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UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





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FORM 10-Q





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




For the quarterly period ended March 31, 2002





Commission File
Number: 000-25291





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TUT SYSTEMS, INC.


(Exact name of registrant as specified in its charter)





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Delaware

94-2958543(State or other jurisdiction of incorporation or
organization)

(I.R.S. Employer Identification No.)5964 W. Las Positas Blvd., Pleasanton, California

94588-8540(Address of principal executive offices)

(Zip Code)





Registrants telephone number, including area code:  (925) 490-3900





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Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.





Yes  x            No  ̈





As of March 31, 2002, 16,411,172 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 INFORMATIONItem 1.

Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of March 31, 2002 and December 31, 2001

3Condensed Consolidated Statements of Operations for the three months ended March 31, 2002 and March 31, 2001

4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and March 31, 2001

5Notes to Unaudited Condensed Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

12Item 3.

Quantitative and Qualitative Disclosures about Market Risk

33PART II.    OTHER INFORMATIONItem 1.

Legal Proceedings

34Item 2.

Changes in Securities and Use of Proceeds

34Item 3.

Defaults Upon Senior Securities

34Item 4.

Submission of Matters to a Vote of Security Holders

34Item 5.

Other Information

34Item 6.

Exhibits and Reports on Form 8-K

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)





March 31, 2002


December 31, 2001ASSETSCurrent assets:Cash and cash equivalents

$
39,621


$
46,338Short-term investments


3,083



3,029Accounts receivable, net of allowance for doubtful accounts of $6,654 and $6,908 in 2002 and 2001, respectively


252



550Inventories, net


10,688



11,839Prepaid expenses and other


2,419



1,742Total current assets


56,063



63,498Property and equipment, net


7,529



8,171Intangibles and other assets (including restricted cash of $1,716 and $1,718 in 2002 and 2001, respectively)


6,896



7,323Total assets

$
70,488


$
78,992LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
711


$
1,204Accrued liabilities


8,999



9,856Deferred revenue


836



954Total current liabilities


10,546



12,014Deferred revenue, net of current portion


358



553Other liabilities


249



329Total liabilities


11,153



12,896Commitments and contingencies (Note 6)Stockholders equity:Common stock, $0.001 par value, 100,000 shares authorized, 16,411 shares issued and outstanding in 2002 and 2001


16



16Additional paid-in capital


301,182



301,182Deferred compensation


(10
)


(17
)Notes receivable from stockholders


(65
)


(96
)Accumulated other comprehensive loss


(96
)


(78
)Accumulated deficit


(241,692
)


(234,911
)Total stockholders equity


59,335



66,096Total liabilities and stockholders equity

$
70,488


$
78,992





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 Ended March 31,2002


2001Revenues:Product

$
2,162


$
4,650License and royalty


196



237Total revenues


2,358



4,887Cost of goods sold:Product


1,523



21,747Total cost of goods sold


1,523



21,747Gross (loss) margin


835



(16,860
)Operating expenses:Sales and marketing


2,316



3,825Research and development


3,287



4,682General and administrative


1,958



3,236In-process research and development






1,160Impairment of intangibles






2,692Amortization of intangibles


300



2,652Noncash compensation expense






61Total operating expenses


7,861



18,308Loss from operations


(7,026
)


(35,168
)Interest and other income, net


245



1,199Net loss

$
(6,781
)

$
(33,969
)Net loss per share, basic and diluted (Note 3)

$
(0.41
)

$
(2.10
)Shares used in computing net loss per share, basic and diluted (Note 3)


16,407



16,213








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)





Three Months Ended March 31,2002


2001Cash flows from operating activities:Net loss

$
(6,781
)

$
(33,969
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and other


877



1,218Provision for allowance for doubtful accounts






70Provision for excess and obsolete inventory and abandoned products


265



18,633Impairment of intangibles






2,692Amortization of intangibles


300



2,641Write-off of in-process research and development






1,160Change in operating assets and liabilities, net of businesses acquired:Accounts receivable


298



1,311Inventories


886



(7,058
)Prepaid expenses and other assets


(578
)


1,168Accounts payable and accrued liabilities


(1,430
)


(12,886
)Deferred revenue


(313
)


(288
)Net cash used in operating activities


(6,476
)


(25,308
)Cash flows from investing activities:Purchase of property and equipment


(241
)


(681
)Purchase of short-term investments






(3,991
)Proceeds from maturities of short-term investments






38,116Acquisition of businesses, net of cash acquired and purchased research and development






(169
)Net cash provided by (used in) investing activities


(241
)


33,275Cash flows from financing activities:Proceeds from issuances of common stock, net






48Net cash provided by financing activities






48Net increase (decrease) in cash and cash equivalents


(6,717
)


8,015Cash and cash equivalents, beginning of period


46,338



47,307Cash and cash equivalents, end of period

$
39,621


$
55,322Noncash financing activities:Common stock issued in connection with the ActiveTelco acquisition in 2001

$



$
2,944





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:





Tut Systems, Inc. (the Company), was founded in 1983 and began operations in August 1991. The Company designs, develops and markets advanced
communications products that enable high-speed data access over the copper infrastructure of telephone companies, as well as the copper telephone wires in residential and commercial multi-tenant buildings. The Companys products incorporate
high-bandwidth access multiplexers, associated modems and routers, ethernet extension products and integrated network management software.





The Company has incurred substantial losses and negative cash flows from operations since inception. For the quarter ended March 31, 2002, the Company incurred a net loss of $6,781, and negative cash flows from
operations of $6,476, and has an accumulated deficit of $241,692 at March 31, 2002. Management expects cash flow from operations to increase during the year, however, to the extent the Companys business continues to be affected by poor
economic conditions impacting the telecommunications industry, the Company will continue to require cash to fund operations. The Company will seek additional funding for operations from alternative debt and equity sources if necessary to maintain
reasonable operating levels. The Company cannot be assured that such funding efforts will be successful. 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 March 31, 2002 and December 31, 2001 and for the three months ended March 31, 2002 and 2001 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on the same basis
as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Companys financial position as of March 31, 2002 and December 31,
2001, its results of operations and its cash flows for the three months ended March 31, 2002 and 2001. These condensed consolidated financial statements and the accompanying notes are unaudited and should be read in conjunction with the
Companys audited financial statements included in the Companys Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 29, 2002. The balance sheet as of December 31, 2001 was derived from audited financial
statements but does not include all disclosures required by generally accepted accounting principles. The results for the three months ended March 31, 2002 are not necessarily indicative of the expected results for any other interim period or the
year ending December 31, 2002.





Concentrations





The Company operates in one business segment, designing, developing and marketing advanced communications products that enable high-speed data access in residential and commercial
multi-tenant buildings. The market for high-speed data access products is characterized by rapid technological developments, frequent new product introductions, changes in end-user requirements and constantly evolving industry standards. The
Companys future success depends on its ability to develop, introduce and market enhancements to its existing products, to introduce new products in a timely manner that meet customer requirements and to respond effectively to competitive
pressures and technological advances. Further, the emergence of new industry standards, whether formally adopted by official standards committees or informally through widespread use of such standards by telephone companies or other service
providers, could require the Company to redesign its products.





Currently, the Company relies on contract manufacturers and
certain single source suppliers of materials for certain product components. As a result, should the Companys current manufacturers or suppliers not produce and deliver inventory for the Company to sell on a timely basis, operating results
could be adversely impacted.




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##### Table of Contents



TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)







From time to time, the Company maintains a substantial portion of its cash and cash
equivalents in money market accounts with one financial institution. The Company invests its excess cash in debt instruments of the U.S. Treasury, governmental agencies and corporations with strong credit ratings. The Company has established
guidelines relating to diversification and maturities in order to maintain the safety and liquidity of these assets. To date, the Company has not experienced any significant losses on its cash equivalents or short-term investments.





Recent accounting pronouncements





In May 2000, the Emerging Issues Task Force, or EITF, issued EITF Issue No. 00-14, Accounting for Certain Sales Incentives, which addresses the recognition, measurement and income statement classification
for sales incentives that a vendor voluntarily offers to customers, without charge, which the customer can use in, or exercise as a result of, a single exchange transaction. In June 2001, the EITF issued EITF Issue No. 00-25, Vendor Income
Statement Characterization of Consideration Paid to a Reseller of the Vendors Products, effective for periods beginning after December 15, 2001 which addresses whether consideration from a vendor to a reseller is: (a) an adjustment of
the selling prices of the vendors products and, therefore, should be deducted from revenue when recognized in the vendors statement of operations; or (b) a cost incurred by the vendor for assets or services received from the reseller
and, therefore, should be included as a cost or expense when recognized in the vendors statement of operations. Upon application of these EITFs, financial statements for prior periods presented for comparative purposes should be reclassified
to comply with the income statement display requirements under these Issues. In September 2001, the EITF issued EITF Issue No. 01-09, Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendors Products,
which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 Accounting for Points and Certain Other Time- or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the
Future. The adoption of these Issues did not impact the Companys financial statements.





In July 2001, the FASB
issued SFAS No. 142, Goodwill and Other Intangible Assets, which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board (APB) Opinion No. 17,
Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their
acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The Company will adopt SFAS No. 142 effective January 1, 2002. The
adoption of SFAS No. 142 did not impact the Companys financial statements. The following table presents the impact of SFAS 142 on net loss and net loss per share had the standard been in effect for the three months ended March 31, 2001:





Three Months Ended March 31,2000


2001Net lossas reported

$
(6,781
)

$
(33,969
)Adjustment:Amortization of goodwill






1,861Net lossas adjusted


(6,781
)


(32,108
)Net loss per share, basic and dilutedas reported

$
(0.41
)

$
(2.10
)Net loss per share, basic and dilutedas adjusted

$
(0.41
)

$
(1.98
)





On October 3, 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. SFAS No. 144 applies to all long-lived assets,
including discontinued operations, and consequently amends APB Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair
value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that: (a) can be distinguished from the rest of the entity, and (b) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for the Company for




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TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)




all financial statements issued in 2002. The adoption of SFAS No. 144 did not impact the Companys financial statements.





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 Ended March 31,2002


2001Net loss per share, basic and diluted:Net loss

$
(6,781
)

$
(33,969
)Net loss per share, basic and diluted

$
(0.41
)

$
(2.10
)Shares used in computing net loss per share, basic and diluted


16,407



16,213Antidilutive securities not included in net loss per share calculations


3,537



3,121





NOTE 4COMPREHENSIVE LOSS:





Comprehensive loss includes net loss and unrealized gains and losses on other assets and foreign currency translation adjustments that have been previously excluded from net loss and
reflected instead in stockholders equity. The following table sets forth the calculation of comprehensive loss:





Three Months Ended March 31,2002


2001Net loss

$
(6,781
)

$
(33,969
)Unrealized losses on other assets


(15
)


(41
)Foreign currency translation adjustment


(3
)


(24
)Net change in other comprehensive loss


(18
)


(65
)Total comprehensive loss

$
(6,799
)

$
(34,034
)




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##### Table of Contents



TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)







NOTE 5BALANCE SHEET COMPONENTS:





March 31, 2002


December 31, 2001Short-term investments:US government agency notes

$
3,083



3,029Inventories, net:Finished goods

$
48,276


$
49,981Raw materials


12,907



15,19061,183



65,171Less: reserves


(50,495
)


(53,332
)$
10,688


$
11,839Prepaid expenses and other:Receivables from contract manufacturers

$
69


$
28Prepaid expenses


2,350



1,714$
2,419


$
1,742Property and equipment:Computers and software

$
6,821


$
6,677Leasehold improvements


4,462



4,437Test equipment


3,692



3,624Office equipment


1,399



1,39516,374



16,133Less: accumulated depreciation


(8,845
)


(7,962
)$
7,529


$
8,171Intangibles and other assets:Completed technology and patents

$
6,467


$
6,467Less: accumulated amortization


(2,515
)


(2,215
)Net intangibles


3,952



4,252Other


2,944



3,071$
6,896


$
7,323Accrued liabilities:Provision for loss on purchase commitments

$
4,421


$
4,421Bankruptcy preference item


1,500



1,500Compensation


944



1,014Other


2,134



2,921$
8,999


$
9,856







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TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)







NOTE 6COMMITMENTS AND CONTINGENCIES:





Lease obligations





The Company leases office,
manufacturing and warehouse space under noncancelable operating leases that expire in 2006 and 2007. In connection with business combinations in 1999 and 2000, the Company assumed operating leases that expired in December 2001 and another that
expires in August 2002.





The lease for the Pleasanton facility expires in April 2007, with an option to renew for five years.
Under the terms of the lease agreement, the Company was required to issue a letter of credit in the amount of $1,850. The letter of credit is reduced annually, beginning July 1, 2001, by approximately $250, provided that the Company is not in
default under the terms of the lease agreement. Pursuant to these terms, the Companys letter of credit was reduced from $1,850 to $1,600 in the third quarter of 2001. In the fourth quarter of 2001, the Company entered into a lease for
engineering facilities in Bridgewater Township, New Jersey. Under the terms of this lease, the Company was required to issue a letter of credit in the amount of $116. These letters of credit are collateralized by restricted funds in the amount of
$1,716, which are included in intangibles and other assets as of March 31, 2002.





Purchase commitments





The Company had noncancellable commitments to purchase finished goods inventory totaling $323 and $531 in aggregate at March 31, 2002 and
December 31, 2001, respectively.





Royalty obligation





In February 1999, the Company paid one of its founders, a former employee of the Company, $2,500 as a lump sum payment for all its future royalty obligations for the rights, title and
interests in two patents. These two patents give the Company exclusive control of the Balun technology required in the Companys products. The Company is amortizing this royalty payment ratably over the five year period beginning February 1999.
This period represents the estimated life of the patented technology. As of March 31, 2002, the balance of this payment remaining to be amortized was $917. Amortization expense for the quarter ended March 31, 2002 was approximately $125.





Contingencies





Beginning July 12, 2001, six putative shareholder class action lawsuits were filed in the United States District Court for the Northern District of California against Tut Systems, Inc. and certain of its current and
former officers and directors. The complaints were filed on behalf of a purported class of people who purchased the Companys stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege
that the Company and certain of its current and former officers and directors made false and misleading statements about its business during the putative class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaints have been consolidated under the name In re Tut Systems, Inc. Securities Litigation, Civil Action No. C-01-2659-JCS. Lead plaintiffs and lead counsel for plaintiffs have been appointed.
Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. The hearing on the Motion to Dismiss is scheduled for June 7, 2002. The Company believes the allegations against it
are without merit and intends to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on the Companys business, results of operations, or financial condition.





On August 3, 2001, a complaint, Arrow Electronics, Inc. v. Tut Systems, Inc., Case No. CV 800433, was filed in the Superior Court of the State of
California for the County of Santa Clara against the Company. The Complaint was filed by one of its suppliers and alleges causes of action for breach of contract and for money on common counts. The Complaint seeks damages in the amount of $10,469.
The case is in the discovery stage and no trial has yet been scheduled. The Company denies liability and intends to defend itself vigorously. An unfavorable resolution of this litigation could have a material adverse effect on the Companys
business, results of operations, or financial condition.




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##### Table of Contents



TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)







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 United States District Court, 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 (the 1933 Act) and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the 1933 Act. The
complaints also name as defendants the underwriters for the Companys initial public offering and secondary offering. The Company believes the allegations against it are without merit and intends to defend the action vigorously. An unfavorable
resolution of this litigation could have a material adverse effect on the Companys business, results of operations, or financial condition.





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.





NOTE 7SEGMENT
INFORMATION:





Revenue





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 Ended March 31,2002

2001United States

$
776

$
1,736International:Denmark


4


524Great Britain


251


308Japan


661


1,981Mexico


404


All other countries


262


338$
2,358

$
4,887





It is impracticable for the Company to compute product revenues by product type
for the three months ended March 31, 2002 and 2001.





Four customers, Capital Planeado SA de CV, Kanematsu Computer System Ltd.,
RIKEI Corporation and BTN Internetworking, accounted for 17%, 13%, 11% and 10%, respectively, of the Companys revenue for the three months ended March 31, 2002. Three customers, Kanematsu Computer System Ltd., RIKEI Corporation and NetPoint AS
accounted for 22%, 13% and 11%, respectively, of the Companys revenue for the three months ended March 31, 2001.




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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. These forward-looking statements include, but not limited to, statements about our revenue sources, our cash flow and cash
position, our expense trends, products and standards development, and our plans, objectives, expectations and intentions and other statements contained herein that are not historical facts. 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. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially
from those expressed or implied by these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. These forward-looking statements reflect current
views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions. As a result, actual results may differ materially from the forward-looking statements contained herein. Such risks and
uncertainties include those set forth below in Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock. In particular, see Additional Risk Factors that Could Affect our Operating Results
and the Market Price of our StockWe have a history of losses and expect to continue to incur losses in the future, Our operating results may fluctuate significantly, which could cause our stock price to decline, and
We are and continue to be affected by poor general economic conditions that have resulted in significantly reduced sales levels and, if such adverse economic conditions continue or worsen, our business, operating results and financial
condition could be negatively impacted. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph.








Overview





We design, develop, and market full-service access systems which enable service providers to deliver broadband services to single-family homes, referred to as neighborhood dwelling units, or NDUs, and to tenants residing in multi-tenant
unit properties, or MTUs. Our systems use the existing copper telephone wiring found in neighborhoods and buildings to simultaneously deliver multiple broadband services such as interactive digital broadcast television, video-on-demand services,
telecommuter data service, high-speed Internet access and high-quality voice services over a single pair of telephone-grade wires. Our target customers are broadband service providers that include telephony-based incumbent local exchange companies,
or ILECs, such as the former Regional Bell Operating Companies, or RBOCs, and international Post, Telephone, and Telegraph companies, or PTTs, as well as regulated and unregulated competitive local exchange carriers, or CLECs, who aim to deliver
services over existing copper infrastructures.





We have incurred net operating losses to date and, as of March 31, 2002, had an
accumulated deficit of $241.7 million. Our ability to generate income from operations will be primarily dependent on increases in sales volume, reductions in manufacturing costs and the growth of high-speed data access solutions in the NDU and MTU
markets. In view of our limited history of product revenue from new markets, our reliance on growth in deployment of high-speed data access solutions and the unpredictability of orders and subsequent revenue, we believe that period-to-period
comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. Failure to generate significant revenue from existing or new products, whether due to lack of market
acceptance, competition, technological change, continued poor economic conditions affecting the telecommunications industry or otherwise, or the inability to reduce manufacturing costs, will harm our business, financial condition and results of
operations.




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During fiscal 2001 and in the first quarter of 2002, we have reduced the sales prices of some
of our products to remain competitive and to reduce our relatively high levels of inventory. Although we have historically been able to offset most price declines with reductions in our manufacturing costs, there can be no assurance that we will be
able to offset further price declines with additional cost reductions. Also, market developments, including the write down of significant amounts of inventory by competitors and products resold as a result of bankruptcies within the industry, have
put increased pressure on the sales prices of our existing inventories. In addition, some of our licensees may sell products based on our technology to our competitors or potential competitors. We cannot assure you that our HomeRun technology will
be successfully deployed on a widespread basis or that such licensing will not result in an erosion of the potential market for our products.





Sales to customers outside of the United States accounted for approximately 67.1%, and 64.5% of revenue for the three months ended March 31, 2002 and 2001, respectively. On average, we expect international sales to
represent approximately 50% of our revenue. However, actual results, both geographically and in absolute dollars, may vary from quarter to quarter depending on the timing of orders placed by customers. To date, all international sales have been
denominated in U.S. dollars.





We expect to continue to evaluate product line expansion and new product opportunities, engage in
research, development and engineering activities and focus on cost-effective design of our products. Accordingly, we will continue to make significant expenditures on research and development activities as a percentage of overall operating expenses.





In February 2000, we acquired FreeGate Corporation (FreeGate) for approximately $25.5 million, consisting of
510,931 shares of our common stock, 19,707 options to acquire shares of our common stock, and acquisition related expenses consisting primarily of investment advisory, legal and other professional service fees and other assumed liabilities. This
transaction was treated as a purchase for accounting purposes. FreeGate was located in Sunnyvale, California. FreeGate designed, developed and marketed Internet server appliances combining the functions of IP routing, firewall security, network
address translation, secure remote access via virtual private networking, or VPN networking, and email and web servers on a compact, PC-based platform.





In April 2000, we acquired certain assets of OneWorld Systems, Inc. (OneWorld) for approximately $2.4 million in cash. This transaction was treated as a purchase of assets for accounting purposes. The
acquired assets consisted of $1.0 million for acquired workforce, $1.1 million for goodwill and $0.3 million for property and equipment.





In May 2000, we acquired Xstreamis Limited (Xstreamis), formerly Xstreamis, PLC, for $19.6 million, consisting of 439,137 shares of our common stock, 10,863 options to acquire shares of our common stock, $0.1 million in
cash and $0.6 million in acquisition related expenses consisting primarily of legal and other professional fees. This transaction was treated as a purchase for accounting purposes. Xstreamis was located in the United Kingdom. Xstreamis provided
policy-driven traffic management for high-performance, multimedia networking solutions including routing, switching and bridging functions.





In January 2001, we acquired ActiveTelco, Inc. (ActiveTelco) for approximately $4.9 million, consisting of an aggregate of 321,343 shares of our common stock and 18,657 options to purchase shares of our
common stock and acquisition related expenses consisting primarily of legal and other professional fees, assumed ActiveTelco convertible notes in the amount of $0.7 million plus accrued interest and other assumed liabilities of approximately $1.1
million. This transaction was treated as a purchase for accounting purposes. ActiveTelco was located in Fremont, California. ActiveTelco provided an Internet telephony platform that enabled Internet and telecommunications service providers to
integrate and deliver Web-based telephony applications such as unified


messaging, long-distance service, voicemail and fax delivery, call forwarding, call conferencing and callback services.




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In September 2001, we acquired certain assets, including some intellectual property rights,
from ViaGate Technologies, Inc. (ViaGate) for approximately $0.6 million in cash. This transaction was treated as a purchase of assets for accounting purposes. The acquired patents and technology of ViaGate provide a highly scalable,
carrier-class, full service gateway built on standards-based asynchronous transfer mode, or ATM, internet protocol, or IP, and very high speed digital subscriber line, or VDSL technology.





While we expect to derive benefits from sales of product lines that are designed, developed and marketed as a result of these acquisitions, there can be no assurance that we will be able
to complete the development and commercial deployment of certain of these products. In January 2001, we decided to abandon future sales of the existing OneGate product that we acquired in the FreeGate acquisition. In April 2001, as part of our cost
reduction efforts, we decided not to pursue further incorporation of the related OneGate and other intellectual property acquired from FreeGate into the design of future products. As a result, we took a write down of $2.7 million for abandonment of
the related completed technology and patents in the first quarter of 2001. During our impairment review for the third quarter of 2001, we evaluated the present value of future expected cash flows to determine the fair value of our long-lived assets.
This evaluation resulted in a write down of $29.9 million of goodwill and other intangible assets. The underlying factors contributing to the decline in expected future cash flows include a continued decline in the telecommunications industry and
the indefinite postponement of capital expenditures, especially within the hospitality industry. As of March 31, 2002, our net intangible assets remaining to be amortized were $4.0 million, comprised entirely of completed technology and patents
related to the acquisitions of the ViaGate assets and Xstreamis.





During fiscal 2001, we reduced our total workforce by
approximately 50% to control overall operating expenses in response to recent declines and expected slower growth in our sales and we also implemented plans to close several of our satellite offices. We incurred restructuring charges of $2.3 million
related to this restructuring.





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 Months Ended March 31,2002


2001Total revenues

100.0
%

100.0
%Total cost of goods sold

64.6


445.0Gross (loss) margin

35.4


(345.0
)Operating expenses:Sales and marketing

98.2


78.3Research and development

139.4


95.1General and administrative

83.1


66.2In-process research and development




23.7Impairment of intangibles




55.1Amortization of intangibles

12.7


54.3Noncash compensation expenses




1.2Total operating expenses

333.4


374.6Loss from operations

(298.0
)

(719.6
)Interest and other income, net

10.4


24.5Net loss

(287.6
)

(695.1
)




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Three Months Ended March 31, 2002 and 2001





Revenue.    We generate revenue primarily from the sale of hardware products and, to a lesser extent, through the licensing
of our HomeRun technology and from the sale of software products. Our total revenue decreased to $2.4 million for the three months ended March 31, 2002 from $4.9 million for the three months ended March 31, 2001. Using a year-over-year comparison,
the decrease in the first quarter of 2002 compared to the first quarter of 2001 of $2.5 million or 51.7% was primarily due to decreased sales of our Expresso MDU products. The market for our products was significantly weaker in the first quarter of
2002 than it was in the first quarter of 2001. During the fourth quarter of 2000, our revenue growth slowed substantially due to (i) several key customers who, in the latter part of the fourth quarter of 2000, experienced a rapid deterioration in
their ability to obtain additional capital and, as a result, severely curtailed or halted their purchases of our product, and (ii) reduced sales volume in the Korean market. These developments were not unique to us and have continued in conjunction
with a general downturn in the telecommunications market throughout 2001, affecting our ability to generate comparatively similar levels of sales. In certain instances, these developments have made collection of receivables less certain and require
us to defer revenue until cash is collected. During the third quarter of 2001, our revenue growth further slowed due to an increase in the number of customers and potential customers, particularly within the hospitality industry, that indefinitely
postponed capital expenditures after the events surrounding September 11, 2001.





License and royalty revenue was $0.2 million
for the three months ended March 31, 2002 and 2001. The generally low revenue was primarily due to decreases in royalty payments, as a result of continued economic conditions affecting the telecommunications market. We did not enter into any new
license or royalty agreements during the first quarter of 2002 or 2001.





Cost of Goods Sold/Gross (Loss) Margin





The following table sets forth items regarding our cost of goods sold, provisions and margins for the periods indicated:





Three Months Ended March 31,2002


2001(in thousands) (unaudited)Total revenues

$
2,358


$
4,887Total cost of goods sold


1,523


$
21,747Gross (loss) margin

$
835


$
(16,860
)Gross (loss) margin as a percentage of revenue


35.4
%


(345.0
)%Detail of gross margin before certain provisions:Total cost of goods sold

$
1,523


$
21,747Less:Provision for excess and obsolete inventory






(18,500
)Total cost of goods sold excluding provisions for excess and obsolete inventory


1,523



3,247Gross margin before the provision for excess and obsolete inventory

$
835


$
1,640Gross margin before the provision for excess andobsolete inventory as a percentage of revenue


35.4
%


33.6
%




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Cost of goods sold consists of raw materials, contract manufacturing, personnel costs, test and
quality assurance for products, and the cost of licensed technology included in the products. Our cost of goods sold decreased to $1.5 million for the three months ended March 31, 2002, from $3.2 million for the three months ended March 31, 2001,
excluding the reserves for excess and obsolete inventory of $18.5 million taken in the first quarter of 2001. The decrease in the first quarter of 2002 compared to the first quarter of 2001 of $1.7 million or 53.1% was primarily due to decreased
sales of our Expresso MDU products.





Gross margin as a percentage of revenue, increased to 35.4% of revenue for the three months
ended March 31, 2002 from 33.6% of revenue for the three months ended March 31, 2001, before the reserves for excess and obsolete inventory. The slight increase in the first quarter of 2002 compared to 2001 of 1.8% was due primarily to the sale of
approximately $.6 million of raw materials previously reserved for through loss on purchase committments and favorable projected warranty cost adjustments, offset by sales price reductions on some of our Expresso MDU products in response to
competitive pricing pressures.





During the first quarter of 2001, we recorded a reserve for excess and obsolete inventory of
$18.5 million. This reserve primarily related to the costs of raw materials and finished goods in excess of what we reasonably expected to sell in the foreseeable future as of the first quarter of 2001. Market developments over the past year,
including the write down of significant amounts of inventory by competitors, the proliferation of products resold as a result of bankruptcies within the industry, continued slowdown in the telecommunications market and more recently, the indefinite
postponement of capital expenditures, especially within the hospitality industry, have contributed to substantial uncertainties related to the value of these inventories. During the first quarter of 2001, we also recorded additional reserves of $0.2
million for excess and obsolete inventory as a part of our normal business operations and product inventory assessments. All of these inventory adjustments for the first quarter of 2001 were included in cost of goods sold resulting in an overall
negative gross margin of (345.0)%.





During the first quarter of 2002, we recorded additional reserves of $0.3 million for excess
and obsolete inventory as a part of our normal business operations and product inventory assessments. This inventory adjustment was included in cost of goods sold resulting in an overall gross margin of 35.4%.





Sales and Marketing.    Sales and marketing expense primarily consists of personnel costs, including commissions and costs
related to customer support, travel, trade shows, promotions and outside services. Our sales and marketing expenses decreased to $2.3 million for the three months ended March 31, 2002 from $3.8 million for the three months ended March 31, 2001. The
decrease in the first quarter of 2002 when compared to the first quarter of 2001 of $1.5 million or 39.5% was primarily due to reduction in our marketing programs in order to reduce our costs in light of the difficult market conditions and, to a
lesser degree, to align our sales commission expense with lower revenue in the first quarter of 2002.





Research and
Development.    Research and development expense consists primarily of personnel costs related to engineering and technical support, contract consultants, outside testing services, equipment and supplies associated with
enhancing existing products and developing new products. Research and development costs are expensed as incurred. Our research and development expenses decreased to $3.3 million for the three months ended March 31, 2002 from $4.7 million for the
three months ended March 31, 2001. The decrease in the first quarter of 2002 when compared to the first quarter of 2001 of $1.4 million or 29.8% was primarily a result of our workforce reductions in 2001 and our continued focus on cost saving
measures, including the reduction, postponement or abandonment of research and development efforts on certain of our product lines. Additionally, in the first quarter of 2001, we amortized to research and development $0.4 million of deferred
compensation and notes receivable related to restricted stock granted to certain FreeGate, OneWorld and ActiveTelco employees. During the three months ended March 31, 2002, this amortization was nominal. Research and development expenses decreased
in absolute dollars in 2001, as a result of our continued focus on cost saving measures. We expect research and development activities to represent a significant percentage of our overall fixed operating expenses during the remainder of fiscal 2002.




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General and Administrative.    General and administrative expense
primarily consists of personnel costs for administrative officers and support personnel, legal, accounting, insurance and consulting fees. Our general and administrative expenses decreased to $2.0 million for the three months ended March 31, 2002
from $3.2 million for the three months ended March 31, 2001. The decrease in the first quarter of 2002 compared to the first quarter of 2001 of $1.3 million or 39.5% was primarily a result of our workforce reductions in 2001 and our continued focus
on cost saving measures. We anticipate that general and administrative expenses will not fluctuate significantly during the remainder of 2002.





In-Process Research and Development.    The amount expensed as in-process research and development was $1.2 million for the three months ended March 31, 2001 related to in-process research
and development purchased from ActiveTelco during the first quarter of 2001. The purchased in-process technology was expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. The
in-process technology percentage of completion was estimated to be 75%. The value of this in-process technology was determined by estimating the cost to develop the purchased in-process technology into a commercially viable product, estimating the
net cash flows from the sale of the product after the completion of the in-process technology and discounting the net cash flows back to their present value using a risk-weighted discount rate of 30%. Research and development costs to bring
in-process technology from ActiveTelco to technological feasibility are not expected to have a material impact on our future results of operations or cash flows. There was no such expense during the first quarter of 2002.





Impairment of Intangibles.    In the first quarter of 2001, we recorded a $2.7 million impairment charge to write off the
completed technology and patents of FreeGate. This resulted from our decision not to pursue further incorporation of the related OneGate product and other intellectual property acquired from FreeGate into the design of future products. There was no
such charge for the first quarter of 2002.





Amortization of Intangibles.    For the three months
ended March 31, 2001, amortization of intangibles was comprised of the amortization of intangible assets related to the purchase acquisitions of Vintel in fiscal 1999, FreeGate, OneWorld assets and Xstreamis in fiscal 2000, and ActiveTelco in the
first quarter of 2001. These intangible assets consisted primarily of assembled workforce, completed technology and patents, and goodwill, and each were amortized over their estimated useful lives of three, five and five years, respectively. For the
three months ended March 31, 2002, amortization of intangibles was comprised entirely of completed technology and patents related to the acquisitions of Xstreamis and the ViaGate assets and are amortized over their estimated useful lives of five
years. Amortization of intangibles decreased to $0.3 million for the three months ended March 31, 2002 from $2.7 million for the three months ended March 31, 2001. The decrease in the first quarter of 2002 compared to the first quarter of 2001 of
$2.4 million or 88.7% was due to our recording of an impairment of these intangibles totaling $32.6 million during fiscal 2001. As of March 31, 2002, intangible assets totaling $4.0 million, which consist entirely of completed technology and
patents, remain to be amortized.





Noncash Compensation Expense.    Noncash compensation expense in
the first quarter of 2001 consisted of the recognition of expense related to certain employee stock option grants based on the difference between the deemed fair value of our common stock and the stock option exercise price at the date of grant. Our
noncash compensation expense was $0.1 million for the three months ended March 31, 2001. There was no such expense during the first quarter of 2002. As of March 31, 2002, we have recognized all of the expenses related to these employee stock
options.





Interest and Other Income, Net.    Interest and other income, net consisted primarily of
interest income on our cash, investments and notes receivable balances, offset by the amortization of premiums paid on investments. Our interest and other income, net decreased to $0.2 million for the three months ended March 31, 2002 from $1.2
million for the three months ended March 31, 2001. The decrease in the first quarter of 2002 compared to the first quarter of 2001 of $1.0 million or 79.6% was primarily due to lower interest rates on lower average cash and investment balances.




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Liquidity and Capital Resources





Historically, our principal source of liquidity has been obtained through equity funding. From our inception through January 1999, we have financed our operations primarily through the
sale of preferred equity securities for an aggregate of $46.2 million net of offering costs. In January 1999, we completed our initial public offering and issued 2,875,000 shares of our common stock at a price of $18.00. We received approximately
$46.9 million in cash, net of underwriting discounts, commissions and other offering costs. We also received approximately $6.7 million as a result of the exercise of a warrant to purchase 666,836 shares of Series G convertible preferred stock at a
price of $10.00 per share. In March 2000, we completed our secondary offering and issued 2,500,000 shares of our common stock at a price of $60.00 and we received approximately $141.7 million in cash, net of underwriting discounts, commissions and
other offering costs. In the future, we cannot be certain that similar equity funding will be available to us and as a result, our business, operating results and financial condition could be negatively impacted.





Cash, cash equivalents and short-term investments totaled $42.7 million at March 31, 2002, a decrease of $6.7 million or 13.5% from $49.4 million at
December 31, 2001.





The net decrease in cash and cash equivalents of $6.7 million during the three months ended March 31, 2002
resulted primarily from our use of $6.5 million for operating activities and the purchase of property and equipment of $0.2 million.





The net increase in cash and cash equivalents of $8.0 million during the three months ended March 31, 2001 resulted primarily from proceeds from maturities of short-term investments of $38.1 million. The increase in cash and cash
equivalents from this source was offset by uses in operating activities of $25.3 million, the purchase of property and equipment of $0.7 million, the purchase of investments of $4.0 million and the acquisition costs for ActiveTelco of $0.1 million.





In future periods, we generally anticipate a decrease in working capital expenditures on a period-to-period basis primarily as
a result of completing a substantial portion of payments for purchase commitments for inventory and a general decrease in our operational costs due to our recent workforce reductions.





We have entered into certain contractual obligations and other purchase commitments that could result in cash outflows. In the first quarter of 2000, we entered into a lease for
administrative and engineering facilities in Pleasanton, California. Under the terms of the lease, we were required to issue a letter of credit in the amount of $1.9 million. The letter of credit is reduced annually, beginning July 1, 2001, by
approximately $0.3 million, provided that we are not in default under the terms of the lease agreement. Pursuant to these terms, our letter of credit was reduced from $1.9 million to $1.6 million in the third quarter of 2001. In the fourth quarter
of 2001, we entered into a lease for engineering facilities in Bridgewater Township, New Jersey. Under the terms of the lease, we were required to issue a letter of credit in the amount of $0.1 million. These letters of credit are collateralized by
restricted funds in the amount of $1.7 million, which are included in intangibles and other assets as of March 31, 2002.





At
March 31, 2002, the remaining accrual for purchase commitments of raw material components was $4.4 million. At this time, we are involved in litigation related to certain of these commitments. As discussed in Note 6 of our Condensed Consolidated
Financial Statements, the outcome of this litigation is uncertain at this time.




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The following summarizes our contractual obligations at March 31, 2002, and the effect these
obligations are expected to have on our liquidity and cash flow in future periods:





Our future minimum lease payments under
operating leases at March 31, 2002 are as follows:





Year

(in millions)The remainder of 2002

$
1.82003


2.02004


1.92005


1.92006


1.9Thereafter


0.9$
10.4





To the extent that our business continues to be affected by the poor economic
conditions impacting the telecommunications industry, we will continue to require cash to fund our operations, reducing our liquidity. We believe that our cash, cash equivalents and short-term investment balances will be sufficient to satisfy our
cash requirements for at least the next 12 months. We expect cash flow from operations to increase during the year and we will seek additional funding for operations from alternative debt and equity sources if necessary to maintain reasonable
operating levels. However, we cannot assure you that such funding efforts will be successful. Failure to generate positive cash flow in the future could harm our business, financial condition and results of operations.





Recent Accounting Pronouncements





In May 2000,
the Emerging Issues Task Force, or EITF, issued EITF Issue No. 00-14, Accounting for Certain Sales Incentives which addresses the recognition, measurement and income statement classification for sales incentives that a vendor voluntarily
offers to customers, without charge, which the customer can use in, or exercise as a result of, a single exchange transaction. In June 2001, the EITF issued EITF Issue No. 00-25, Vendor Income Statement Characterization of Consideration Paid
to a Reseller of the Vendors Products, effective for periods beginning after December 15, 2001 which addresses whether consideration from a vendor to a reseller is: (a) an adjustment of the selling prices of the vendors products
and, therefore, should be deducted from revenue when recognized in the vendors statement of operations; or (b) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be included as a cost or
expense when recognized in the vendors statement of operations. Upon application of these EITFs, financial statements for prior periods presented for comparative purposes should be reclassified to comply with the income statement display
requirements under these Issues. In September 2001, the EITF issued EITF Issue No. 01-09, Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendors Products, which is a codification of EITF Issues No.
00-14, No. 00-25 and No. 00-22 Accounting for Points and Certain Other Time- or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future. The adoption of these Issues did not
impact our financial statements.





In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets,
which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group
of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have
been initially recognized in the financial statements. We will adopt SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 142 did not impact our financial statements.




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On October 3, 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 applies to all long-lived assets, including
discontinued operations, and consequently amends APB Opinion No. 30, Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair
value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that: (a) can be distinguished from the rest of the entity, and (b) will be eliminated from the
ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for all of our financial statements issued in 2002. The adoption of SFAS No. 144 did not impact our financial statements.





Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock





We have a history of losses and expect to continue to incur losses in the future.





We
have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. We incurred a net loss of $6.8 million for the three months ended March 31, 2002 and a net loss of $104.3 million for the year ended
December 31, 2001. As of March 31, 2002, we had an accumulated deficit of $241.7 million. We expect that we will continue to incur losses for the remainder of fiscal year 2002.





We may never achieve profitability and, if we do so, we may not be able to maintain profitability. We have spent substantial amounts of money on the development of our Expresso products,
HomeRun and LongRun technology, IntelliPOP products and software products. During fiscal 2001, we reduced our workforce in an effort to decrease certain of our operating expenditures, including our sales and marketing, research and development and
general and administrative expenditures. However, we may not be able to generate a sufficient level of revenue to offset the current level of expenditures. Additionally, we may be unable to adjust spending in a timely manner to respond to any
unanticipated decline in revenue due to the fact that our expenditures for sales and marketing, research and development, and general and administrative functions are relatively fixed in the short term. Our ability to achieve and maintain
profitability in the future will primarily depend on our ability to do the following:





| |  |  | increase the level of sales of our Expresso products, including existing Expresso inventories;
| | - |  | ----------------------------------------------------------------------------------------------




| |  |  | successfully penetrate new markets for our IntelliPOP products;
| | - |  | ---------------------------------------------------------------




| |  |  | reduce manufacturing costs;
| | - |  | ---------------------------




| |  |  | sell excess component parts obtained as a result of canceled purchase commitments; and
| | - |  | --------------------------------------------------------------------------------------




| |  |  | successfully introduce and sell enhanced versions of our existing and new products.
| | - |  | -----------------------------------------------------------------------------------




Our operating results may fluctuate significantly, which could cause our stock price to decline.





A number of factors could cause our quarterly and annual financial results to be worse than expected, which could result in a decline in our stock price. Our annual and quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of numerous factors, some of which are outside of our control. These factors include:





| |  |  | availability of capital in the network infrastructure industry;
| | - |  | ---------------------------------------------------------------




| |  |  | management of inventory levels;
| | - |  | -------------------------------




| |  |  | market acceptance of our products;
| | - |  | ----------------------------------



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| |  |  | competitive pressures, including pricing pressures from our partners and competitors, particularly in light of continued announcements from competitors in recent quarters that
they took significant write downs in inventory, which could lead to a general excess of competitive products in the marketplace;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | the timing or cancellation of orders from, or shipments to, existing and new customers;
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | the timing of new product and service introductions by us, our customers, our partners or our competitors;
| | - |  | ----------------------------------------------------------------------------------------------------------




| |  |  | variations in our sales or distribution channels;
| | - |  | -------------------------------------------------




| |  |  | variations in the mix of products that we offer;
| | - |  | ------------------------------------------------




| |  |  | changes in the pricing policies of our suppliers;
| | - |  | -------------------------------------------------




| |  |  | the availability and cost of key components; and
| | - |  | ------------------------------------------------




| |  |  | the timing of personnel hiring.
| | - |  | -------------------------------




We
anticipate that average selling prices for our products will decrease in the near future due to increased competitive price pressures in certain geographical regions. In addition, we may also experience substantial period-to-period fluctuations in
future operating results and declines in gross margin as a result of the erosion of average selling prices for high-speed data access products and services due to a number of factors, including increased competition and rapid technological change.
Decreasing the average selling prices of our products could cause us to experience decreased revenue despite an increase in the number of units sold. We may be unable to sustain our gross margins, even at the anticipated reduced levels, improve our
gross margins by offering new products or increased product functionality or offset future price declines with cost reductions.





As a result of these and other factors, it is possible that in some future period our operating results will be below the expectations of securities analysts and investors. In that event, the price of our common stock would likely further
decline.





We are and continue to be affected by poor general economic conditions that have resulted in significantly reduced sales levels and, if such
adverse economic conditions continue or worsen, our business, operating results and financial condition could be negatively impacted.





The continued poor economic conditions in the world economy, which became particularly acute after the events surrounding September 11, 2001, and the continued industry-wide downturn in the telecommunications market
have affected, and may continue to affect, our sales in the future. As a result, we may experience a material adverse impact on our business, operating results and financial condition. Comparatively lower sales have resulted in operating expenses
increasing as a percentage of revenue for the three months ended March 31, 2002 and the year ended December 31, 2001 compared to the years ended December 31, 2000 and 1999. Although we took actions throughout 2001 to create revenue opportunities and
reduce operating expenses, a prolonged continuation or worsening of sales trends that we faced in 2001 may force us to take additional actions and charges in order to reduce our operating expenses. If we are unable to reduce operating expenses at a
rate and level consistent with future adverse sales trends or if we incur significant special charges associated with such expense reductions that are disproportionate to sales, our business, operating results and financial condition could be
negatively impacted.





We depend on a limited number of large customers for a substantial portion of our revenue during any given period, and the loss
of a key customer or loss or delay of a key order could substantially reduce our revenue in a given period.





We derive a
significant portion of our revenue in each period from a limited number of customers. Four customers, Capital Planeado SA de CV, Kanematsu Computer System Ltd., RIKEI Corporation and BTN Internetworking, accounted for 17%, 13%, 11% and 10%,
respectively, of our revenue for the three months ended March 31, 2002. Three customers, Kanematsu Computer System Ltd., RIKEI Corporation and NetPoint AS accounted for 22%, 13% and 11%, respectively, of our revenue for the three




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months ended March 31, 2001. Many of our past customers have limited or, in some cases, no access to capital and are experiencing significant financial
difficulties, including bankruptcy. In order to meet our revenue targets, we must continue to acquire new customers and increase sales to our existing customers. In addition, our strategy of targeting larger, more established customers may result in
longer sales cycles and delayed revenue. Sales to larger accounts could also result in increased competition from larger and more established competitors. If sales to our largest customers decrease materially below current levels or if we are unable
to establish a new base of customers, such decreases or failures could materially and adversely affect our business, results of operations and financial condition.





We are currently engaged in multiple securities class action lawsuits and a lawsuit with one of our suppliers, any of which, if it results in an unfavorable resolution, could adversely affect our business, results
of operations or financial condition.





Beginning July 12, 2001, six putative shareholder class action lawsuits were filed in
the United States District Court for the Northern District of California against us and certain of our current and former officers and directors. The complaints were filed on behalf of a purported class of people who purchased our stock during the
period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that we and certain of our current and former officers and directors made false and misleading statements about our business during the putative
class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaints have been consolidated under the name In re Tut Systems, Inc. Securities Litigation,Civil Action
No. C-01-2659-JCS. Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. The hearing on the Motion to
Dismiss is scheduled for June 7, 2002. We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of
operations, or financial condition.





On August 3, 2001, a complaint, Arrow Electronics, Inc. v. Tut Systems, Inc., Case
No. CV 800433, was filed in the Superior Court of the State of California for the County of Santa Clara against us. The Complaint was filed by one of our suppliers and alleges causes of action for breach of contract and for money on common counts.
The Complaint seeks damages in the amount of $10.5 million. The case is in the discovery stage and no trial has yet been scheduled. We deny liability and intend to defend ourselves vigorously. An unfavorable resolution of this litigation could have
a material adverse effect on our business, results of operations, or financial condition.





On October 30, 2001, we and certain
of our 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 United States District Court, 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 our January 29, 1999 initial public offering and our March
23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and former officers and directors under Section 11 of the 1933 Act and
under Section 10 (b) and Rule 10b-5 of the Securities Exchange Act of 1934 and alleges claims against certain of our current and former officers and directors under Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the
underwriters for our initial public offering and secondary offering. We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse
effect on our business, results of operations, or financial condition.





We face substantial risk in introducing our new IntelliPOP products.





We launched our new IntelliPOP 5000 series product in the first half of 2001, and recently announced that we intend to
launch our IntelliPOP 8000 series product in 2002. We face significant risks associated with the launch of these new products which include, but are not limited to:





| |  |  | delays in shipping;
| | - |  | -------------------




| |  |  | software defects;
| | - |  | -----------------



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| |  |  | delays in product hardware and software testing; and
| | - |  | ----------------------------------------------------




| |  |  | production delays in building the products.
| | - |  | -------------------------------------------




The complexity of the products requires additional customer support resources. Since the products include major software components, we include software maintenance agreements in the sales of our products. Accordingly, revenue associated
with such maintenance agreements will be deferred and recognized over the life of the underlying support of the products. The launch of our IntelliPOP products may also cause customers to delay purchases of our existing products. In addition, the
introduction of new, more complex products, coupled with a search for larger, more established customers may result in longer sales cycles and delayed revenue from the IntelliPOP series of products.





If we do not reduce our inventory, we may be forced to incur charges, which could materially and adversely impact our business, results of operations and financial condition.





We have accumulated a substantial inventory of finished goods and components due to poor global economic conditions, which
became more acute after the events surrounding September 11, 2001, and the reduction in product demand due to capital funding decreases experienced by several key customers. In addition, announcements of large-scale inventory write downs by
competitors indicate that the risk of inexpensive competitive products coming into the marketplace has continued to increase. We have provided for losses related to the cancellation of purchase commitments and further allowances for excess and
obsolete finished goods inventories and related raw materials. However, we must sell existing finished goods inventory and sell component inventory resulting from deliveries on already canceled purchase commitments. Failure to do so may require that
we take additional charges related to slow moving or obsolete inventory and components. If we are unable to sell a substantial amount of both the finished goods and the component inventories, our expected cash position throughout 2002 could be
negatively impacted, which could harm our business, results of operations and financial condition.





If our Expresso and IntelliPOP products are not
accepted in the market, our business, financial condition and results of operations could be harmed.





We must devote a
substantial amount of human and capital resources in order to maintain commercial acceptance of our Expresso products and IntelliPOP products and to expand offerings of these products in the multi-dwelling unit, or MDU, and the multi-tenant
commercial unit, or MCU, markets and to further penetrate these markets. Historically, the majority of our Expresso products has been sold into the MDU market. Our future success depends on the ability to continue to penetrate this market and to
expand our penetration into the MCU market. Our success also depends on our ability to educate existing and potential customers and end-users about the benefits of our Fast Copper and Signature Switch technologies, our LongRun and IntelliPOP
products, and about the development of new products to meet changing and expanding demands of service providers, MTU owners and corporate customers. The success of our Expresso and IntelliPOP products will also depend on the ability of our service
provider customers to market and sell high-speed data services to end-users. If our IntelliPOP or our Expresso products do not achieve or maintain broad commercial acceptance within the MDU market, MCU market, or in any other markets we may enter,
our business, financial conditions and results of operations could be materially and adversely affected.




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The market in which we operate is highly competitive, and we may not be able to compete effectively.





The market for multi-service broadband access systems is intensely competitive, and we expect that this market will become
increasingly competitive in the future. Our most immediate competitors include, or are expected to include, Cisco Systems, Inc., Lucent Technologies, Inc., Next Level Communications, Inc., Paradyne Networks, Inc. and a number of other public and
private companies. Many of these competitors offer or may offer technologies and services that directly compete with some or all of our high-speed access products and related software products. Also, many of these competitors have continued to
announce significant changes in their business plans and operations, some of which, such as major write downs of inventory, could result in lower priced products flooding the market and thus have a negative impact on our ability to sustain our
current pricing or to sell current levels of inventory. In addition, the market in which we compete is characterized by increasing consolidation, and we cannot predict with certainty how industry consolidation will affect us or our competitors.





Many of our competitors and potential competitors have substantially greater name recognition and technical, financial and
marketing resources than we do, and we can give you no assurance that we will be able to compete effectively in our target markets. These competitors may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies
and devote substantially more resources to developing new products than we can. In addition, our HomeRun licensees may sell products based on our HomeRun technology to our competitors or potential competitors. This licensing may cause an erosion in
the potential market for our products. We cannot assure you that we will have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete successfully. This competition could result in
price reductions, reduced profit margins and loss of market share, which could harm our business, financial condition and results of operations.





Our
copper-wire based solutions face severe competition from other technologies, and the commercial acceptance of any competing solutions could harm our ability to compete and thus materially and adversely impact our business, financial condition and
results of operations.





The market for high-speed data access products and services is characterized by several competing
technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. These competing solutions provide fast access, high reliability and cost-effective solutions for some users. Many of our products are based on the
use of 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. To the extent that telecommunications service providers choose to install fiber optic cable or other transmission media in the last mile, or to the extent that homes and businesses install other transmission
media within buildings, we expect that demand for our products that are based on copper telephone wires will decline. Commercial acceptance of any one of these competing solutions or any technological advancement or product introduction that
provides faster access, greater reliability, increased cost-effectiveness or other advantages over technologies that utilize existing copper telephone wires could decrease the demand for our products and reduce average selling prices and gross
margins associated with our products. The occurrence of any one or more of these events could harm our business, financial condition and results of operations.





If we fail to manage our operations in light of our changing revenue base, our ability to increase our revenues and improve our results of operations could be harmed.





Our operations have changed significantly due to volatility in our business. In the past, we have rapidly and significantly expanded our operations. However, in fiscal 2001, we reduced
our workforce by approximately 50% to control overall operating expenses in response to recent declines in and expected slowing of our sales growth. We anticipate that, in the future, expansion in certain areas of our business may be required to
expand our customer base and exploit market opportunities. In particular, we expect to face numerous challenges in the implementation of our business strategy to focus on the larger, more established customers such as ILECs and PTTs in both domestic
and international markets.




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To exploit the market for our products, we must develop new and enhanced products while
implementing and managing effective planning and operating processes. To manage our operations, we must, among other things, continue to implement and improve our operational, financial and management information systems, hire and train additional
qualified personnel, continue to expand and upgrade core technologies and effectively manage multiple relationships with various customers, suppliers and other third parties. We cannot assure you that our systems, procedures or controls will be
adequate to support our operations or that our management will be able to achieve the rapid execution necessary to exploit fully the market for our products or systems. If we are unable to manage our operations effectively, our business, financial
condition and results of operations could be harmed.





We depend on international sales for a significant portion of our revenue, which could subject
our business to a number of risks; if we are unable to generate significant international sales, our business, financial condition and results of operations could be materially and adversely affected.





Sales to customers outside of the United States accounted for approximately 67.1%, and 64.5% of revenue for the three months ended March 31, 2002 and
2001, respectively. There are a number of risks arising from our international business, including, but not limited to:





| |  |  | longer receivables collection periods;
| | - |  | --------------------------------------




| |  |  | increased exposure to bad debt write-offs
| | - |  | -----------------------------------------




| |  |  | risk of political and economic instability;
| | - |  | -------------------------------------------




| |  |  | difficulties in enforcing agreements through foreign legal systems;
| | - |  | -------------------------------------------------------------------




| |  |  | unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------




| |  |  | import or export licensing requirements;
| | - |  | ----------------------------------------




| |  |  | reduced protection for intellectual property rights in some countries; and
| | - |  | --------------------------------------------------------------------------




| |  |  | currency fluctuations.
| | - |  | ----------------------




We expect
sales to customers outside of the United States to continue to account for a significant portion of our revenue. However, we cannot assure you that foreign markets for our products will develop at the rate or to the extent currently anticipated. If
we fail to continue to generate significant international sales, our business, financial condition and results of operations could be materially and adversely affected.





We also expend product development and other resources in order to meet regulatory and technical requirements of foreign countries. We depend on sales of our products in these foreign
markets to recoup the costs associated with developing products for these markets.





Our ability to attract and retain our personnel may be impaired by
the decrease in our stock price.





The drop in our stock price has resulted in most of our outstanding employee stock options
being under water or priced substantially above the current market price. In response to the drop in our stock price, on May 14, 2001, we offered our eligible employees the opportunity to tender their existing stock options for
cancellation pursuant to a stock option exchange program and have new stock options granted at a date at least six months and two days later than June 8, 2001, the date of cancellation. Accounting and other regulatory concerns prevented or limited
our ability to issue additional stock options to these employees during the period between cancellation and the date of the new grant. In the interim, those employees who participated in the stock option exchange offer were granted fewer or, in
certain cases, were not granted stock options until December 13, 2001, the date that was six months and two days after the date of such cancellation. Further, employees who did not participate in the stock option exchange offer continue to hold
stock options that are priced substantially above the current market price. In both cases, our employees may have felt, and may continue to feel, that they are receiving inadequate compensation. If adverse market conditions persist, the
attractiveness of our stock option offerings and the success of our employee stock plans may be negatively impacted and, as a result, diminish our ability to attract and retain qualified personnel.




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Our customers may have difficulty meeting their financial obligations to us due to changes in the capital markets,
which would reduce our revenue and harm our business.





Due to increased volatility in equity markets and tightening of
lending in the credit markets, we believe that we are exposed to a greater risk that customers will alter their payment practices to conserve capital. These changes may lead to increases in our outstanding accounts receivable as a percentage of
revenue, extended payback periods and increased risk of default. During the latter part of the fourth quarter of 2000, several key customers experienced a rapid deterioration in their ability to obtain additional capital to fund their businesses. As
a result, these customers declared their inability to make timely payments on their accounts and have not been able to demonstrate the ability to pay their existing account balances with us since that time. During fiscal 2001, a significant number
of these customers commenced bankruptcy proceedings. We factor these increased risks of non-payment into our assessment of our customers ability to pay, and these considerations will likely result in longer revenue deferrals than we have
previously experienced. We also believe that certain of our customers will alter their plans to deploy products to meet the constraints imposed on them by changes in the capital markets. If we are not able to increase sales in other customer
segments, or if our sales are otherwise delayed, our sales growth patterns may become increasingly volatile. This would increase the risk that our sales would decline in any particular quarter and could harm our business, operating results or
financial condition.





If we inaccurately estimate customer demand, our business, results of operations and financial condition could be harmed.





We plan our expense levels in part on our expectations about future revenue. These expense levels are relatively fixed in
the short-term. However, orders for our products may vary from quarter to quarter. In some circumstances, customers may delay purchasing our current products in favor of next-generation products. In addition, our new products are generally subject
to technical evaluations by potential customers that typically last 60 to 90 days. In the case of IntelliPOP, those evaluations may increase to six months. If orders forecasted for a specific customer for a particular quarter are delayed or
cancelled, our revenue for that quarter may be less than our forecast. Currently, we have minimal risk of loss associated with long-term customer commitments or penalties for delayed and/or cancelled orders. However, we may be unable to reduce our
spending accordingly in the short-term, and any such revenue shortfall would have a direct impact on our results of operations for that quarter. 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 order we actually receive and we are unable
to cancel future purchase and manufacturing commitments in a timely manner, our inventory levels could increase. This could expose us to losses related to slow moving and obsolete inventory which would have a material adverse effect on our business,
operating results and financial condition.





We depend on contract manufacturers to manufacture all of our products and rely on them to deliver
high-quality products in a timely manner; the failure of these manufacturers to continue to deliver quality products in a timely manner could have a materially adverse effect on our business, results of operations and financial condition.





We do not manufacture our products. We rely on contract manufacturers to assemble, test and package our products. We cannot
assure you that these contract manufacturers and suppliers will be able to meet our future requirements for manufactured products, components and subassemblies. In addition, we believe that current market conditions have placed additional financial
strain on our contract manufacturers. Any interruption in the operations of one or more of these contract manufacturers would harm our ability to meet our scheduled product deliveries to customers. We also intend to regularly introduce new products
and product enhancements, which will require that we rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturers to provide us with adequate
supplies of high-quality products or the loss of a current contract manufacturer would cause a delay in our ability to fulfill customer orders while we obtain a replacement




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manufacturer and would harm our business, operating results and financial condition. In addition, we have canceled certain finished goods and component orders
which may harm our relationship with certain contract manufacturers. Moreover, if we do not accurately forecast the actual demand for our products, we may face supply, manufacturing or testing capacity constraints. These constraints could result in
delays in the delivery of our products or the loss of existing or potential customers, either of which could harm our business, operating results or financial condition.





If our contract manufacturers fail to obtain the raw materials and component products we require in a timely manner, our business could be harmed.





We currently purchase most of our raw materials and components used in our products through our contract manufacturers. Components are purchased pursuant to purchase orders based on
forecasts, but neither we nor our contract manufacturers have any guaranteed supply arrangements with these suppliers. The availability of many of these components depends in part on our ability to provide our contract manufacturers and their
suppliers with accurate forecasts of our future needs. If we or our manufacturers are unable to obtain a sufficient supply of key components from current sources, we could experience difficulties in obtaining alternative sources at reasonable
prices, if at all, or in altering product designs to use alternative components. Resulting delays and reductions in product shipments could damage customer relationships and could harm our business, financial condition or results of operations. In
addition, any increases in component costs that are passed on to our customers could reduce demand for our products.





We rely on third parties to test
substantially all of our products and our failure to adequately control the quality of our products could harm our business, financial condition and results of operations.





Substantially all of our products are assembled and tested by our contract manufacturers. Although we perform random spot testing on manufactured products, we rely on our contract
manufacturers for assembly and primary testing of our products. Any quality assurance problems could increase the cost of manufacturing, assembling or testing our products and could harm our business, financial condition and results of operation.
Moreover, defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or liability claims, each of which could harm our business, financial condition and results of
operations.





Based on our building specifications, several key components are purchased from single or limited sources and we could lose sales if
these sources fail to fill our needs; if we lose sales, our business, financial condition and results of operations could be materially and adversely affected.





We currently purchase most of the raw materials and components used in our products through our contract manufacturers. In procuring components for our products, we and our contract
manufacturers rely on some suppliers that are the sole source of those components, and we are dependent upon supplies from these sources to meet our needs. For example, field programmable gate array supplies used in our products are purchased from
Xilinx or Altera. We also depend on various sole source offerings from Broadcom, Dallas Semiconductor, Metalink US, Motorola, Flextronics Semiconductor and SaRonix for certain of our products. If there is any interruption in the supply of any of the
key components currently obtained from a single or limited source, obtaining these components from other sources could take a substantial period of time which could cause us to redesign our products or could disrupt our operations and harm our
business, financial condition and results of operation in any given period.





Our business relies on the continued growth of the Internet and any
negative issues associated with the Internet could harm our business.





The market for high-speed data access products
depends in large part on the increased use of the Internet. Issues concerning the use of the Internet, including security, lost or delayed packets, and quality of service may negatively affect the development of the market for our products.







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Our industry is characterized by rapid technological change and we must continually introduce new products that achieve broad market acceptance in order
remain competitive.





The markets for high-speed data access products are characterized by rapid technological developments,
frequent enhancements to existing products and new product introductions, changes in end-user requirements and evolving industry standards. To remain competitive, we must continually improve the performance, features and reliability of our products,
particularly in response to competitive product offerings. We must introduce products that incorporate or are compatible with these new technologies as they emerge and must do so in a timely manner. We cannot assure you that we will be able to
respond quickly and effectively to technological change. We may have only limited time to penetrate certain markets, and we cannot assure you that we will be successful in achieving widespread acceptance of our products before competitors offer
products and services similar or superior to our products. Any failure to introduce new products addressing technological changes or any delay in our product introductions could adversely affect our ability to compete and cause our operating results
to be below our expectations or the expectations of public market analysts or investors. In addition, when we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products,
customers may defer purchasing our existing products. These actions could harm our business, financial condition and operating results by unexpectedly decreasing sales, increasing our inventory levels of older products and exposing us to greater
risk of product obsolescence.





Manufacturing or design defects in our products could harm our reputation and our business, financial condition and
results of operations.





Any defect or deficiency in our products could reduce the functionality, effectiveness or
marketability of our products. These defects or deficiencies could cause orders for our products to be canceled or delayed, reduce revenue, or render our product designs obsolete. In that event, we would be required to devote substantial financial
and other resources for a significant period of time to the development of new product designs. We cannot assure you that we would be successful in addressing any manufacturing or design defects in our products or in developing new product designs
in a timely manner, if at all. Any of these events, individually or in the aggregate, could harm our business, financial condition and results of operations.





Changing industry standards may reduce the demand for our products, which would harm our business, financial condition and results of operations.





We will not be competitive unless we continually introduce new products and product enhancements that meet constantly changing industry standards. The emergence of new industry
standards, whether through adoption by official standards committees or through widespread use of such standards by telephone companies or other service providers, could require the redesign of our products. If these standards become widespread and
our products do not comply with these standards, our customers and potential customers may not purchase our products, which would harm our business, financial condition and results of operations. The rapid development of new standards increases the
risk that competitors could develop products that make our products obsolete. Any failure by us to develop and introduce new products or enhancements directed at new industry standards could harm our business, financial condition and results of
operations. In addition, selection of competing technologies as standards by standards setting bodies such as the HomePNA could negatively affect our reputation in the market, regardless of whether our products are standards-compliant or demand for
our products does not decline. This selection could be interpreted by the press and others as having a negative impact on our business which could negatively impact our stock price.




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We have in the past and may in the future acquire companies, technologies or products and if we fail to integrate
these acquisitions, our business, results of operations and financial condition could be harmed.





In fiscal 2001 and fiscal
2000, we completed five acquisitions. As a part of our business strategy, we expect to make additional acquisitions of, or significant investments in, complementary companies, products or technologies. We may need to overcome significant issues in
order to realize any benefits from our past transactions, and any future acquisitions would be accompanied by similar risks. These risks include, but are not limited to:





| |  |  | difficulties in assimilating the operations and personnel of the acquired companies;
| | - |  | ------------------------------------------------------------------------------------




| |  |  | the potential disruption of our ongoing business and the distraction of our management;
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | the potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | additional expense associated with amortization of acquired intangible assets;
| | - |  | ------------------------------------------------------------------------------




| |  |  | maintenance of uniform standards, controls, procedures and policies; and
| | - |  | ------------------------------------------------------------------------




| |  |  | impairment of existing relationships with employees, suppliers and customers as a result of the integration of new personnel.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------




We cannot assure you that we will be able to successfully integrate any business, products, technologies or personnel that we have acquired or may
acquire in the future, and our failure to do so could harm our business, operating results and financial condition.





Fluctuations in currency exchange
rates may harm our business.





All of our foreign sales are invoiced in U.S. dollars. As a result, fluctuations in currency
exchange rates could cause our products to become relatively more expensive for international customers and reduce demand for our products. We anticipate that foreign sales will generally continue to be invoiced in U.S. dollars. Accordingly, we do
not currently engage in foreign currency hedging transactions. However, as we expand our current international operations, we may allow payment in foreign currencies and, as a result, our exposure to foreign currency transaction losses may increase.
To reduce this exposure, we may purchase forward foreign exchange contracts or use other hedging strategies. However, we cannot assure you that any currency hedging strategy would be successful in avoiding exchange related losses.





If we fail to protect our intellectual property, or if others use our proprietary technology without authorization, our competitive position may suffer.





Our future success and ability to compete depends in part upon our proprietary technology. We rely on a combination of
copyright, patent, trademark and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. We currently hold 26 United States patents and have 26 United States patent applications pending. However, we
cannot assure you that patents will be issued with respect to pending or future patent applications that we have filed or plan to file or that our patents will be upheld as valid or will prevent the development of competitive products or that any
actions we have taken will adequately protect our intellectual property rights.





We generally enter into confidentiality
agreements with our employees, consultants, resellers, customers and potential customers, in which we strictly limit access to and distribution of our software, and further limit the disclosure and use of our proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use our products or technology. Our competitors may also independently develop technologies that are substantially equivalent or superior to
our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States.




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We may be subject to intellectual property infringement claims that are costly to defend and could harm our business
and ability to compete.





Our industry is characterized by vigorous protection and pursuit of intellectual property rights.
We are subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. From time to time, third parties may assert infringement claims with respect to our current or future products. Any such
assertion, regardless of its merit, could require us to pay damages or settlement amounts and could require us to develop non-infringing technology or acquire licenses to the technology that is the subject of the asserted infringement. This
litigation or potential litigation could result in product delays, increased costs or both. In addition, the cost of any litigation and the resulting distraction of our management resources could harm our business, results of operations or financial
condition. We also cannot assure you that any licenses of technology necessary for our business will be available or that, if available, these licenses can be obtained on commercially reasonable terms. Our failure to obtain these licenses could harm
our business, results of operations and financial condition.





If our products do not comply with complex government regulations, our products may not
be sold, preventing us from increasing our revenue or achieving profitability.





We and our customers are subject to varying
degrees of federal, state and local regulation. Our products must comply with various regulations and standards defined by the Federal Communications Commission, 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, certain of our products must be certified by Underwriters Laboratories in order to meet federal safety requirements relating to electrical
appliances to be used inside the home. In addition, certain products must be Network Equipment Building Standard certified before they may be deployed by certain of our customers. Any delay in or failure to obtain these approvals could harm our
business, financial condition or results of operations. Outside of the United States, our products are subject to the regulatory requirements of each country in which our products are manufactured or sold. These requirements are likely to vary
widely. If we do not obtain timely domestic or foreign regulatory approvals or certificates, we would not be able to sell our products where these regulations apply, which may prevent us from sustaining our revenue or achieving profitability.





In addition, regulation of our customers may adversely impact our business, operating results and financial condition. For
example, FCC regulatory policies affecting the availability of data and Internet services and other terms on which telecommunications companies conduct their business may impede our penetration of certain markets. In addition, the increasing demand
for communications systems has exerted pressure on regulatory bodies worldwide to adopt new standards, generally following extensive investigation of competing technologies. The delays inherent in this governmental approval process may cause the
cancellation, postponement or rescheduling of the installation of communications systems by our customers, which in turn may harm the sale of products by us to these customers.





If our customers do not receive adequate and timely customer support from us or our third-party providers our relationships with our customers could be damaged, which could harm our business, financial condition
and results of operations.





Our ability to achieve our planned sales growth and to retain current and future customers will
depend in part on the quality of our customer support operations. Our customers generally require significant support and training with respect to our products, particularly in the initial deployment and implementation stage. As our systems and
products become more complex, we believe our ability to provide adequate customer support will be increasingly important to our success. Moreover, we believe that our IntelliPOP products will add a significant layer of complexity to the demands on
our customer support organizations. We have limited experience with widespread deployment of our products to a diverse customer base, and we cannot assure you that we will have adequate personnel to provide the levels of support that our customers
may require during initial product deployment or on an ongoing basis. In addition, we rely on a third party for a substantial portion of our customer support functions, and therefore we may




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have limited control over the level of support that is provided. Our failure to provide sufficient support to our customers could delay or prevent the
successful deployment of our products. Failure to provide adequate support could also have an adverse impact on our reputation and relationship with our customers, could prevent us from gaining new customers and could harm our business, financial
condition or results of operations.





If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to
manage our business successfully, which could materially and adversely affect our business, financial condition and results of operations.





We depend on the performance of Salvatore DAuria, our President, Chief Executive Officer, Chairman of the Board and Secretary, and on other senior management and technical personnel with experience in the data
communications, telecommunications and high-speed data access industries. The loss of any one of them could harm our ability to execute our business strategy. Additionally, we do not have employment contracts with any of our executive officers. We
believe that our future success will depend in large part upon our continued ability to identify, hire, retain and motivate highly skilled employees who are in great demand. We cannot assure you that we will be able to do so.





Our stock price has fluctuated and is likely to continue to fluctuate, and you may not be able to resell your shares at or above their purchase price.





The price of our common stock has been and is likely to continue to be highly volatile. Our stock price could fluctuate
widely in response to factors including, but not limited to, the following:





| |  |  | actual or anticipated variations in operating results;
| | - |  | ------------------------------------------------------




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




| |  |  | changes in financial estimates or recommendations by stock market analysts regarding us or our competitors;
| | - |  | -----------------------------------------------------------------------------------------------------------




| |  |  | conditions or trends in the telecommunications industry, including regulatory developments;
| | - |  | -------------------------------------------------------------------------------------------




| |  |  | growth of the Internet;
| | - |  | -----------------------




| |  |  | announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
| | - |  | ---------------------------------------------------------------------------------------------------------------




| |  |  | additions or departures of key personnel;
| | - |  | -----------------------------------------




| |  |  | future equity or debt offerings or our announcements of these offerings; and
| | - |  | ----------------------------------------------------------------------------




| |  |  | general market and economic conditions.
| | - |  | ---------------------------------------




In addition, in recent years, the stock market in general, and the Nasdaq National Market and the securities of Internet and technology companies in particular, have experienced extreme price and volume fluctuations with severe drops. These
fluctuations have often been unrelated or disproportionate to the operating performance of these technology companies. These market and industry factors may harm our stock price, regardless of our operating results.





Our stock may be delisted from the Nasdaq National Market.





At the closing of the Nasdaq National Market on April 1, 2002, the minimum bid price of a share of our common stock was $1.73. Nasdaq corporate governance rules require that all shares listed on the Nasdaq National
Market maintain a minimum bid price at closing of $1.00 per share. Our failure to maintain such a minimum bid price for a period of thirty or more consecutive trading days could result in the Nasdaq governing board taking action to remove our shares
from the Nasdaq National Market. Since the second quarter of 2001, the minimum closing bid price of our common stock has dropped below $1.00 per share on a number of occasions, and we cannot assure you that it will not do so again in the future. The
delisting of our common stock as well as the threat of delisting of our common stock may negatively impact the value of our shares because shares that trade on the over-the-counter market, rather than the Nasdaq National Market, are typically less
liquid and, therefore, trade with larger variations between the bid and asking price.




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Our charter, bylaws, retention and change of control plans and Delaware law contain provisions that could delay or
prevent a change in control.





Certain provisions of our charter and bylaws and our retention and change of control plans,
the Plans, may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. The provisions of the charter and bylaws and the Plans could limit the
price that certain investors may be willing to pay in the future for shares of our common stock . Our charter and bylaws provide for a classified board of directors, eliminate cumulative voting in the election of directors, restrict our stockholders
from acting by written consent and calling special meetings, and provide for procedures for advance notification of stockholder nominations and proposals. In addition, our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing
flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. The Plans provide for
severance payments and accelerated stock option vesting in the event of termination of employment following a change of control. The provisions of the charter and bylaws, and the Plans, as well as Section 203 of the Delaware General Corporation Law,
to which we are subject, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management.





Future sales of our common stock could depress our stock price.





Sales of a substantial number of shares of our
common stock in the public market, or the appearance that these shares are available for sale, could harm the market price of our common stock. These sales also may make it more difficult for us to sell equity securities or equity-related securities
in the future at a time and price that we deem appropriate. As of March 31, 2002, we had 16,411,172 shares outstanding. Of these shares, 16,407,460 shares of our common stock are currently available for sale in the public market, some of which are
subject to volume and other limitations under securities laws.





Our facilities are located near known earthquake fault zones, and the occurrence of an
earthquake or other natural disaster could cause damage to our facilities and equipment which could require us to curtail or cease operations.





Our facilities are located in the San Francisco Bay Area near known earthquake fault zones and are vulnerable to damage from earthquakes. In October 1989, a major earthquake that caused significant property damage and
a number of fatalities struck this area. We are also vulnerable to damage from other types of disasters, including fire, floods, power loss, communications failures and similar events. If any disaster were to occur, our ability to operate our
business at our facilities could be seriously, or completely, impaired. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions.





We rely on a continuous power supply to conduct our operations, and a statewide energy crisis could disrupt our operations and increase our expenses.





In the fourth quarter of 2000 and the first quarter of 2001, California suffered an energy crisis that could have disrupted our operations and increased
our expenses. In the event of an acute power shortage which occurs when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future implement, rolling blackouts throughout the
state. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our
power supply. If California was to suffer a similar energy crisis in the future and blackouts interrupt our power supply, we would be temporarily unable to continue operations at our facilities. Any such interruption in our ability to continue
operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations.




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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





We are
exposed to changes in interest rates primarily from our investments in certain held-to-maturity securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical
100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of interest sensitive financial instruments at March 31, 2002.





We have no investments, nor are any significant sales, expenses, or other financial items denominated in foreign country currencies. All of our international sales are denominated
in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, reduce the demand for our products.




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##### Table of Contents

PART II.    OTHER INFORMATION





ITEM 1.    LEGAL PROCEEDINGS





Beginning July 12, 2001, six putative shareholder
class action lawsuits were filed in the United States District Court for the Northern District of California against us and certain of our current and former officers and directors. The complaints were filed on behalf of a purported class of people
who purchased our stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that we and certain of our current and former officers and directors made false and misleading statements about
our business during the putative class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The complaints have been consolidated under the name In re Tut Systems, Inc.
Securities Litigation,Civil Action No. C-01-2659-JCS. Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March
29, 2002. The hearing on the Motion to Dismiss is scheduled for June 7, 2002. We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material
adverse effect on our business, results of operations, or financial condition.





On August 3, 2001, a complaint, Arrow
Electronics, Inc. v. Tut Systems, Inc., Case No. CV 800433, was filed in the Superior Court of the State of California for the County of Santa Clara against us. The Complaint was filed by one of our suppliers and alleges causes of action for
breach of contract and for money on common counts. The Complaint seeks damages in the amount of $10,469,088. The case is in the discovery stage and no trial has yet been scheduled. We deny liability and intend to defend ourselves vigorously. An
unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.





On October 30, 2001, we and certain of our 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 United States District Court, 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 our January 29, 1999 initial public offering and our March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our
current and former officers and directors under Section 11 of the Securities Act of 1933, as amended (the 1933 Act) and under Section 10 (b) and Rule 10b-5 of the Securities Exchange Act of 1934 and alleges claims against certain of our
current and former officers and directors under Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the underwriters for our initial public offering and secondary offering. We believe the allegations against us are without
merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.





ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS





None





ITEM 3.    DEFAULTS UPON SENIOR SECURITIES





None





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





None





ITEM 5.    OTHER INFORMATION





None





ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K





(a) Exhibits




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##### Table of Contents




Exhibit Number

Description2.1

Agreement and Plan of Reorganization dated as of October 15, 1999, by and among the Company, Vintel Acquisition Corp., and Vintel
Communications, Inc.(3)2.2

Agreement and Plan of Reorganization dated as of June 8, 1999, by and among the Company, Public Port Acquisition Corporation, and
Public Port, Inc.(2)2.3

Agreement and Plan of Reorganization dated as of November 16, 1999, as amended, by and among the Company, Fortress Acquisition
Corporation and FreeGate Corporation.(4)2.4

Asset Purchase Agreement by and between the Company and OneWorld Systems, Inc. dated as of February 3, 2000.(5)2.5

Amendment No. 1 to Asset Purchase Agreement by and between the Company and OneWorld Systems, Inc. dated as of February 17,
2000.(5)2.6

Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of
Xstreamis plc and Philip Corbishley.(6)2.7

Agreement and Plan of Reorganization dated as of December 21, 2000, by and among the Company, ActiveTelco Incorporated,
ActiveTelco Acquisition Corporation, and, with respect to Article VII only, Azeem Butt, as shareholder representative, and U.S. Bank Trust, as escrow agent.(7)3.1

Second Amended and Restated Certificate of Incorporation of the Company.(1)3.2

Bylaws of the Company, as currently in effect.(1)4.1

Specimen Common Stock Certificate.(1)10.25

Indemnification Agreement by and between the Company and Alida Rincon, effective as of March 3, 2000.(8)10.26

Indemnification Agreement by and between the Company and Marilyn Lobel, effective as of April 17, 2001.(8)11.1

Calculation of net loss per share (contained in Note 3 of Notes to Condensed Consolidated Financial Statements).


---

|(1) |  | Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-60419) as declared effective by the Securities and Exchange Commission on January 28, 1999.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
|--- |  | ---------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
|--- |  | --------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2000.
|--- |  | ------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- |  | -------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference to our Current Report on Form 8-K dated May 26, 2000 as filed June 9, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------

|(7) |  | Incorporated by reference to our Current Report on Form 8-K dated January 18, 2001.
|--- |  | -----------------------------------------------------------------------------------

|(8) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
|--- |  | ---------------------------------------------------------------------------------------------------




(b)  Reports on Form 8-K.





The Company did not
file any reports on Forms 8-K during the quarter ended March 31, 2002.




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SIGNATURE





Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





TUT SYSTEMS, INC.By:

/s/    MARILYN LOBELMarilyn Lobel Vice President, Finance and Chief Financial Officer
(Principal Financial and Accounting Officer and Duly Authorized Officer)





Date: April 26, 2002




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##### Table of Contents




INDEX TO EXHIBITS





Exhibit Number

Description2.1

Agreement and Plan of Reorganization dated as of October 15, 1999, by and among the Company, Vintel Acquisition Corp., and Vintel
Communications, Inc.(3)2.2

Agreement and Plan of Reorganization dated as of June 8, 1999, by and among the Company, Public Port Acquisition Corporation, and
Public Port, Inc.(2)2.3

Agreement and Plan of Reorganization dated as of November 16, 1999, as amended, by and among the Company, Fortress Acquisition
Corporation and FreeGate Corporation.(4)2.4

Asset Purchase Agreement by and between the Company and OneWorld Systems, Inc. dated as of February 3, 2000.(5)2.5

Amendment No. 1 to Asset Purchase Agreement by and between the Company and OneWorld Systems, Inc. dated as of February 17,
2000.(5)2.6

Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of
Xstreamis plc and Philip Corbishley.(6)2.7

Agreement and Plan of Reorganization dated as of December 21, 2000, by and among the Company, ActiveTelco Incorporated,
ActiveTelco Acquisition Corporation, and, with respect to Article VII only, Azeem Butt, as shareholder representative, and U.S. Bank Trust, as escrow agent.(7)3.1

Second Amended and Restated Certificate of Incorporation of the Company.(1)3.2

Bylaws of the Company, as currently in effect.(1)4.1

Specimen Common Stock Certificate.(1)10.25

Indemnification Agreement by and between the Company and Alida Rincon, effective as of March 3, 2000.(8)10.26

Indemnification Agreement by and between the Company and Marilyn Lobel, effective as of April 17, 2001.(8)11.1

Calculation of net loss per share (contained in Note 3 of Notes to Condensed Consolidated Financial Statements).


---

|(1) |  | Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-60419) as declared effective by the Securities and Exchange Commission on January 28, 1999.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
|--- |  | ---------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 1999.
|--- |  | --------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2000.
|--- |  | ------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- |  | -------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference to our Current Report on Form 8-K dated May 26, 2000 as filed June 9, 2000.
|--- |  | -----------------------------------------------------------------------------------------------------

|(7) |  | Incorporated by reference to our Current Report on Form 8-K dated January 18, 2001.
|--- |  | -----------------------------------------------------------------------------------

|(8) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
|--- |  | ---------------------------------------------------------------------------------------------------



37