zero to approximately $7.0 million, depending on plaintiffs recovery from
the underwriter-defendants and from other non-settling parties and the amount of insurance available under the Companys applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement
payments would be made on behalf of the Company under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, the Company believes that its insurance will likely cover some or all of its share of any payments towards
satisfying plaintiffs $1 billion recovery deficit. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the
uncertainties described above regarding the amount the Company will ultimately be required to pay, if any, as of June 30, 2005, the Company has not accrued a liability for this matter.



The Company is subject to other 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.



In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation



Copper Mountain, which the Company acquired on June
1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re
Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities law under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange
Act. As a result of the acquisition, the Company has inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and the Company is exposed to any liability that may come out of the claims. The Copper
Mountain action described in this paragraph like the Whalen action described above has been coordinated for pretrial purposes under the matter In Re Initial Public Offering Securities Litigation. The individual defendants in the Copper
Mountain action were also dismissed without prejudice pursuant to the October 9, 2002 Order of the Court approving the parties October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying
Copper Mountains motion to dismiss. Copper Mountain entered into the same stipulation of settlement as the Company did in the Whalenaction described above. The Copper Mountain stipulation of settlement is subject to the same
terms, conditions and contingencies as the stipulation of settlement the Company entered into with respect to the Whalenaction described above. At this time, the Company cannot estimate the amount that the Company may be required to pay the
plaintiffs under a final settlement with respect to the Copper Mountain action described in this paragraph.



NOTE 9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 as 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 EndedJune 30, |       | Six Months EndedJune 30,
|                    |  | 2004                       |       | 2005                     |   | 2004  |  | 2005
|United States       |  | $                          | 3,753 |                          | $ | 8,162 |  | $    | 9,154  |  | $ | 13,949
|International:      |  |                            |       |                          |   |       |  |      |        |  |   |       
|Canada              |  |                            | 515   |                          |   | 350   |  |      | 708    |  |   | 735   
|China               |  |                            | 11    |                          |   | 497   |  |      | 31     |  |   | 706   
|Ireland             |  |                            | 584   |                          |   | 204   |  |      | 545    |  |   | 485   
|All other countries |  |                            | 260   |                          |   | 461   |  |      | 861    |  |   | 852   
|                    |  |                            |       |                          |   |       |  |      |        |  |   |       
|                    |  | $                          | 5,123 |                          | $ | 9,674 |  | $    | 11,299 |  | $ | 16,727
|                    |  |                            |       |                          |   |       |  |      |        |  |   |       



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##### Table of Contents

One customer, Enterasys Networks Ltd. accounted for 11% of the Companys revenue for the three
months ended June 30, 2004. No individual customer accounted for greater than 10% of the Companys revenue for the three months ended June 30, 2005 or the six months ended June 30, 2004. One customer, FTC Management, Inc. accounted for 15.1% of
the Companys revenue for the six months ended June 30, 2005.



Products



The Company designs, develops, and sells video processing
systems and broadband transport and service management products. Video processing systems include both digital TV headend systems and video systems. The digital TV headend system enables telephony-based service providers to transport broadcast
quality digital video signals across their networks and our digital video transmission systems optimize the delivery of video signals across enterprise, government and education networks. The broadband transport and service management products
enable the transmission of broadband data over existing hotels and private campus networks.



Revenue relating to the broadband transport and service management products was $2,016 and $1,244 for the three months ended June 30, 2004 and 2005, respectively and $3,916 and $2,386 for the six months ended June 30,
2004 and 2005, respectively. Revenue related to video processing systems was $3,107 and $6,902 for the three months ended June 30, 2004 and 2005, respectively and $7,383 and $12,813 for the six months ended June 30, 2004 and 2005, respectively.
Revenue related to legacy product sales from the recently completed Copper Mountain merger was $1,528 for the quarter ended June 30, 2005.



NOTE 10SUBSEQUENT EVENT:



On July 22, 2005, the Company completed the private sale of 5,535 shares of its common stock at a price of $2.70 per share for gross proceeds of $14,945.
Net proceeds from the offering were approximately $14,100. Under the terms of the financing, the Company also issued warrants to purchase an additional 2,768 shares of its common stock. The warrants expire in 2010 and, beginning in 2006, are
exercisable at a per share price of $4.25. The Company has the right to call the warrants in the event that the trading price of its common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would
provide an additional $11,764 in proceeds to the Company.



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##### Table of Contents



|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



The section entitled Managements Discussion and Analysis of Financial Condition and Results of
Operations set forth below contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used herein, the
words anticipates, believes, continue, could, estimates, expects, intends, may, plans, seeks, should,
will or the negative of these terms or similar expressions are generally intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events.
Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The forward-looking statements contained in this quarterly report include statements about the following: (1) our belief that video products will provide most of our growth opportunities for the
foreseeable future, (2) our belief that the number of telco video subscribers will grow significantly between 2004 and 2007 and that this market space will continue to become more competitive, (3) our expectation that we will compete with larger
public companies as we begin to target larger telco customers, (4) our expectation that digital subscriber line or DSL technology will continue to dominate telco broadband networks for the foreseeable future, (5) our expectation that demand for our
products will increase, (6) our expectation that our sales and marketing expenses will increase for the remainder of 2005, (7) our expectation that sales of broadband transport and service management products will remain flat until the expected
introductions of next generation service management products for the multiple dwelling unit and enterprise market during the second half of 2005, (8) our expectation that our research and development expenses will increase during the remainder of
2005 when compared with the first half of the year and compared to 2004, (9) our expectation that capital expenditures for research and development will remain consistent throughout the remainder of 2005, (10) our expectation that capital
expenditures in 2005 will be comparable to 2004 and that these capital expenditures will be funded from cash, cash equivalents and availability under the credit facility, (11) our belief that our cash and cash equivalents, availability under the
credit facility as of June 30, 2005 and subsequent cash proceeds from the July 2005 common stock sale are sufficient to fund our operating activities and capital expenditure needs for the next twelve months, (12) our expectation that we will incur
losses in the near future, (13) our expectation that some competitors will market some of their products for use in TV over DSL applications, (14) our anticipation that our sales and operating margins will continue to fluctuate, (15) our
anticipation that we will generally continue to invoice foreign sales in U.S. dollars, (16) our intention to continue to evaluate new acquisition candidates, divesture and diversification strategies, and (17) our expectation that customers outside
of the United States will represent a significant and growing portion of our revenue.



The cautionary statements contained under the caption Additional Risk Factors that Could Affect Our Operating Results and the Market Price of Our Stock and other similar statements contained elsewhere
in this report, identify important factors with respect to such forward-looking statements, including certain risks and uncertainties that could cause our actual results, performance or achievements to differ from those expressed or implied by such
forward-looking statements.



Although we believe that
the expectations reflected in such forward-looking statements are based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. We disclaim any obligation or
undertaking to disseminate any updates or revision to any forward-looking statement contained herein or reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is
based.



Overview



Our Business



We design, develop, and sell digital video processing systems that enable telephony-based service providers to deliver
broadcast quality digital video signals across their networks. We refer to these systems as digital TV headends or video content processing systems. We also offer digital video processing systems that enable private enterprise and government
entities to transport video signals across satellite, fiber, radio, or copper facilities for surveillance, distance learning, and TV production applications.



We also offer broadband transport and service management products that enable the provisioning of high speed Internet access and other broadband data
services over existing copper networks within hotels and private campus facilities.



Our History



Prior to November 2002,
most of our sales were derived from our broadband transport and service management products. With our November 2002 acquisition of Tektronixs subsidiary VTC, we extended our product offerings to add video processing systems for digital TV
headends and for the transmission of video signals over private and government networks. The acquisition of VTC resulted in significant changes in our business. On June 1, 2005, we acquired Copper Mountain Networks, Inc. referred to in this report
as Copper Mountain, to further expand our video content processing systems product line in order to address our growing video market opportunities. This acquisition resulted in an additional research and development facility in San Diego,
California, and 37 additional employees. We do not expect significant future revenue from the sale of Copper Mountains historical product line. With our acquisition of VTC and Copper Mountain, sales of video processing systems now represent a
majority of our total revenues and will provide most of our growth opportunities in the foreseeable future.



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##### Table of Contents

We earn revenue primarily by selling video content processing systems both directly and through resellers
to telecommunications service providers. We also earn revenue by selling video transmission systems to TV broadcasters, government agencies and educational institutions, and by selling broadband transport and service management products directly and
through distributors to the hospitality industry and to owners of private multi-tenant campus facilities.



Although international sales are still a material portion of our total sales, since our acquisition of VTC, international sales have represented a smaller
percentage of our overall business relative to prior years. During the years ended December 31, 2002, 2003 and 2004, international sales represented 43.0%, 18.4% and 23.3% of our total sales, respectively. During the three months ended June 30, 2004
and 2005, international sales represented 26.7% and 15.6% of our total sales, respectively. During the six months ended June 30, 2004 and 2005, international sales represented 19.0% and 16.6% of our total sales, respectively.



Material Trends and Uncertainties



We pay close attention to and monitor various trends and uncertainties about
our business. There is a growing demand by independent operating telephone companies to offer video services to their customer base. According to a report released by InStat/MDR in April 2003, the number of telco video subscribers worldwide will
increase from 572,000 at the end of 2003 to over 19.0 million by the end of 2007. While this growing market presents opportunities to serve a larger customer base, we are also seeing the emergence of intense competition as more companies compete to
sell digital TV headend products. We expect this market space will continue to become more competitive in the future. Our immediate competitors in the digital TV headend markets are primarily small private companies that are focused on a more narrow
product line than ours and thereby may be able to devote substantially more targeted resources to developing, marketing and selling new products than we are able to. In addition, these companies may become targets for acquisition by larger
companies, in which case we would face competitors with substantially greater name recognition, and technical, financial and marketing resources than we have. This increased competitive pressure may adversely affect the amount and timing of our
revenue in future periods, thereby making it more difficult for us to accurately forecast our future revenue, and may also adversely affect our product and service margins.



The growth in the market for delivery of switched digital video has begun to accelerate as larger tier one telcos and cable
multi system operators, or MSOs, are evaluating this new technology. As we begin to target larger telco customers, we expect to compete with larger public companies, including Harmonic, Motorola and Tandberg Television.



The emergence of new technologies to serve the digital TV headend market
means that we must continue to invest in these new technologies to maintain our market position. Digital subscriber line, or DSL, technologies use sophisticated signal blending techniques to transmit data through copper wires. The limitations on the
amount of data that can be transmitted in a fixed amount of time (such limitations are referred to as bandwidth) and the distance data may be transmitted using copper wire constrain both the number of video channels that may be delivered
simultaneously and the number of customers that are reachable from a telco central office over a DSL network. Emerging advancements in video compression technology are now enabling high quality video streams to be transported at lower data transfer
rates than has been previously available. These emerging compression advancements also introduce the possibility of delivering high-definition television over bandwidth constrained asymmetric DSL, or ADSL, lines for the first time. ADSL is a new
technology that allows more data to be transmitted over existing copper telephone lines compared with standard DSL. Additionally, DSL advancements are emerging that expand the available bandwidth from the telco to the subscriber thereby supporting
higher DSL data transfer rates over longer distances. As our products continue to incorporate these new technological advancements, we expect the demand for our products will increase because our products will enable more telcos to reach more of
their customers with a greater number of video channels. However, because of the increasing competition in the markets in which we compete, regardless of our revenue and product and service margins in future periods, we will have to continue to
devote significant resources to research and development in future periods in order to continue to offer our customers competitive products that incorporate these emerging technologies. As a consequence, our research and development expenses have
increased during the first half of 2005 and we expect our research and development expenses to increase for the remainder of 2005.



As we continue to capitalize on the growing number of telcos deploying video services in the United States and abroad, we will also have to continue to
aggressively market our new and existing products and expand our marketing and sales efforts domestically and internationally. Nevertheless, our operations have been and will continue to be subject to pressure from weakness in the overall technology
sector as well as the digital media industry, the continued lengthening of our sales cycle and delays of customer purchasing decisions, which may continue to reduce our expected revenue. We believe that the lengthening of the purchase decision by
prospective customers has occurred and may continue because of several factors that are affecting the overall digital TV headend market. Such factors include, but are not limited to, the delays in the introduction of advanced compression technology
set top boxes, the transition to more efficient data transmission technologies and the emergence of video signal encryption requirements. Nevertheless, given the opportunities offered by the growing number of telcos deploying video services and
despite the length of the sales cycle, we expect our sales and marketing expenses to increase for the remainder of 2005 compared to our spending in 2004.



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##### Table of Contents

Definitions for Discussion of Results of Operations



The following is an explanation of how we employ certain concepts in our
discussion of our results of operations:



| |  |  | Revenue. Revenue consists of sales of our video processing systems, which includes both digital TV headend and video transmission systems. Revenue also includes sales of our
broadband transport and service management products, as well as revenue related to legacy products from the recently completed Copper Mountain merger. Since our acquisition of VTC, a large part of our revenue has been associated with the sale of
digital TV headends. Furthermore, each individual headend sale has represented a significant portion of our revenue. If we were to sell even one less system than our forecasted number of headend sales, our revenue would be materially impacted.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Costs of Goods Sold. Cost of goods sold, or COGS, consists of costs related to raw materials, contract manufacturing, personnel, overhead, test and quality assurance for
products, and the cost of licensed technology included in our products. Raw materials, contract manufacturing and licensed technology are the principal elements of COGS and vary directly with product sales.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Sales and Marketing. Sales and marketing expense consists primarily of selling and marketing personnel costs, including sales commissions, travel, trade shows, promotions and
outside services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Research and Development. Research and development expense consists primarily of personnel and facilities costs, contract consultants, outside testing services, and equipment
and supplies associated with enhancing existing products and developing new products.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | General and Administrative. General and administrative expense consists primarily of personnel costs for administrative officers and support personnel, professional services
and insurance expenses.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amortization of Intangible Assets. Amortization of intangible assets consists primarily of expenses associated with the amortization of technology and patents related to
acquisitions.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



The following table sets forth items from our statements of operations as a
percentage of total revenues for the periods indicated:



|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|------------------------------ |  | -------------------------- | -- |  | ------------------------ | -- |  | ----- | -- |  | ----- | --
|                               |  | Three MonthsEnded June 30, |    |  | Six MonthsEnded June 30, |   
|                               |  | 2004                       |    |  | 2005                     |    |  | 2004  |    |  | 2005  |   
|Total revenues                 |  | 100.0                      | %  |  | 100.0                    | %  |  | 100.0 | %  |  | 100.0 | % 
|Total cost of goods sold       |  | 67.3                       |    |  | 60.1                     |    |  | 75.9  |    |  | 59.6  |   
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|Gross margin                   |  | 32.7                       |    |  | 39.9                     |    |  | 24.1  |    |  | 40.4  |   
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|Operating expenses:            |  |                            |    |  |                          |    |  |       |    |  |       |   
|Sales and marketing            |  | 37.7                       |    |  | 28.4                     |    |  | 34.0  |    |  | 31.3  |   
|Research and development       |  | 36.3                       |    |  | 33.2                     |    |  | 32.6  |    |  | 31.9  |   
|General and administrative     |  | 21.5                       |    |  | 20.3                     |    |  | 19.6  |    |  | 18.7  |   
|Impairment of intangibles      |  |                           |    |  |                         |    |  | 1.8   |    |  |      |   
|Amortization of intangibles    |  | 7.3                        |    |  | 4.1                      |    |  | 6.8   |    |  | 4.6   |   
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|Total operating expenses       |  | 102.8                      |    |  | 86.0                     |    |  | 94.8  |    |  | 86.5  |   
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|Loss from operations           |  | (70.1                      | )  |  | (46.1                    | )  |  | (70.7 | )  |  | (46.1 | ) 
|Interest and other income, net |  | (0.9                       | )  |  | (0.6                     | )  |  | (0.9  | )  |  | (0.7  | ) 
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   
|Net loss                       |  | (71.0                      | )% |  | (46.7                    | )% |  | (71.6 | )% |  | (46.8 | )%
|                               |  |                            |    |  |                          |    |  |       |    |  |       |   



Three and Six Months Ended June 30,
2004 and 2005



Total Revenues. Our total revenues
increased to $9.7 million and $16.7 million for the three and six months ended June 30, 2005, respectively, when compared with total revenues of $5.1 million and $11.3 million for the same periods in 2004. For the three months ended June 30, 2005,
our product revenue from video processing systems increased by 122.1% to $6.9 million from $3.1 million for the three months ended June 30, 2004. Included in our total revenues for the three and six months ended June 30, 2005 was revenue related to
legacy product sales from the recently completed Copper Mountain merger totaling $1.5 million. We do not expect similar revenue contribution from these legacy products in future quarters. For the six months ended June 30, 2005, our product revenue
from video processing systems increased by 73.5%, to $12.8 million from $7.4 million for the same period in 2004. The increases in video processing systems revenue was due primarily to the introduction of our upgraded Astria video processing systems
that incorporate recent Motion Pictures Experts Group (MPEG) advanced video compression technologies or MPEG-4. Our upgraded Astria products enable our customers to address a larger percentage of their geographic market and deliver advanced video
services. Sales of broadband transport and service management products decreased from $2.0 million in the second quarter of 2004 to $1.2 million in the second quarter of 2005 and decreased from $3.9 million for the six months ended June 30, 2004 to
$2.4 million for the six months ended June 30, 2005. The decrease in broadband transport and service management products revenue was primarily the result of customers choosing competing products that transmit data via wireless data transmission
technologies instead of our products



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##### Table of Contents

which transmit data over telephone wires. In future quarters, we expect sales of broadband transport and service management products to increase with the
introduction of our next generation service management products later in the second half of this year. Included in sales of broadband transport and service management products were sales to one customer, Enterasys Networks Ltd. which accounted for
11% of our total revenue for the three months ended June 30, 2004.



Cost of Goods Sold. For the three months ended June 30, 2005, our cost of goods sold increased by $2.4 million to $5.8 million from $3.4 million for the three months ended June 30, 2004. The increase in cost of goods sold was due to
a $1.6 million increase in material costs relating to higher sales volume, an increase in freight and overhead costs of $0.3 million and the amortization of $0.5 million in backlog acquired in the Copper Mountain merger. Cost of goods sold increased
by $1.4 million to $10.0 million during the six months ended June 30, 2005, from $8.6 million for the six months ended June 30, 2004. The increase in cost of goods sold was due to a $1.9 million increase in material costs and the amortization of
$0.5 million in backlog acquired in the Copper Mountain merger. Included in cost of sales during the six months ended June 30, 2004 was an increase of $1.0 million in inventory reserves recorded during the first quarter of 2004.



Sales and Marketing. For the three months ended June 30, 2005, sales
and marketing expense increased by $0.8 million or 42.1% to $2.7 million from $1.9 million for the three months ended June 30, 2004. The $0.8 million increase was due to a $0.4 million increase in personnel related costs, $0.3 million increase in
promotion and product demonstration expenses, and $0.1 million in travel expenditures. For the six months ended June 30, 2005 sales and marketing expense increased to $5.2 million from $3.8 million for the six months ended June 30, 2004. The $1.4
million increase is due to a $0.9 million increase in personnel related costs, $0.1 million in contractor and outside services, and $0.4 million in promotion expenses.



Research and Development. For the three months ended June 30, 2005, our research and development expense increased by
72.9% to $3.2 million from $1.9 million for the three months ended June 30, 2004. The $1.4 million increase in our research and development expense for the second quarter of 2005 when compared with the same period in 2004 was due to an increase of
$0.6 million in personnel related costs related in part to our recently completed Copper Mountain merger, $0.1 million in outside service costs, and $0.7 million in purchases of materials. With the additional personnel and research and development
facility acquired from the Copper Mountain merger, we expect that our research and development expenses will increase during the remainder of 2005 when compared with the first half of the year. Research and development expense increased by $1.7
million to $5.3 million for the six months ended June 30, 2005 from $3.7 million for the six months ended June 30, 2004. The $1.7 million increase was due to an increase of $0.8 million in personnel related costs, and $0.9 million in purchases of
materials. Our capital expenditures for research and development were $0.2 million and $19,000 for the three months ended June 30, 2005 and 2004, respectively and $0.4 million and $0.3 million for the six months ended June 30, 2005 and 2004,
respectively. We expect capital expenditures for research and development to remain consistent throughout the remainder of 2005.



General and Administrative. For the three months ended June 30, 2005 general and administrative expense increased 78.8% to $2.0 million from $1.1
million for the three months ended June 30, 2004. For the six months ended June 30, 2005, general and administrative expense increased to $3.1 million from $2.2 million for the six months ended June 30, 2004. The increase of $0.9 million was due to
a $1.2 million one-time write off of costs relating to CoSines termination of the proposed merger and an increase in personnel related costs of $0.1 million partially offset by bad debt recoveries of $0.4 million.



Impairment of Intangible Assets.During the first quarter of 2004, we
determined that certain of the technology acquired as part of the purchase of the ViaGate Technology assets had become impaired. As a result, we recorded an impairment charge of $0.2 million to write off the book value of the intangible assets
associated with this technology.



Amortization of Intangible
Assets. Amortization of intangible assets is comprised of intangibles related to the acquisitions of Xstreamis Limited in 2000, VTC in 2002 and Copper Mountain in the second quarter of 2005. The remaining intangible assets subject to
amortization from these acquisitions consist primarily of completed technology and patents. For the three and six months ended June 30, 2005 and 2004, amortization of intangible assets remained consistent at $0.4 million and $0.8 million
respectively.



Interest and Other Income, Net. Interest
and other income, net consists primarily of interest income and expense and foreign currency exchange gains and losses. For the three and six months ended June 30, 2005 and 2004, our interest and other income remained flat at $50,000 and $0.1
million, respectively.



Liquidity and Capital Resources



Cash and cash equivalents totaled $10.4 million at June 30, 2005 compared
with $12.4 million at December 31, 2004, reflecting a net reduction of $2.1 million.



Cash used in operating activities was $7.6 million for the six months ended June 30, 2005, compared with $5.2 million for the six months ended June 30, 2004. The increased cash used in operating activities was
primarily due to an increase in accounts receivable resulting from higher revenue in the second quarter of 2005 and an increase in unbilled receivables.



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Cash provided by investing activities was $0.4 million for the six months ended June 30, 2005, compared
with cash used of $0.8 million for the six months ended June 30, 2004. Net cash acquired from the Copper Mountain acquisition was $1.6 million, consisting of cash acquired of $3.1 million offset by legal, insurance and other professional fees of
$1.5 million. Additions to property and equipment were $1.1 million in the six months ended June 30, 2005, compared with $0.8 million in the six months ended June 30, 2004, primarily reflecting an increased investment in research and development
assets. In total we expect capital expenditures for 2005 to be comparable to 2004. We expect these capital expenditures to be funded from cash, cash equivalents and availability under the credit facility.



Cash from financing activities was $5.1 million in the six months ended June
30, 2005, compared with $0.3 for the six months ended June 30, 2004. The increase is due to the proceeds from the line of credit which was repaid subsequent to June 30, 2005.



The following table sets forth our contractual obligations as of June 30, 2005:



|                            |  |                        |        |                  |   |              |  |            |       |            |   |    |  |   |  
|--------------------------- |  | ---------------------- | ------ | ---------------- | - | ------------ |  | ---------- | ----- | ---------- | - | -- |  | - | -
|                            |  | Payments due by period
|Contractual Obligations     |  | Total                  |        | Remainderof 2005 |   | 2006 to 2007 |  | 2008to2009 |       | Thereafter
|Line of Credit              |  | $                      | 5,000  |                  | $ | 5,000        |  | $          |      |            | $ |   |  | $ | 
|Long-Term Debt Obligations  |  |                        | 3,967  |                  |   |             |  |            | 3,967 |            |   |   |  |   | 
|Operating Lease Commitments |  |                        | 942    |                  |   | 395          |  |            | 528   |            |   | 19 |  |   | 
|Purchase Obligations        |  |                        | 1,913  |                  |   | 1,913        |  |            |      |            |   |   |  |   | 
|                            |  |                        |        |                  |   |              |  |            |       |            |   |    |  |   |  
|Total                       |  | $                      | 11,822 |                  | $ | 7,308        |  | $          | 4,495 |            | $ | 19 |  | $ | 
|                            |  |                        |        |                  |   |              |  |            |       |            |   |    |  |   |  



On September 23, 2004,
we entered into a revolving asset based credit facility (credit facility), with Silicon Valley Bank (the Bank). This facility has a term of two years and expires on September 23, 2006. Borrowings under the credit facility are
formula based and limited to the lesser of $7.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate, 6.0% as of June
30, 2005, plus 0.5%. The rate may increase by 1.0% if we do not meet certain financial covenants. The credit facility is collateralized by all of our assets, and contains various financial covenants. We had $5.0 million in outstanding borrowings
under this credit facility at June 30, 2005. The maximum amount available based on the maximum percentages of eligible accounts receivable and inventory was $6.6 million. Subsequent to the end of the quarter, we repaid all the outstanding borrowings
under this credit facility.



As part of our acquisition of VTC
from Tektronix in November 2002, we issued a note payable to Tektronix for $3.2 million, with repayment in sixty months, or by November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued
interest is added to the principal balance of the note. Thereafter, we will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and October 31 thereafter until the principal balance is due in full.
Principal and accrued interest on the note payable is $4.0 million at June 30, 2005. Accrued interest in the six months ended June 30, 2005 was $0.2 million.



We have incurred substantial losses and negative cash flows from operations since inception. For the six months ended June 30, 2005, we incurred a net
loss of $7.8 million, negative cash flows from operating activities of $7.6 million, and have an accumulated deficit of $303.3 million.



In July 2005, we completed the sale of 5,535,000 shares of our common stock at a price of $2.70 per share for gross proceeds of $14.9 million. Net
proceeds from the offering were approximately $14.1 million. Under the terms of the sale, we also issued warrants to purchase an additional 2.8 million shares of our common stock. The warrants expire in 2010 and, beginning in 2006, are exercisable
at a per share price of $4.25. We also have the right to call the warrants in the event that the trading price of our common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would provide us an
additional $11.8 million in cash.



We believe that the cash and
cash equivalents and the availability under the credit facility as of June 30, 2005 combined with the cash proceeds from the July 2005 common stock sale are sufficient to fund our operating activities and capital expenditure needs for the next
twelve months. However, in the event that general economic conditions worsen, we may require additional cash to fund our operations. Failure to generate positive cash flow in the future could have a material adverse effect on our ability to achieve
our intended business objectives.



Off Balance Sheet Arrangements



We do not have any material off balance sheet
arrangements.



Critical Accounting Policies and Estimates



Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The



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preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.



We
have identified the policies below as critical to our business operations and the understanding of our results of operations.



Revenue recognition. We generate revenue primarily from the sale of hardware products, including third-party products, through professional
services, and through the sale of our software products. We sell products through direct sales channels and through distributors. Generally, product revenue is generated from the sale of video processing systems and components and the sale of
broadband transport and service management products. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyers specifications.



Product revenue is generated primarily from the sale of
complete end-to-end video processing systems generally referred to as turnkey solutions. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services and post contract support. Sales
of turnkey solutions are classified as product revenue in the statement of operations.



Product revenue is also generated from the sale of video processing component products the sale of broadband transport and service management products and the sale of certain legacy products acquired with the Copper
Mountain merger. We sell these products through our own direct sales channels and also through distributors.



Our revenue recognition policies for turnkey solutions are in accordance with SOP 97-2,Software Revenue Recognition, as amended, which is the
authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP 97-2 requires that revenue recognized from software arrangements be allocated to each element
of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or other elements. Under SOP 97-2, the determination of fair value is based on objective evidence
that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements
of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by SOP 98-4,Deferral of the Effective Date of a Provision of SOP 97-2 and was amended again in
December 1998 by SOP 98-9,Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments deferred and then clarified, respectively, the specification of what was considered vendor specific
objective evidence of fair value for the various elements in a multiple element arrangement.



In the case of software arrangements that require significant production, modification or customization of software, which encompasses all of our turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We recognize revenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the PCS element of the multi-element arrangement, for
which we have established vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally recognized using the percentage-of-completion method, as stipulated by SOP 81-1. The
percentage-of-completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total
labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing
of approximately 90% of the contract value prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. In
connection with these contracts, we may perform the work prior to when the revenue is billable pursuant to the contract. The termination clauses in most of our contracts provide for the payment for the fair value of products delivered and services
performed in the event of an early termination. In connection with certain of our contracts, we have recorded unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts
which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. Management reviews unbilled receivables and related contract provisions to ensure we are justified in recognizing
revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are
generally considered to be incidental to the arrangement in its entirety because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.



For direct sales of video processing systems component products not included
as part of turnkey solutions and the direct sale of broadband transport and service management products, we recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection
is reasonably assured.



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Management must make significant management judgments and estimates in connection with the measurement of
revenue in a given period. We follow specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, we assess a number of factors, including specific contract and purchase order terms, completion
and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, we may
recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. In order to recognize revenue, we must also make a judgment regarding collectibility. Managements
judgment of collectibility is applied on a customer-by-customer basis pursuant to our credit review policy. We sell to customers with which we have a history of successful collection and to new customers for which such history may not exist. New
customers are subject to a credit review process, which evaluates the customers financial position and ability to pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are
only increased after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility is not probable based upon our credit review process, no credit is extended and
revenue is recognized on a cash-collected basis, after shipment has occurred or the revenue has been earned under the percentage-of-completion method.



We also maintain accruals and allowances for all cooperative marketing and other programs, as necessary. Estimated sales returns and warranty costs are
based on historical experience and are recorded at the time revenue is recognized, as necessary. Our products generally carry a one-year warranty from the date of purchase. To date, warranty costs have been insignificant to the overall financial
statements taken as a whole.



Unbilled Receivables.Unbilled receivables (costs and estimated profit in excess of billings) may be recorded in connection with certain turnkey solution contracts. Unbilled receivables are not billable at the balance sheet date but are recoverable over the remaining
life of the contract through billings made in accordance with contractual agreements. Management reviews unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we
have objective evidence which allows us to recognize such revenue.



Inventories. Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. We record provisions to write down our inventory and related
firm, non-cancelable and unconditional purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about the future demand
and market conditions. If actual future demand or market conditions are less favorable than we estimate, additional inventory provisions may be required.



Recent Accounting Pronouncements



In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share-Based Payment, which amends FASB Statement No. 123 and will be effective
for public companies for first fiscal years beginning after June 15, 2005. We will adopt SFAS 123R on January 1, 2006. The new standard will require us to expense employee stock options and other share-based payments. The FASB believes the use of a
binomial lattice model for option valuation is capable of more fully reflecting certain characteristics of employee share options compared to the Black-Scholes options pricing model. The new standard may be adopted in one of three waysthe
modified prospective transition method, a variation of the modified prospective transition method or the modified retrospective transition method. We are currently evaluating how we will adopt the standard and evaluating the effect that the adoption
of SFAS 123R will have on our financial position and results of operations.



On March 29, 2005, the SEC issued Staff Accounting Bulletin 107, or SAB 107, which expresses the views of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provides the
SECs views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with non-employees, the transition from nonpublic to public
entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instrument issues under share-based payment arrangements, the classification of compensation
expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Managements Discussion and Analysis of Financial Condition and Results of Operations subsequent to
adoption of SFAS No. 123R. We are currently evaluating the impact that SAB 107 will have on our results of operations and financial position when we adopt it in fiscal 2006.



In June 2005, the FASB issued FAS No. 154, Accounting Changes and Error Corrections  a replacement of APB No. 20
and FAS No. 3, which replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and
reporting of a change in accounting principle. This Statement requires retrospective application to prior periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities
as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement.
When it is impracticable to determine the cumulative effect of applying a change in



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accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the
earliest date practicable. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting
principle. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Its adoption is not expected to have a significant impact on our financial position or results of
operations.



ADDITIONAL RISK FACTORS THAT COULD AFFECT OUR
OPERATING RESULTS AND THE MARKET PRICE OF OUR STOCK



We have a
history of significant losses, and we may never achieve profitability.



We have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. As of June 30, 2005, we had an accumulated deficit of $303.3 million. We expect to incur losses in the
near future. Moreover, we may never achieve profitability and, even if we do, we may not be able to maintain profitability. We may not be able to generate a sufficient level of revenue to offset our current level of expenses. Moreover, because our
expenditures for sales and marketing, research and development, and general and administrative functions are relatively fixed in the short term, we may be unable to adjust our spending in a timely manner to respond to any unanticipated decline in
revenue. If we fail to achieve and maintain profitability within the timeframe expected by securities analysts or investors, then the market price of our common stock will likely decline.



Each sale of our digital headend systems represents a significant portion of our revenue for any given quarter. Our failure to meet
our quarterly forecast of sales of digital headend systems in any given quarter could have a material adverse impact on our financial results for a given quarter.



Since we acquired VTC in November 2002, a large part of our quarterly revenue is associated with the sale of digital headend
systems. Each sale represents a significant portion of our revenue for each quarter. We base our operating forecast on our historical sales. Because of the high cost per unit of our digital headend systems, if we were to sell even one less system
than our forecasted number of headend sales per quarter, such a decrease in sales would have a material and adverse impact on our revenue for that quarter.



We operate in an intensely competitive marketplace, and many of our competitors have greater resources than we do.



Our primary competitors in the digital TV headend market are small private
companies that are focused on a more narrow product line than ours, thereby allowing these competitors to devote substantially more targeted resources to developing and marketing new products than we can. As we target larger telco customers for our
video content processing systems, we expect more competition from large public companies like Harmonic, Inc., Tandberg Television ASA, and Motorola, Inc., all of which have substantially greater financial, technical and other resources than we do.
These competitors have achieved success in providing headend components for cable multiple system operators and satellite TV providers and, we expect these competitors to market some of their products for use in TV over DSL applications. For
example, in the past, Harmonic provided video content processing systems to SaskTel, a large Canadian telephone service provider. Harmonic also recently announced that it will provide video content processing systems to Video Networks Limited, a
video-over-DSL provider in the United Kingdom.



Our competition
in the market for video transmission processing products primarily comes from small private companies such as SkyStream Networks and public companies such as Optibase Inc. and Tandberg Television that, together, offer a wide array of products with
special features and functions. Our broadband transport and service management business tends to compete against public, private and foreign network equipment companies.



To the extent that any of these current or potential future competitors enter or expand further into our markets, develop
superior technology and products or offer superior prices or performance features relative to our products, such competition could result in lost sales and severe downward pressure on our pricing, either of which would adversely affect our revenue
and profitability.



Commercial acceptance of any technological solution
that competes with technology based on communication over copper telephone wire could materially and adversely impact demand for our products, our revenue and growth strategy.



The markets for video content processing, transmission and high-speed data access systems and services are characterized by
several competing communication technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. Many of our products are based on communication over copper telephone wire. Because there are physical limits to
the speed and distance over which data can be transmitted over copper wire, our products may not be a viable solution for customers requiring service at performance levels beyond the current limits of copper telephone wire. Our customer base is
concentrated on telephone service providers that have a large investment in copper wire technology. If these customers lose market share to their competitors who use competing technologies that are not as constrained by physical limitations as
copper telephone wire, and that are able to provide faster access, greater reliability, increased cost-effectiveness or other advantages, demand for our products will decrease. Moreover, to the extent that our customers choose to install fiber optic
cable or other transmission media as part of their infrastructure,



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or to the extent that homes and businesses install other transmission media within buildings, demand for our products may decline. The occurrence of any one
or more of these events would harm demand for our products, which would thereby adversely affect our revenue and growth strategy.



If the projected growth in demand for video services from telephone service providers does not materialize or if our customers find alternative methods of
delivering video services, future sales of our video content processing systems will suffer.



We manufacture video content processing systems that enable telephone service providers to offer video services to their customers. Our customers, the
telephone service providers, face competition from cable companies, satellite service providers and wireless companies. For some users, these competing solutions provide fast access, high reliability and cost-effective solutions for delivering data,
including video services. Telephone service providers hope to maintain their market share in their core business of voice telephony as well as increase their revenue per customer by offering their customers more services, including video services
and high-speed data services. However, if the telephone service providers find alternative ways of maintaining and growing their market share in their core business that do not require that they offer video services, demand for our products will
decrease substantially. Moreover, if technological advancements are developed that allow our customers to provide video services without upgrading their current system infrastructure, or that offer our customers a more cost-effective method of
delivering video services, sales of our video content processing systems will suffer. Alternatively, even if the telephone service providers choose our video content processing systems, the service providers may not be successful in marketing video
services to their customers, in which case our sales would decrease substantially.



Our operating results fluctuate significantly from quarter to quarter, and this may cause the price of our stock to decline.



Over the last 12 quarters, our revenue per quarter has fluctuated between $9.7 million and $2.0 million. Over the same periods, our losses from operations
as a percentage of revenue have fluctuated between approximately 5.2% and 691.0% of revenue. We anticipate that our sales and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:



| |  |  | the timing of customers purchase decisions, acceptance of our new products and possible cancellations;
| | - |  | -------------------------------------------------------------------------------------------------------



| |  |  | competitive pressures, including pricing pressures from our partners and competitors;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | delays or problems in the introduction of our new products;
| | - |  | -----------------------------------------------------------



| |  |  | announcements of new products, services or technological innovations by us or our competitors; and
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | management of inventory levels.
| | - |  | -------------------------------



Fluctuations in our sales and operating margins will make it more difficult for us to accurately forecast our results of operations and this could
negatively impact the market price of our stock.



The sales cycle for
video content processing systems is long and unpredictable, which requires us to incur high sales and marketing expenses with no assurance that a sale will result.



The sales cycle for our headend systems can be as long as 12-18 months. Additionally, with respect to the sale of our
products to U.S. and foreign government organizations, we may experience long sales cycles as a result of government procurement processes. As a result, while we continue to incur costs associated with a particular sale prior to payment from the
customer, we may not recognize revenue from efforts to sell particular products for extended periods of time. As a result, our quarter-to-quarter comparisons of our revenue and operating results may not be meaningful and may not provide an accurate
indicator of our future performance. Our operating results in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the trading price of
our common stock.



If we fail to accurately forecast demand for our
products, our revenue, profitability and reputation could be harmed.



We rely on contract manufacturers and third-party equipment manufacturers, or OEMs, to manufacture, assemble, test and package our products. We also depend on third-party suppliers for the materials and parts that
constitute our products. Our reliance on contract manufacturers, OEMs and third-party suppliers requires us to accurately forecast the demand for our products and coordinate our efforts with those of our contract manufacturers, OEMs and suppliers.
We often make significant up-front financial commitments with our contract manufacturers, OEMs and suppliers in order to procure the raw materials and begin manufacturing and assembly of the products. If we fail to accurately forecast demand or
coordinate our efforts with our suppliers, OEMs and contract manufacturers, we may face supply, manufacturing or testing capacity constraints. These constraints could result in delays in the delivery of our products, which could lead to the loss of
existing or potential customers and could thereby result in lost sales and damage to our reputation, which would adversely affect our revenue and profitability. Further, we outsource the manufacturing of our products based on forecasts of sales. If
orders for our 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 our forecasts exceed the orders we actually receive and
we are unable to cancel future purchase and manufacturing commitments in a timely manner, our inventory levels would increase. This could expose us to losses related to slow moving and obsolete inventory, which would have a material adverse effect
on our profitability.



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If we fail to develop and introduce new products in response to the rapid technological changes in the markets in
which we compete, we will not remain competitive.



The
markets for video content processing, transmission and high-speed data access systems are characterized by rapid technological developments, frequent enhancements to existing products and new product introductions, changes in end-user requirements
and evolving industry standards. To remain competitive, we must continually improve the performance, features and reliability of our products. For example, advances in compression technology are leading the video content processing industry to begin
the transition to next generation compression standards. These advances will allow for further reductions in the bandwidth required to deliver standard definition video channels and introduce the possibility of delivering high-definition television
over asymmetric digital subscriber lines, or ADSL, for the first time. ADSL is a new technology that allows more data to be transmitted over copper telephone lines than standard DSL. Further advances in compression technology, or the emergence of
new industry standards would require that we further redesign our products to incorporate, and remain compatible with, emerging technologies and industry standards.



We cannot assure you that we will be able to respond quickly and effectively to technological change. We may have only
limited time to enter certain markets, and we cannot assure you that we will be successful in achieving widespread acceptance of our products before competitors can offer products and services similar or superior to our products. If we fail to
introduce new products that address technological changes or if we experience delays in our product introductions, our ability to compete would be adversely affected, thereby harming our revenue, profitability and growth strategy.



We depend on international sales for a significant portion of our revenue, which
subjects our business to a number of risks. If we are unable to generate significant international sales, our revenue, profitability and share price could be materially and adversely affected.



Sales to customers outside of the United States accounted for approximately
43.0%, 18.4% and 23.3% of revenue for the years ended December 31, 2002, 2003 and 2004, respectively and 19.0% and 16.6% for the six months ended June 30, 2004 and 2005, respectively. Sales and operating activities outside of the United States are
subject to inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies; tariffs, quotas, taxes and other market barriers; political and economic instability; restrictions on the export or import of
technology; potentially limited intellectual property protection; difficulties in staffing and managing international operations and potentially adverse tax consequences. Any of these factors may have a material adverse effect on our ability to grow
or maintain international revenue.



We expect sales to
customers outside of the United States to represent a significant and growing portion of our revenue. However, we cannot assure you that foreign markets for our products will develop at the rate or to the extent that we anticipate. If we fail to
generate significant international sales, our revenue, profitability and share price could be materially and adversely affected.



Fluctuations in interest and currency exchange rates may decrease demand for our products.



Substantially 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, thereby reducing demand for our products. We anticipate that we will generally continue to invoice foreign sales in U.S. dollars. 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. Any such losses would adversely
impact our profitability.



If our contract manufacturers, third-party
OEMs and third-party suppliers fail to produce quality products or parts in a timely manner, we may not be able to meet our customers demands.



We do not manufacture our products. We rely on contract manufacturers and OEMs to manufacture, assemble, package and test substantially all of our
products and to purchase most of the raw materials and components used in our products. Additionally, we depend on third-party suppliers to provide quality parts and materials to our contract manufacturers and OEMs, and we obtain some of the key
components and sub-assemblies used in our products from a single supplier or a limited group of suppliers. Neither we nor our contract manufacturers or OEMs have any guaranteed supply arrangements with the suppliers. If our suppliers fail to provide
a sufficient supply of key components, we could experience difficulties in obtaining alternative sources at reasonable prices, if at all, or in altering product designs to use alternative components. Moreover, if our contract manufacturers or OEMs
fail to deliver quality products in a timely manner, such failure would harm our ability to meet our scheduled product deliveries to customers. Delays and reductions in product shipments could increase our production costs, damage customer
relationships and harm our revenue and profitability. In addition, if our contract manufacturers and OEMs fail to perform adequate quality control and testing of our products, we would experience increased production costs for product repair and
replacement, and our profitability would be harmed. Moreover,



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defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or product
liability claims, each of which could harm our revenue, profitability and reputation.



Design defects in our products could harm our reputation, revenue and profitability.



Any defect or deficiency in our products could reduce the functionality, effectiveness or marketability of our products. These defects or deficiencies
could cause customers to cancel or delay their orders for our products, reduce revenue or render our product designs obsolete. In any of these events, we would be required to devote substantial financial and other resources for a significant period
of time to develop new product designs. We cannot assure you that we would be successful in addressing any 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 revenue, profitability and reputation.



Our
business depends on the integrity of our intellectual property rights. If we fail to adequately protect our intellectual property, our revenue, profitability, reputation or growth strategy could be adversely affected.



We attempt to protect our intellectual property and proprietary technology
through patents, trademarks and copyrights, by generally entering into confidentiality or license agreements with our employees, consultants, vendors, strategic partners and customers as needed, and by generally limiting access to and distribution
of our trade secret technology and proprietary information. However, any of our pending or future patent or trademark applications may not ultimately be issued as patents or trademarks of the scope that we sought, if at all, and any of our patents,
trademarks or copyrights may be invalidated, deemed unenforceable, or otherwise challenged. In addition, other parties may circumvent or design around our patents and other intellectual property rights, may misappropriate our proprietary technology,
or may otherwise develop similar, duplicate or superior products. Further, the intellectual property laws and our agreements may not adequately protect our intellectual property rights and effective intellectual property protection may be
unavailable or limited in certain foreign countries in which we do business or may do business in the future.



The telecommunications and data communications industries are characterized by the existence of extensive patent portfolios and frequent intellectual
property litigation. From time to time, we have received, and may in the future receive, claims that we are infringing third parties intellectual property rights. Any present or future claims, with or without merit, could be time-consuming,
result in costly litigation, divert management time and attention and other resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available
on terms acceptable to us. In addition, any such litigation could force us to cease selling or using certain products or services, or to redesign such products or services. Further, we may in the future, initiate claims or litigation against
third-parties for infringement of our intellectual property rights or to determine the scope and validity of our intellectual property rights or those of competitors. Such litigation could result in substantial costs and diversion of resources. Any
of the foregoing could have an adverse effect upon our revenue, profitability, reputation or growth strategy.



If we fail to provide our customers with adequate and timely customer support, our relationships with our customers could be damaged, which would harm our revenue and profitability.



Our ability to achieve our planned sales growth and retain 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. 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 revenue
and profitability.



Failure to integrate acquired businesses into our
operations successfully could adversely affect our business.



As part of our strategy to develop and identify new products and technologies, we have made acquisitions, such as our recent acquisition of Copper Mountain. We are likely to make more acquisitions in the future. Our integration of
the operations of acquired businesses requires significant efforts, including the coordination of information technologies, research and development, sales and marketing, operations, manufacturing and finance. These efforts result in additional
expenses and involve significant amounts of managements time that cannot then be dedicated to other projects. Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our
business. In addition, there is no guarantee that any of the businesses we acquire will become profitable or remain so. If our acquisitions do not reach our initial expectations, we may record unexpected impairment charges. Factors that will affect
the success of our acquisitions include:



| |  |  | absence of adequate internal controls or presence of significant fraud in the financial systems of acquired companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



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| |  |  | any decrease in customer loyalty and product orders caused by dissatisfaction with the combined companies product lines and sales and marketing practices, including price
increases;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to retain key employees; and
| | - |  | ----------------------------------------



| |  |  | the ability of the combined company to achieve synergies among its constituent companies, such as increasing sales of the combined companys products, achieving cost savings
and effectively combining technologies to develop new products.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



These factors, among others, will affect whether our recent and proposed acquisitions are successfully integrated into our business. Additionally, any future acquisitions may also result in potentially dilutive
issuances of our equity securities, acquisition or divestiture related write-offs and the assumption of debt and contingent liabilities. If we fail to integrate acquired businesses into our operations successfully, we may be unable to achieve our
revenue, profitability, operations, strategic goals and our competitive position in the marketplace could suffer.



If we fail to manage our expanding operations, our ability to increase our revenues and improve our results of operations could be harmed.



We anticipate that, in the future, we may need to expand certain areas of
our business to grow 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 selling our products to the larger, more established service
providers. 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 revenue, results of operations and share price could be harmed.



If material weaknesses in our internal control over financial reporting were to develop
(such as those that our independent registered public accounting firm identified in January 2004) and we were unable to remedy such weaknesses in an effective and timely manner, such weaknesses could materially and adversely affect our ability to
provide the public with timely and accurate material information about Tut Systems.



In January 2004, our independent registered public accounting firm identified deficiencies in our internal controls that they considered to be material weaknesses. Based on these weaknesses, our chief executive
officer and chief financial officer determined that, as of December 31, 2003, our disclosure controls and procedures were not effective to record, process, summarize and report information required to be reported within the time periods specified by
the SEC and accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely discussions regarding required disclosure. These material weaknesses related to our inventory and our
accounts payable processes, both of which affect our balance sheet and may also affect our income statement reporting. We believe that we have fully addressed these issues, and, therefore, our chief executive officers and chief financial
officers evaluation of our disclosure controls and procedures as of June 30, 2005 concluded that they were effective. (See Item 9A of our Form 10-K for the year ended December 31, 2004 as filed with the SEC for further discussion of these
weaknesses as well as for our chief executive officers and chief financial officers evaluation as of December 31, 2004.) In order for investors and the equity analyst community to make informed investment decisions and recommendations
about our securities, it is important that we provide them with accurate and timely information in accordance with the Securities Exchange Act of 1934, as amended (the Exchange Act) and the rules promulgated thereunder. Material
weaknesses in our internal control over financial reporting and our disclosure controls and procedures would hinder the flow of timely and accurate information to investors. If such material weaknesses were to develop and we did not address them in
a timely matter, investors might sell our shares and industry analysts might either make incorrect recommendations about Tut Systems or else end coverage of Tut Systems altogether, any of which results could harm our reputation and adversely impact
our share price.



We are currently engaged in a securities class action
lawsuit which, if it were to result in an unfavorable resolution, could adversely affect our reputation, profitability and share price.



We are currently engaged as a defendant in a lawsuit (i.e., Whalen v. Tut Systems, Inc. et al.) that alleges
securities law violations against us and certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. Additionally, our subsidiary Copper
Mountain , which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of
New York, now captioned In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as amended, and Section
10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, we have inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability that may come out of the claims.
The Whalen action described and the Copper Mountain action are being coordinated with approximately 300 suits before United States District Judge Shira Scheindlin of the Southern District of New York under the matter In re Initial
Public Offering Securities Litigation. While we have reached a settlement with the plaintiffs in the Whalen lawsuit, and prior to the acquisition Copper Mountain reached a settlement in the Copper Mountain action, the settlements
are subject to certain contingencies, including court approval of the terms of settlements. If the court does not approve the settlements, or any other applicable contingencies are not resolved or otherwise addressed, we would be required to resume
litigation in these matters.



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If our products do not comply with complex government regulations, our product sales will suffer.



We and our customers are subject to varying degrees
of federal, state and local as well as foreign governmental regulation. Our products must comply with various regulations and standards defined by the Federal Communications Commission, or FCC. 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, Underwriters Laboratories must certify certain of our products 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 certain of our customers may deploy them. 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 could prevent us from maintaining or growing 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 entry into 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 our sale of products to these customers.



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, which could materially and adversely affect our growth strategy, reputation and share price.



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 video and 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, which could adversely affect our reputation and share price. Additionally, we do not have employment contracts with any of our executive officers. We believe that our future success will depend in
large part on 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 is volatile, and, if you invest in Tut Systems, you may suffer a loss of some or all of your investment.



The market price and trading volume of our common
stock has been subject to significant volatility, and this trend may continue. In particular, trading volume historically has been low and the market price of our common stock has increased dramatically in recent months. Since the announcement of
our acquisition of VTC, the closing price of our common stock, as traded on The Nasdaq National Market, has fluctuated from a low of $1.23 to a high of $7.49 per share. The value of our common stock may decline regardless of our operating
performance or prospects. Factors affecting our market price include:



| |  |  | our perceived prospects;
| | - |  | ------------------------



| |  |  | variations in our operating results and whether we have achieved our key business targets;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | the limited number of shares of our common stock available for purchase or sale in the public markets;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | differences between our reported results and those expected by investors and securities analysts;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | announcements of new contracts, products or technological innovations by us or our competitors; and
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors.
| | - |  | ----------------------------------------------------------------------------------------------------------------



Recent events have caused stock prices for many companies, including ours, to
fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common
stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such
litigation, if instituted against us, could result in substantial costs and a diversion of managements attention and resources.



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 has the authority to issue up to 5,000,000



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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.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



We are exposed to changes in interest rates primarily from our investments in certain cash equivalents and from our variable
rate credit facility. 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 our interest-sensitive financial instruments at June 30, 2005. We do not anticipate any near-term changes in the nature of our market risk exposures or in managements objectives and
strategies with respect to managing such exposures.



We have no
investments, nor are any of our 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.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our principal executive officer and
principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as
of the end of the period covered by this report (the Evaluation Date). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and
procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (SEC) reports (i) is recorded, processed, summarized
and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Companys management, including our principal executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.



Changes in internal control
over financial reporting. There were no changes in our internal control over financial reporting which occurred during the second quarter of fiscal year 2005 and which have materially affected or are reasonably likely to materially affect our
internal control over financial reporting.



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PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------



Whalen v. Tut Systems, Inc. et al



On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc.
et al.,Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was
filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from the Companys January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged actions by the
underwriters for the offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and under Section 10(b) and Rule 10b-5 of the
Securities Exchange Act of 1934, as amended, and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the Securities Act. The complaint also names as defendants the underwriters for the
Companys initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public offerings and secondary offerings conducted in 1999 and 2000. Therefore, for
pretrial purposes, the Whalen action is being coordinated with the approximately 300 other suits before United States District Court Judge Shira Scheindlin of the Southern District of New York under the matter In Re Initial Public Offering
Securities Litigation.The individual defendants in the Whalen action, namely, Nelson Caldwell, Salvatore D Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, approving the
parties October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying the Companys motion to dismiss.



In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including the Company, was submitted
to the Court in the In Re Initial Public Offering Securities Litigation. On February 15, 2005, the Court granted preliminary approval of the settlement, conditioned upon the parties modification of a proposed bar order with respect to
potential contribution claims. The settlement is subject to a number of conditions, most of which are outside of the Companys control, including approval by the Court. The underwriters named as defendants in the In Re Initial Public
Offering Securities Litigation (collectively, the underwriter-defendants), including the underwriters named in the Whalen suit, are not parties to the stipulation of settlement.



The stipulation of settlement provides that, in exchange for a release of
claims against the settling issuer-defendants, the insurers of all of the settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the
underwriter-defendants. The ultimate amount, if any, that may be paid on behalf of the Company will therefore depend on the final terms of the settlement, including the number of issuer-defendants that ultimately participate in the final settlement,
and the amounts, if any, recovered by the plaintiffs from the underwriter-defendants and other non-settling defendants.



In the event that all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on
behalf of the Company could range from zero to approximately $7.0 million, depending on plaintiffs recovery from the underwriter-defendants and from other non-settling parties and the amount of insurance available under the Companys
applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement payments would be made on behalf of the Company under the proposed terms of the settlement. If the plaintiffs recover less
than $1 billion, we believe that our insurance will likely cover some or all of our share of any payments towards satisfying plaintiffs $1 billion recovery deficit. Management estimates that its range of loss relative to this matter is zero to
$7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount we will ultimately be required to pay, if any, as of June 30, 2005, we have not
accrued a liability for this matter.



In re Copper Mountain Networks,
Inc. Initial Public Offering Securities Litigation



Copper Mountain, which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the
Southern District of New York, now captioned In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as
amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, we have inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability that may
come out of the claims. The Copper Mountain action described in this paragraph, like the Whalenaction described above, has been coordinated for pretrial purposes under the matter In Re Initial Public Offering Securities
Litigation. The individual defendants in the Copper Mountainaction were also dismissed without prejudice pursuant to the October 9, 2002 Order of the Court approving the parties October 1, 2002 Stipulation of Dismissal. On February
19, 2003, the Court issued an Opinion and Order denying Copper Mountains motion to dismiss. Copper Mountain entered into the same stipulation of settlement as we did in the Whalenaction described above. The Copper Mountain
stipulation of settlement is subject to the same terms, conditions and contingencies as the stipulation of settlement we entered into with respect to the Whalenaction described above. At this time, we cannot estimate the amount that we may
be required to pay the plaintiffs under a final settlement with respect to the Copper Mountainaction described in this paragraph.



|ITEM 2. | UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS
|------- | ----------------------------------------------------



On July 22, 2005, the Company completed a private placement of 5,535,000 newly-issued common shares to accredited investors
at a price of $2.70 per share, for net proceeds of approximately $14.1 million. Under the terms of the financing, the Company also issued warrants to purchase an additional 2,768,000 shares of its common stock. The warrants expire in 2010 and,
beginning in 2006, are exercisable at a per share price of $4.25. The Company has the right to call the warrants in the event that the



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trading price of its common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would provide an additional
$11,764,000 in proceeds to the Company.



The sale of
these securities was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof. Under the terms of the agreement between the Company and the accredited investors, the Company agreed to file
a Registration Statement on Form S-3 with the SEC to register for resale the 5,535,000 common shares issued in the financing as well as the 2,768,000 common shares to be issued upon exercise of the warrants. The accredited investors that will be
named as Selling Stockholders in the Registration Statement on Form S-3 will be Greenway Capital and certain of its affiliates, Bonanza Master Fund, and Special Situations Fund and certain of its affiliates. The Selling Shareholder table that will
be filed as part of the registration statement is incorporated by reference into this Item 2 of Part II of this report.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------



None



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------



The Companys Annual Meeting of Shareholders, referred to as the Annual Meeting, was held on June 20, 2005. At the
Annual Meeting, stockholders voted on five matters: (i) the election of one Class I directors for a term of three years expiring in 2008, and (ii) the approval to increase the maximum number of shares of common stock that may be issued under the
1999 nonstatutory stock option plan by 500,000 (iii) the approval to increase the maximum number of shares of common stock that may be issued under the 1998 stock option plan by 500,000 (iv) the ratification of the appointment of
PricewaterhouseCoopers LLP as the Companys independent registered public accounting firm, and (v) the approval of an adjournment or postponement of the annual meeting, if necessary. The stockholders elected managements nominee as the
Class I director in an uncontested election, approved the increase in shares of common stock under both the 1999 nonstatutory plan and the 1998 stock plan, ratified the appointment of the registered public accounting firm and approved the
adjournment or postponement of the annual meeting by the following votes, respectively:



| | (i) | Election of the Class I director for a term expiring in 2008:
| | --- | -------------------------------------------------------------



|                   |  |            |  |               |  |                 |  |                 
|------------------ |  | ---------- |  | ------------- |  | --------------- |  | ----------------
|                   |  | Votes For  |  | Votes Against |  | Votes Abstained |  | Broker Non Votes
|Clifford Higgerson |  | 13,607,085 |  | 749,333       |  |                |  |                



The Companys
Board of Directors is currently comprised of five members who are divided into three classes with overlapping three year terms. The remaining directors whose term of office continued after the meeting are Salvatore DAuria, Neal Douglas, George
Middlemas, and Roger H. Moore.



| | (ii) | Approval to increase the maximum number of shares of common stock that may be issued under the 1999 nonstatutory stock option plan by 500,000:
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------------------



|           |  |               |  |                 |  |                 
|---------- |  | ------------- |  | --------------- |  | ----------------
|Votes For  |  | Votes Against |  | Votes Abstained |  | Broker Non Votes
|13,301,851 |  | 1,027,528     |  | 27,038          |  |                



| | (iii) | Approval to increase the maximum number of shares of common stock that may be issued under the 1998 stock option plan by 500,000:
| | ----- | ---------------------------------------------------------------------------------------------------------------------------------



|           |  |               |  |                 |  |                 
|---------- |  | ------------- |  | --------------- |  | ----------------
|Votes For  |  | Votes Against |  | Votes Abstained |  | Broker Non Votes
|12,745,224 |  | 1,584,155     |  | 27,038          |  |                



| | (iv) | Ratification of appointment of PricewaterhouseCoopers LLP as the Companys independent registered public accounting firm:
| | ---- | -------------------------------------------------------------------------------------------------------------------------



|           |  |               |  |                 |  |                 
|---------- |  | ------------- |  | --------------- |  | ----------------
|Votes For  |  | Votes Against |  | Votes Abstained |  | Broker Non Votes
|14,281,636 |  | 57,709        |  | 17,073          |  |                



| | (v) | Approval of a postponement or adjournment of the annual meeting:
| | --- | ----------------------------------------------------------------



|           |  |               |  |                 |  |                 
|---------- |  | ------------- |  | --------------- |  | ----------------
|Votes For  |  | Votes Against |  | Votes Abstained |  | Broker Non Votes
|12,832,435 |  | 1,324,393     |  | 199,590         |  |                



|ITEM 5. | OTHER INFORMATION
|------- | -----------------



None



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|ITEM 6. | EXHIBITS
|------- | --------



(a) Exhibits



|               |  |                                                                                                                                                                                                                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                                                                                                                                     
|               | 
|1.1            |  | Underwriting Agreement between the Company, Needham & Company, Inc. and Merriman Curhan Ford & Co., dated October 7, 2004 (11)                                                                                                                                                                                                                  
|               | 
|2.1            |  | Agreement and Plan of Merger by and among Tut Systems, Inc., Tiger Acquisition Corporation, Tektronix, Inc. and VideoTele.com, Inc. dated as of October 28, 2002.(7)                                                                                                                                                                            
|               | 
|2.3            |  | Agreement and plan of Merger and Reorganization with Copper Mountain Networks, Inc. (12)                                                                                                                                                                                                                                                        
|               | 
|3.1            |  | Second Amended and Restated Certificate of Incorporation of the Company.(1)                                                                                                                                                                                                                                                                     
|               | 
|3.2            |  | Bylaws of the Company, as currently in effect. (4)                                                                                                                                                                                                                                                                                              
|               | 
|4.1            |  | Specimen Common Stock Certificate.(1)                                                                                                                                                                                                                                                                                                           
|               | 
|10.1*          |  | 1992 Stock Plan, as amended, and form of Stock Option Agreement thereunder.(1)                                                                                                                                                                                                                                                                  
|               | 
|10.2*          |  | 1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase Agreement thereunder.(1)                                                                                                                                                                                                                                                 
|               | 
|10.3*          |  | 1998 Employee Stock Purchase Plan, as amended.(2)                                                                                                                                                                                                                                                                                               
|               | 
|10.4*          |  | 1998 Stock Plan Inland Revenue Approved Rules for UK Employees.(3)                                                                                                                                                                                                                                                                              
|               | 
|10.5           |  | American Capital Marketing, Inc. 401(k) Plan.(1)                                                                                                                                                                                                                                                                                                
|               | 
|10.6           |  | Form of Indemnification Agreement entered into between the Company and each director and officer.(1)                                                                                                                                                                                                                                            
|               | 
|10.8           |  | Home Phoneline Promoters Agreement by and between the Company and IBM Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Advanced Micro Devices, Inc., Intel Corporation,
Epigram, Inc., AT&T Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998.(1)
|               | 
|10.9           |  | Master Agreement between the Company and Compaq Computer Corporation dated April 21, 1998 including supplements thereto.(1)                                                                                                                                                                                                                     
|               | 
|10.12*         |  | Executive Retention and Change of Control Plan.(5)                                                                                                                                                                                                                                                                                              
|               | 
|10.13*         |  | Non-Executive Retention and Change of Control Plan and Summary Plan Description.(5)                                                                                                                                                                                                                                                             
|               | 
|10.14*         |  | Non-Qualified Stock Option Agreement issued to Mark Carpenter on March 3, 2000.(5)                                                                                                                                                                                                                                                              
|               | 
|10.15*         |  | 1999 Non-Statutory Stock Option Plan(6)                                                                                                                                                                                                                                                                                                         
|               | 
|10.16          |  | Office Lease Agreement between Kruse Way Office Associates Limited Partnership and VideoTele.com dated April 28, 2000.(8)                                                                                                                                                                                                                       



32



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##### Table of Contents

|               |  |                                                                                                                                                                                                                  
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                      
|               | 
|10.17          |  | Office Lease Agreement between The Richard Oppenheimer Living Trust, The Maurice Oppenheimer Living Trust, The Helene Oppenheimer Living Trust, and Tut Systems Inc. dated November 2002 and
amended May 2005.(8)
|               | 
|10.18          |  | 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.(5)                                          
|               | 
|10.19          |  | Loan and Security Agreement (10)                                                                                                                                                                                 
|               | 
|11.1           |  | Calculation of net loss per share (contained in Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements).                                                                                       
|               | 
|31.1           |  | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                           
|               | 
|31.2           |  | Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                           
|               | 
|32.1           |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                       
|               | 
|32.2           |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                       



|(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 March 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------



|(3) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- | -------------------------------------------------------------------------------------------------



|(4) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.
|--- | ----------------------------------------------------------------------------------------------------



|(5) | Incorporated by reference to our Current Report on Form 8-K dated May 26, 2000 as filed June 9, 2000.
|--- | -----------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
|--- | ---------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference to our Schedule TO (File No. 005-58093) filed May 11, 2001.
|--- | -------------------------------------------------------------------------------------



|(8) | Incorporated by reference to our Current Report on Form 8-K dated October 29, 2002, addendum attached herewith.
|--- | ---------------------------------------------------------------------------------------------------------------



|(9) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002.
|--- | -------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference to our Current Report on Form 8-K dated October 8, 2004.
|---- | ----------------------------------------------------------------------------------



|(12) | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2005.
|---- | ------------------------------------------------------------------------------------



|* | Indicates management contracts or compensatory plans and arrangements.
|- | ----------------------------------------------------------------------



33



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##### Table of Contents



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.By:

/s/ Randall K. GausmanRandall K. Gausman Vice-President, Finance and Administration, Chief Financial Officer and Secretary (Principal
Financial and Accounting Officer and Duly Authorized Officer)




Date: August 2, 2005



34



---

##### Table of Contents

INDEX TO EXHIBITS



|              |  |                                                                                                                                                                                                                                                                                                                                                 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                                                                                     
|              | 
|1.1           |  | Underwriting Agreement between the Company, Needham & Company, Inc. and Merriman Curhan Ford & Co., dated October 7, 2004 (11)                                                                                                                                                                                                                  
|              | 
|2.1           |  | Agreement and Plan of Merger by and among Tut Systems, Inc., Tiger Acquisition Corporation, Tektronix, Inc. and VideoTele.com, Inc. dated as of October 28, 2002.(7)                                                                                                                                                                            
|              | 
|2.3           |  | Agreement and plan of Merger and Reorganization with Copper Mountain Networks, Inc. (12)                                                                                                                                                                                                                                                        
|              | 
|3.1           |  | Second Amended and Restated Certificate of Incorporation of the Company.(1)                                                                                                                                                                                                                                                                     
|              | 
|3.2           |  | Bylaws of the Company, as currently in effect. (4)                                                                                                                                                                                                                                                                                              
|              | 
|4.1           |  | Specimen Common Stock Certificate.(1)                                                                                                                                                                                                                                                                                                           
|              | 
|10.1*         |  | 1992 Stock Plan, as amended, and form of Stock Option Agreement thereunder.(1)                                                                                                                                                                                                                                                                  
|              | 
|10.2*         |  | 1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase Agreement thereunder.(1)                                                                                                                                                                                                                                                 
|              | 
|10.3*         |  | 1998 Employee Stock Purchase Plan, as amended.(2)                                                                                                                                                                                                                                                                                               
|              | 
|10.4*         |  | 1998 Stock Plan Inland Revenue Approved Rules for UK Employees.(3)                                                                                                                                                                                                                                                                              
|              | 
|10.5          |  | American Capital Marketing, Inc. 401(k) Plan.(1)                                                                                                                                                                                                                                                                                                
|              | 
|10.6          |  | Form of Indemnification Agreement entered into between the Company and each director and officer.(1)                                                                                                                                                                                                                                            
|              | 
|10.8          |  | Home Phoneline Promoters Agreement by and between the Company and IBM Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Advanced Micro Devices, Inc., Intel Corporation,
Epigram, Inc., AT&T Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998.(1)
|              | 
|10.9          |  | Master Agreement between the Company and Compaq Computer Corporation dated April 21, 1998 including supplements thereto.(1)                                                                                                                                                                                                                     
|              | 
|10.12*        |  | Executive Retention and Change of Control Plan.(6)                                                                                                                                                                                                                                                                                              
|              | 
|10.13*        |  | Non-Executive Retention and Change of Control Plan and Summary Plan Description.(6)                                                                                                                                                                                                                                                             
|              | 
|10.14*        |  | Non-Qualified Stock Option Agreement issued to Mark Carpenter on March 3, 2000.(6)                                                                                                                                                                                                                                                              
|              | 
|10.15*        |  | 1999 Non-Statutory Stock Option Plan(7)                                                                                                                                                                                                                                                                                                         
|              | 
|10.16         |  | Office Lease Agreement between Kruse Way Office Associates Limited Partnership and VideoTele.com dated April 28, 2000.(9)                                                                                                                                                                                                                       
|              | 
|10.17         |  | Office Lease Agreement between The Richard Oppenheimer Living Trust, The Maurice Oppenheimer Living Trust, The Helene Oppenheimer Living Trust, and Tut Systems Inc. dated November 2002 and
amended May 2005.(8)                                                                                                                               
|              | 
|10.18         |  | 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.(5)                                                                                                                                                                         
|              | 
|10.19         |  | Loan and Security Agreement (10)                                                                                                                                                                                                                                                                                                                



35



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##### Table of Contents

|              |  |                                                                                                                                           
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                               
|              | 
|11.1          |  | Calculation of net loss per share (contained in Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements).                
|              | 
|31.1          |  | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                    
|              | 
|31.2          |  | Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                    
|              | 
|32.1          |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|              | 
|32.2          |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---

|(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 March 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------



|(3) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- | -------------------------------------------------------------------------------------------------



|(4) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2005.
|--- | ----------------------------------------------------------------------------------------------------



|(5) | Incorporated by reference to our Current Report on Form 8-K dated May 26, 2000 as filed June 9, 2000.
|--- | -----------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
|--- | ---------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference to our Schedule TO (File No. 005-58093) filed May 11, 2001.
|--- | -------------------------------------------------------------------------------------



|(8) | Incorporated by reference to our Current Report on Form 8-K dated October 29, 2002, addendum attached herewith.
|--- | ---------------------------------------------------------------------------------------------------------------



|(9) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002.
|--- | -------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference to our Current Report on Form 8-K dated October 8, 2004.
|---- | ----------------------------------------------------------------------------------



|(12) | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2005.
|---- | ------------------------------------------------------------------------------------



|* | Indicates management contracts or compensatory plans and arrangements.
|- | ----------------------------------------------------------------------



36