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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended March 31, 2006

Commission File Number: 000-25291



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TUT SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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

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



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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated
filer See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act:

Large accelerated
filer ̈Accelerated
filer ̈Non-accelerated
filer  x

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act): Yes ̈No  x

As of May 5, 2006, 33,680,990 shares of the Registrants common stock, par value $0.001 per share, were issued and outstanding.



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##### Table of Contents

TUT SYSTEMS, INC.

FORM 10-Q

INDEX



|           |  |                                                                                                              |  |   
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|PART I.    |  | FINANCIAL INFORMATION                                                                                        |  |   
|           |  |                                                                                                             
|Item 1.    |  | Condensed Consolidated Financial Statements (unaudited):                                                     |  | 3 
|           |  |                                                                                                             
|           |  | Condensed Consolidated Balance Sheets as of December 31, 2005 and March 31, 2006                             |  | 3 
|           |  |                                                                                                             
|           |  | Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and March 31, 2006 |  | 4 
|           |  |                                                                                                             
|           |  | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and March 31, 2006 |  | 5 
|           |  |                                                                                                             
|           |  | Notes to Unaudited Condensed Consolidated Financial Statements                                               |  | 6 
|           |  |                                                                                                             
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 20
|           |  |                                                                                                             
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                                   |  | 33
|           |  |                                                                                                             
|Item 4.    |  | Controls and Procedures                                                                                      |  | 33
|           |  |                                                                                                             
|PART II.   |  | OTHER INFORMATION                                                                                            |  |   
|           |  |                                                                                                             
|Item 1.    |  | Legal Proceedings                                                                                            |  | 34
|           |  |                                                                                                             
|Item 1A    |  | Risk Factors                                                                                                 |  | 35
|           |  |                                                                                                             
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                  |  | 35
|           |  |                                                                                                             
|Item 3.    |  | Defaults Upon Senior Securities                                                                              |  | 35
|           |  |                                                                                                             
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                          |  | 35
|           |  |                                                                                                             
|Item 5.    |  | Other Information                                                                                            |  | 35
|           |  |                                                                                                             
|Item 6.    |  | Exhibits                                                                                                     |  | 36
|           | 
|Signatures |  | 38                                                                                                          



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##### Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

TUT SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                                          |  |                  |          |   |               |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ------------- | - | -------- | -
|                                                                                                                                          |  | December 31,2005 |          |   | March 31,2006 |  
|ASSETS                                                                                                                                    |  |                  |          |   |               |   |          |  
|Current assets:                                                                                                                           |  |                  |          |   |               |   |          |  
|Cash and cash equivalents                                                                                                                 |  | $                | 12,111   |   |               | $ | 11,432   |  
|Short term investments                                                                                                                    |  |                  | 1,693    |   |               |   |         |  
|Accounts receivable, net of allowance for doubtful accounts of $56 and $98 in 2005 and 2006, respectively                                 |  |                  | 14,873   |   |               |   | 16,217   |  
|Inventories, net                                                                                                                          |  |                  | 6,719    |   |               |   | 8,238    |  
|Prepaid expenses and other                                                                                                                |  |                  | 983      |   |               |   | 1,321    |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total current assets                                                                                                                      |  |                  | 36,379   |   |               |   | 37,208   |  
|Property and equipment, net                                                                                                               |  |                  | 2,827    |   |               |   | 2,957    |  
|Intangibles and other assets                                                                                                              |  |                  | 6,305    |   |               |   | 5,885    |  
|Goodwill                                                                                                                                  |  |                  | 1,672    |   |               |   | 1,672    |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total assets                                                                                                                              |  | $                | 47,183   |   |               | $ | 47,722   |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                      |  |                  |          |   |               |   |          |  
|Current liabilities:                                                                                                                      |  |                  |          |   |               |   |          |  
|Line of credit                                                                                                                            |  | $                | 7,080    |   |               | $ | 8,149    |  
|Accounts payable                                                                                                                          |  |                  | 5,678    |   |               |   | 6,473    |  
|Accrued liabilities                                                                                                                       |  |                  | 3,274    |   |               |   | 4,668    |  
|Deferred revenue                                                                                                                          |  |                  | 527      |   |               |   | 516      |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total current liabilities                                                                                                                 |  |                  | 16,559   |   |               |   | 19,806   |  
|Note payable                                                                                                                              |  |                  | 4,122    |   |               |   | 4,203    |  
|Other liabilities                                                                                                                         |  |                  | 100      |   |               |   | 82       |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total liabilities                                                                                                                         |  |                  | 20,781   |   |               |   | 24,091   |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Commitments and contingencies (Note 9)                                                                                                    |  |                  |          |   |               |   |          |  
|Stockholders equity:                                                                                                                     |  |                  |          |   |               |   |          |  
|Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding in 2005 and 2006, respectively               |  |                  |         |   |               |   |         |  
|Common stock, $0.001 par value, 100,000 shares authorized, 33,474 and 33,648 shares issued and outstanding in 2005 and 2006,
respectively |  |                  | 33       |   |               |   | 34       |  
|Additional paid-in capital                                                                                                                |  |                  | 339,692  |   |               |   | 340,050  |  
|Accumulated other comprehensive loss                                                                                                      |  |                  | (165     | ) |               |   | (159     | )
|Accumulated deficit                                                                                                                       |  |                  | (313,158 | ) |               |   | (316,294 | )
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total stockholders equity                                                                                                                |  |                  | 26,402   |   |               |   | 23,631   |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  
|Total liabilities and stockholders equity                                                                                                |  | $                | 47,183   |   |               | $ | 47,722   |  
|                                                                                                                                          |  |                  |          |   |               |   |          |  

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 EndedMarch 31, |       
|                                                                        |  | 2005                        |        |   | 2006 |  
|Revenue                                                                 |  | $                           | 7,053  |   |      | $ | 11,522 |  
|Cost of goods sold                                                      |  |                             | 4,515  |   |      |   | 7,571  |  
|                                                                        |  |                             |        |   |      |   |        |  
|Gross profit                                                            |  |                             | 2,538  |   |      |   | 3,951  |  
|                                                                        |  |                             |        |   |      |   |        |  
|Operating expenses:                                                     |  |                             |        |   |      |   |        |  
|Sales and marketing                                                     |  |                             | 2,488  |   |      |   | 2,565  |  
|Research and development                                                |  |                             | 2,121  |   |      |   | 3,210  |  
|General and administrative                                              |  |                             | 1,175  |   |      |   | 1,280  |  
|                                                                        |  |                             |        |   |      |   |        |  
|Total operating expenses                                                |  |                             | 5,784  |   |      |   | 7,055  |  
|                                                                        |  |                             |        |   |      |   |        |  
|Loss from operations                                                    |  |                             | (3,246 | ) |      |   | (3,104 | )
|Interest and other income (expense), net                                |  |                             | (74    | ) |      |   | (32    | )
|                                                                        |  |                             |        |   |      |   |        |  
|Net loss                                                                |  | $                           | (3,320 | ) |      | $ | (3,136 | )
|                                                                        |  |                             |        |   |      |   |        |  
|Net loss per share, basic and diluted (Note 3)                          |  | $                           | (0.13  | ) |      | $ | (0.09  | )
|                                                                        |  |                             |        |   |      |   |        |  
|Shares used in computing net loss per share, basic and diluted (Note 3) |  |                             | 25,187 |   |      |   | 33,563 |  
|                                                                        |  |                             |        |   |      |   |        |  

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 EndedMarch 31, |       
|                                                                            |  | 2005                        |        |   | 2006 |  
|Cash flows from operating activities:                                       |  |                             |        |   |      |   |        |  
|Net loss                                                                    |  | $                           | (3,320 | ) |      | $ | (3,136 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                             |        |   |      |   |        |  
|Depreciation                                                                |  |                             | 219    |   |      |   | 362    |  
|Provision for doubtful accounts                                             |  |                             | 104    |   |      |   | 42     |  
|Provision for excess and obsolete inventory                                 |  |                             | 20     |   |      |   | 13     |  
|Amortization of intangible assets                                           |  |                             | 376    |   |      |   | 423    |  
|Non cash compensation                                                       |  |                             | 193    |   |      |   | 111    |  
|Deferred interest on note payable                                           |  |                             | 76     |   |      |   | 81     |  
|Change in operating assets and liabilities:                                 |  |                             |        |   |      |   |        |  
|Accounts receivable                                                         |  |                             | (796   | ) |      |   | (1,386 | )
|Inventories                                                                 |  |                             | 463    |   |      |   | (1,532 | )
|Prepaid expenses and other assets                                           |  |                             | (1,394 | ) |      |   | (335   | )
|Accounts payable and accrued liabilities                                    |  |                             | 1,477  |   |      |   | 2,184  |  
|Deferred revenue                                                            |  |                             | 165    |   |      |   | (11    | )
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash used in operating activities                                       |  |                             | (2,417 | ) |      |   | (3,184 | )
|Cash flows from investing activities:                                       |  |                             |        |   |      |   |        |  
|Purchase of property and equipment                                          |  |                             | (511   | ) |      |   | (492   | )
|Purchase of short term investments                                          |  |                             |       |   |      |   | (7     | )
|Sale of short-term investments                                              |  |                             |       |   |      |   | 1,700  |  
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                         |  |                             | (511   | ) |      |   | 1,201  |  
|Cash flows from financing activities:                                       |  |                             |        |   |      |   |        |  
|Proceeds from line of credit                                                |  |                             |       |   |      |   | 1,069  |  
|Repayment of capital lease                                                  |  |                             |       |   |      |   | (13    | )
|Proceeds from issuances of common stock                                     |  |                             | 16     |   |      |   | 248    |  
|                                                                            |  |                             |        |   |      |   |        |  
|Net cash provided by financing activities                                   |  |                             | 16     |   |      |   | 1,304  |  
|                                                                            |  |                             |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                   |  |                             | (2,912 | ) |      |   | (679   | )
|Cash and cash equivalents, beginning of period                              |  |                             | 12,440 |   |      |   | 12,111 |  
|                                                                            |  |                             |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                    |  | $                           | 9,528  |   |      | $ | 11,432 |  
|                                                                            |  |                             |        |   |      |   |        |  

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



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TUT SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share amounts)

NOTE
1DESCRIPTION OF BUSINESS:

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

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

The Company has
incurred substantial losses and negative cash flows from operations since inception. For the three months ended March 31, 2006, the Company incurred a net loss of $3,136 and negative cash flows from operating activities of $3,184, and has an
accumulated deficit of $316,294 at March 31, 2006. Management believes that its cash and cash equivalents and availability under the credit facility as of March 31, 2006 are sufficient to fund its operating activities and capital
expenditure needs for at least the next twelve months. However, in the event that the Company does not meet its revenue and earnings expectations, the Company may require additional cash to fund operations. Failure to generate positive cash flow in
the future would have a material adverse effect on the Companys ability to achieve its intended business objectives.

NOTE 2SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES:

Basis of presentation

The accompanying condensed consolidated financial statements as of December 31, 2005 and March 31, 2006 and for the three months ended March 31, 2005 and 2006 are unaudited. The unaudited interim
condensed consolidated financial statements have been prepared on the same basis as the annual financial statements, except for the adoption of Statement of Financial Accounting Standard No. 123R, Share-Based Payment (Revised 2004)
(SFAS No. 123R) on January 1, 2006, as described in Note 10 - Stock Based Compensation. In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments, which include only normal
recurring adjustments, necessary to state fairly the Companys financial position as of December 31, 2005 and March 31, 2006, its results of operations for the three months ended March 31, 2005 and 2006 and its cash flows for the
three months ended March 31, 2005 and 2006. 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 February 23, 2006. The balance sheet as of December 31, 2005 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, 2006 are not necessarily indicative of the expected results for any other interim period or the year ending December 31, 2006.

Revenue recognition

The Company
generates revenue primarily from the sale of hardware products, including third-party products, through professional services, and through the sale of its software products. The Company sells products through direct sales channels and through
distributors. Generally, revenue is generated from the sale of video processing systems and components and the sale of private broadband network products.

Revenue is generated primarily from the sale of complete end-to-end video processing systems generally referred to as turnkey solutions. Turnkey solution revenue is principally generated by the sale of complete
end-to-end video processing systems that are designed, developed and produced according to a buyers specifications. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services
and post-contract support.

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

The Companys revenue recognition policies for turnkey solutions are in accordance with SOP 97-2, Software Revenue Recognition, as amended, which is
the authoritative guidance for recognizing revenue on software transactions and transactions in



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

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

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

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

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

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

Inventories

Inventories are stated at the lower of cost or market. Cost is computed using standard cost which approximates actual cost on a first-in, first-out basis.
The Company records provisions to write down its inventory and related purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value



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based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than those estimated by
the Company, additional inventory provisions may be required.

Short-term investments

The Companys short-term investments are stated at fair value, and are principally comprised of corporate debt securities. The Company classifies its
investments as available for sale in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and states its investments at estimated fair value, with unrealized gains and losses reported in
accumulated other comprehensive income (loss). The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in interest and other income (expense), net. A liquid market exists
for these short-term investments.

Unbilled Receivables

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

Allowance for doubtful accounts

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

Property and equipment

Property and equipment are
stated at cost less accumulated depreciation. The Company provides for depreciation by charges to expense which are sufficient to write off the cost of the assets over their estimated useful lives on the straight-line basis. Leasehold improvements
are amortized over the lesser of the lease term or the estimated useful life of the improvement. Useful lives by principal classifications are as follows:



|                       |  |          
|---------------------- |  | ---------
|                       | 
|Office equipment       |  | 3-5 years
|Computers and software |  | 3-7 years
|Test equipment         |  | 3-5 years
|Leasehold improvements |  | 1-7 years

When assets are sold or otherwise disposed of, the cost and accumulated depreciation are removed
from the asset and accumulated depreciation accounts, respectively. Upon the disposition of property and equipment, the accumulated depreciation is deducted from the original cost and any gain or loss on that sale or disposal is credited or charged
to income.

Maintenance, repairs, and minor renewals are charged to expense as incurred. Expenditures which substantially increase an
assets useful life are capitalized.

Intangible assets

Intangible assets are stated at cost less accumulated amortization. Intangible assets consist of completed technology and patents, customer lists, maintenance contract renewals and trademarks. These intangible assets
are amortized on a straight line basis over the estimated periods of benefit, which are as follows:



|                                 |  |          
|-------------------------------- |  | ---------
|Completed technology and patents |  | 3-5 years
|Customer lists                   |  | 7 years  
|Maintenance contract renewals    |  | 5 years  
|Trademarks                       |  | 7 years  



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Accounting for long-lived assets

The Company periodically assesses the impairment of long-lived assets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to
expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends, a significant decline in the stock
price for a sustained period and the Companys market capitalization relative to net book value.

When management determines that the
carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment, any impairment measured is based on a projected discounted cash flow method using a discount rate commensurate with the risk
inherent in the Companys current business model.

During 2005, the Company determined that certain long-lived assets and certain
intangible long-lived assets were impaired and recorded losses accordingly under SFAS No. 144. No such impairment was recorded in the three months ended March 31, 2006. Future events could cause the Company to conclude that impairment
indicators once again exist. Any resulting impairment loss could have a material adverse impact on the Companys financial condition and results of operations.

Goodwill

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

Factors considered important which could trigger an impairment
review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business,
significant negative industry or economic trends, a significant decline in the stock price for a sustained period and the Companys market capitalization relative to net book value.

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

Accounting for stock based compensation

Effective January 1, 2006, the Company adopted SFAS No. 123R on a modified prospective basis. As a result, the Company has included stock-based
compensation costs in its results of operations for the three months ended March 31, 2006, as more fully described in Note 10.

Reclassifications

Certain reclassifications have been made to prior year balances in order to conform to the current year presentation. Amortization of
intangible assets relating to completed technology and patents have been reclassified from operating expenses to cost of goods sold. This reclassification did not affect cash flows, financial position or net loss.

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 EndedMarch 31, |       
|                                                                        |  | 2005                        |        |   | 2006 |  
|Net loss per share, basic and diluted:                                  |  |                             |        |   |      |   |        |  
|Net loss                                                                |  | $                           | (3,320 | ) |      | $ | (3,136 | )
|                                                                        |  |                             |        |   |      |   |        |  
|Net loss per share, basic and diluted                                   |  | $                           | (0.13  | ) |      | $ | (0.09  | )
|                                                                        |  |                             |        |   |      |   |        |  
|Shares used in computing net loss per share, basic and diluted          |  |                             | 25,187 |   |      |   | 33,563 |  
|                                                                        |  |                             |        |   |      |   |        |  
|Antidilutive securities not included in net loss per share calculations |  |                             | 4,208  |   |      |   | 7,056  |  
|                                                                        |  |                             |        |   |      |   |        |  



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NOTE 4COMPREHENSIVE LOSS:

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



|                                         |  |                             |        |   |      |   |        |  
|---------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                         |  | Three Months EndedMarch 31, |       
|                                         |  | 2005                        |        |   | 2006 |  
|Net loss                                 |  | $                           | (3,320 | ) |      | $ | (3,136 | )
|Unrealized gains on investments          |  |                             | 19     |   |      |   | 3      |  
|Foreign currency translation adjustments |  |                             | (3     | ) |      |   | 3      |  
|                                         |  |                             |        |   |      |   |        |  
|Net change in other comprehensive loss   |  |                             | 16     |   |      |   | 6      |  
|                                         |  |                             |        |   |      |   |        |  
|Total comprehensive loss                 |  | $                           | (3,304 | ) |      | $ | (3,130 | )
|                                         |  |                             |        |   |      |   |        |  

NOTE 5CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:

At December 31, 2005 and March 31, 2006, cash, cash equivalents and short term investments are summarized as follows:



|                                                 |  |                  |        |              |   |       
|------------------------------------------------ |  | ---------------- | ------ | ------------ | - | ------
|                                                 |  | December 31,2005 |        | March 312006
|Cash and cash equivalents                        |  | $                | 12,111 |              | $ | 11,432
|Short-term investments due in less than one year |  |                  | 1,693  |              |   |      
|                                                 |  |                  |        |              |   |       
|                                                 |  | $                | 13,804 |              | $ | 11,432
|                                                 |  |                  |        |              |   |       

The following is a summary of available-for-sale securities:



|                          |  |                         |       |                      |   |                       |  |                     |   |  |   |      
|------------------------- |  | ----------------------- | ----- | -------------------- | - | --------------------- |  | ------------------- | - |  | - | -----
|                          |  | As of December 31, 2005
|                          |  | AmortizedCost           |       | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Estimated FairValue
|Corporate debt securities |  | $                       | 1,693 |                      | $ |                      |  | $                   |  |  | $ | 1,693
|                          | 
|                          |  | As of March 31, 2006   
|                          |  | AmortizedCost           |       | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | Estimated FairValue
|Corporate debt securities |  | $                       |      |                      | $ |                      |  | $                   |  |  | $ |     

NOTE 6ACQUISITIONS:

On June 1, 2005, the Company acquired 100% of the outstanding common stock of Copper Mountain for approximately $11,729. The purchase price consisted of 2,467 shares of the Companys common stock valued in
aggregate at $9,787, warrants to purchase the Companys common stock valued at $58, acquisition related expenses consisting of legal, insurance and other professional fees of $1,503 and employee severance costs of $351. The value of the
Companys common stock was determined based on the average market price over the two day period before and after the acquisition was announced on February 11, 2005. The results of operations of Copper Mountain have been included in the
consolidated statement of operations from June 1, 2005. The Company acquired Copper Mountain for its additional product and engineering resources, which are being refocused to address the Companys



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##### Table of Contents

expanding video market opportunities. The Company believes that the acquisition of Copper Mountain is accelerating the Companys plans to address the
growing number of opportunities in the market for video processing systems. During the three months ended March 31, 2006, the Company recognized revenue of $48 from the sale of legacy Copper Mountains products. The Company will honor
Copper Mountains existing customer support agreements but does not expect significant future revenue from the sale of Copper Mountains historical product lines.

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



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

Completed technology and patents are being amortized over a weighted average life of five years.
Amortization of $341 has been included in cost of goods sold for the three months ended March 31, 2006. The goodwill of $1,672 will not be deductible for tax purposes.

The following unaudited pro forma consolidated information gives effect to the acquisition of Copper Mountain as if it had occurred on January 1,
2005 by consolidating the results of operations of Copper Mountain with the results of operations of the Company for the three months ended March 31, 2005.



|                                           |  |                                  |        |  
|------------------------------------------ |  | -------------------------------- | ------ | -
|Proforma Results of Operations (unaudited) |  | Three MonthsEnded,March 31,
2005 |       
|Revenue                                    |  | $                                | 7,370  |  
|Net loss                                   |  |                                  | (8,496 | )
|Basic and diluted net loss per share       |  |                                  | (0.34  | )



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NOTE 7BALANCE SHEET COMPONENTS:



|                                            |  |                  |        |   |               |   |        |  
|------------------------------------------- |  | ---------------- | ------ | - | ------------- | - | ------ | -
|                                            |  | December 31,2005 |        |   | March 31,2006 |  
|Accounts receivable, net:                   |  |                  |        |   |               |   |        |  
|Accounts receivable                         |  | $                | 10,574 |   |               | $ | 10,215 |  
|Unbilled receivables                        |  |                  | 4,355  |   |               |   | 6,100  |  
|Provision for doubtful accounts             |  |                  | (56    | ) |               |   | (98    | )
|                                            |  |                  |        |   |               |   |        |  
|                                            |  | $                | 14,873 |   |               | $ | 16,217 |  
|                                            |  |                  |        |   |               |   |        |  
|Inventories, net:                           |  |                  |        |   |               |   |        |  
|Finished goods                              |  | $                | 7,794  |   |               | $ | 8,081  |  
|Raw materials                               |  |                  | 843    |   |               |   | 2,087  |  
|Allowance for excess and obsolete inventory |  |                  | (1,918 | ) |               |   | (1,930 | )
|                                            |  |                  |        |   |               |   |        |  
|                                            |  | $                | 6,719  |   |               | $ | 8,238  |  
|                                            |  |                  |        |   |               |   |        |  
|Property and equipment:                     |  |                  |        |   |               |   |        |  
|Computers and software                      |  | $                | 1,853  |   |               | $ | 1,909  |  
|Test equipment                              |  |                  | 4,837  |   |               |   | 5,149  |  
|Office equipment                            |  |                  | 68     |   |               |   | 191    |  
|                                            |  |                  |        |   |               |   |        |  
|                                            |  |                  | 6,758  |   |               |   | 7,249  |  
|Less: accumulated depreciation              |  |                  | (3,931 | ) |               |   | (4,292 | )
|                                            |  |                  |        |   |               |   |        |  
|                                            |  | $                | 2,827  |   |               | $ | 2,957  |  
|                                            |  |                  |        |   |               |   |        |  
|Accrued liabilities:                        |  |                  |        |   |               |   |        |  
|Professional services                       |  | $                | 590    |   |               | $ | 657    |  
|Provision for purchase commitments          |  |                  | 568    |   |               |   | 1,555  |  
|Compensation                                |  |                  | 1,518  |   |               |   | 1,683  |  
|Other                                       |  |                  | 598    |   |               |   | 773    |  
|                                            |  |                  |        |   |               |   |        |  
|                                            |  | $                | 3,274  |   |               | $ | 4,668  |  
|                                            |  |                  |        |   |               |   |        |  

Intangibles and other assets:



|                                 |  |                         |        |                         |   |        |                |  |   |      
|-------------------------------- |  | ----------------------- | ------ | ----------------------- | - | ------ | -------------- |  | - | -----
|                                 |  | As of December 31, 2005
|                                 |  | GrossCarryingAmount     |        | AccumulatedAmortization |   |        | NetIntangibles
|Amortized intangible assets:     |  |                         |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                       | 13,681 |                         | $ | (7,769 | )              |  | $ | 5,912
|Customer list                    |  |                         | 86     |                         |   | (39    | )              |  |   | 47   
|Maintenance contract renewals    |  |                         | 50     |                         |   | (32    | )              |  |   | 18   
|Trademarks                       |  |                         | 315    |                         |   | (142   | )              |  |   | 173  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  | $                       | 14,132 |                         | $ | (7,982 | )              |  |   | 6,150
|                                 |  |                         |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                         |        |                         |   |        |                |  |   | 155  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  |                         |        |                         |   |        |                |  | $ | 6,305
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 | 
|                                 |  | As of March 31, 2006   
|                                 |  | GrossCarryingAmount     |        | AccumulatedAmortization |   |        | NetIntangibles
|Amortized intangible assets:     |  |                         |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                       | 13,681 |                         | $ | (8,176 | )              |  | $ | 5,505
|Customer list                    |  |                         | 86     |                         |   | (42    | )              |  |   | 44   
|Maintenance contract renewals    |  |                         | 50     |                         |   | (34    | )              |  |   | 16   
|Trademarks                       |  |                         | 315    |                         |   | (154   | )              |  |   | 161  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  | $                       | 14,132 |                         | $ | (8,406 | )              |  |   | 5,726
|                                 |  |                         |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                         |        |                         |   |        |                |  |   | 159  
|                                 |  |                         |        |                         |   |        |                |  |   |      
|                                 |  |                         |        |                         |   |        |                |  | $ | 5,885
|                                 |  |                         |        |                         |   |        |                |  |   |      



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The aggregate amortization expense for the three months ended March 31, 2005 and
2006 was $376, and $423 respectively.

Minimum future amortization expense for subsequent years is as follows:



|     |  |   |      
|---- |  | - | -----
|2006 |  | $ | 1,271
|2007 |  |   | 1,649
|2008 |  |   | 1,247
|2009 |  |   | 1,115
|2010 |  |   | 444  
|     |  |   |      
|     |  | $ | 5,726
|     |  |   |      

NOTE 8INDEBTEDNESS

Line of Credit

On September 23, 2004, the Company entered into a revolving asset based credit
facility (credit facility), with Silicon Valley Bank (the Bank) which was amended on December 29, 2005. This facility expires on September 23, 2007. Borrowings under the credit facility are formula based and limited
to the lesser of $10.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate, 7.75% as of March 31, 2006, plus
0.5%. The rate may increase by 1.0% if the Company does not meet certain financial covenants. All of the Companys assets are pledged as collateral and the credit facility contains various covenants. The Company was in compliance with these
financial covenants as of March 31, 2006. Based on the maximum percentages of eligible accounts receivable and eligible inventory levels, available borrowings under this facility were $9,746 as of March 31, 2006. In addition, this credit
facility allows for long-term borrowings of up to $1.2 million for the purchase of fixed assets. The Company had outstanding borrowings under this facility of $8,149 against the revolving credit facility at March 31, 2006.

Note Payable

As part of the Companys
acquisition of VTC from Tektronix, Inc. in November 2002, the Company issued a note payable to Tektronix, Inc. for $3,232, with repayment in sixty months, or November 2007. The interest rate on this note is 8% and is compounded annually. Through
January 31, 2006, the accrued interest was added to the principal balance of the note. Thereafter, the Company will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and
October 31 thereafter until the principal balance is paid in full. As of March 31, 2006, this note payable balance, including accrued interest, was $4,203.

NOTE 9COMMITMENTS AND CONTINGENCIES:

Lease obligations

The Company leases office, manufacturing and warehouse space under noncancelable operating leases that expire in 2007 and 2010. In January 2006, the
Company entered into a lease agreement for a facility in San Diego, California that expires in February, 2010. The Company also leases certain office equipment under capitalized lease obligations that expire in 2008.

Minimum future lease payments under operating and capital leases at March 31, 2006 are as follows:



|                                  |  |                 |       |               |   |     |  
|--------------------------------- |  | --------------- | ----- | ------------- | - | --- | -
|                                  |  | OperatingLeases |       | CapitalLeases |  
|2006                              |  | $               | 839   |               | $ | 44  |  
|2007                              |  |                 | 1,081 |               |   | 59  |  
|2008                              |  |                 | 330   |               |   | 44  |  
|2009                              |  |                 | 404   |               |   |    |  
|2010                              |  |                 | 61    |               |   |    |  
|                                  |  |                 |       |               |   |     |  
|                                  |  | $               | 2,715 |               |   | 147 |  
|                                  |  |                 |       |               |   |     |  
|Less amount representing interest |  |                 |       |               |   | (10 | )
|                                  |  |                 |       |               |   |     |  
|                                  |  |                 |       |               |   | 137 |  
|Less current portion              |  |                 |       |               |   | (55 | )
|                                  |  |                 |       |               |   |     |  
|                                  |  |                 |       |               | $ | 82  |  
|                                  |  |                 |       |               |   |     |  



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Rent expense for the three months ended March 31, 2005 and 2006 was $317 and $370 respectively. At
March 31, 2006, the cost of the leased capital assets were $168 with accumulated amortization of $28 resulting in a net book value of leased capital assets of $140.

Purchase commitments

The Company had noncancelable commitments to purchase finished goods inventory
totaling $450 and $586 in aggregate at December 31, 2005 and March 31, 2006, respectively. These purchase commitments represent outstanding purchase orders submitted to the Companys third party manufacturers for goods to be produced
and delivered to the Company in 2006.

Contingencies

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

In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including the Company, was submitted to the Court in theIn Re Initial Public Offering Securities Litigation. On
August 31, 2005, the Court granted preliminary approval of the settlement. The settlement is subject to a number of conditions, most of which are outside of the Companys control, including final approval by the Court. The underwriters
named as defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the underwriter-defendants), including the underwriters named in theWhalen suit, are not parties to the stipulation of
settlement.

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

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

Copper Mountain, which the Company acquired on June 1, 2005, was in December 2001, along with certain of its officers and
directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captionedIn re Copper Mountain Networks, Inc. Initial Public Offering Securities
Litigation, Case No. 01-CV-10943 alleging violations of securities law under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, the Company
has inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and the Company is exposed to any liability that may come out of the claims. TheCopper Mountain action described in this paragraph like the
Whalen action described above has been coordinated for pretrial purposes under



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the matterIn Re Initial Public Offering Securities Litigation. The individual defendants in theCopper Mountain action were also dismissed
without prejudice pursuant to the October 9, 2002 Order of the Court approving the parties October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order granting in part and denying in
part Copper Mountains motion to dismiss. Thereafter, Copper Mountain entered into the same stipulation of settlement as the Company did in theWhalen action described above. The Copper Mountain stipulation of settlement is
subject to the same terms, conditions and contingencies as the stipulation of settlement the Company entered into with respect to theWhalen action described above.

In the event that all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on
behalf of the Company could range from zero to approximately $7.0 million which consists of the approximately $3.5 million from the Copper Mountain action described above and approximately $3.5 million from the Whalen action described
above, depending on plaintiffs recovery from the underwriter-defendants and from other non-settling parties and the amount of insurance available under the Companys applicable insurance policies. If the plaintiffs recover at least $1
billion from the underwriter-defendants, no settlement payments would be made on behalf of the Company under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, the Company believes that its insurance will likely
cover some or its entire share of any payments towards satisfying its share of plaintiffs $1 billion recovery amount. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more
likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount the Company will ultimately be required to pay, if any, as of March 31, 2006, the Company has not accrued a liability
for this matter.

The Company is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. The
Companys management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Companys consolidated financial position, results of operations, or cash flows.

NOTE 10STOCK-BASED COMPENSATION

Stock option plans

In November 1993, the Company adopted the 1992 Stock Plan (the 1992 Plan), under which the Company may grant both
incentive stock options and nonstatutory stock options to employees, consultants and directors. Options issued under the 1992 Plan can have an exercise price of no less than 85% of the fair market value, as defined under the 1992 Plan, of the stock
at the date of grant. The 1992 Plan, including amendments, allows for the issuance of a maximum of 178 shares of the Companys common stock. This number of shares of common stock has been reserved for issuance under the 1992 Plan. The Company
is no longer granting stock options from the 1992 Plan. As stock options are terminated or cancelled from the 1992 Plan, the stock options are being retired and are no longer available for future grant.

The Companys 1998 Stock Plan (the 1998 Plan) was adopted by the Board of Directors in July 1998 and was approved by the
stockholders in September 1998 and has rights and privileges similar to the 1992 Plan. The 1998 Plan allows for the issuance of a maximum of 1,000 shares of the Companys common stock with annual increases starting in 2000, subject to
certain limitations. In January 2000, the 1998 Plan was amended to increase the maximum number of shares that may be issued to 1,358. In January 2001, the 1998 Plan was amended to increase the maximum number of shares that may be issued by
375 to 1,733. In January 2002, the 1998 Plan was amended to increase the maximum number of shares by 375 to 2,108. In January 2005, the 1998 Plan was amended to increase the maximum number of shares by 375 to 2,483. In August 2005, the 1998
Plan was amended to increase the maximum number of shares by 500 to 2,983. In January 2006, the 1998 Plan was amended to increase the maximum number of shares by 375 to 3,358.

The Companys 1999 Nonstatutory Stock Option Plan (the 1999 Plan) was adopted by the Board of Directors in December 1999. The 1999
Plan allows for the issuance of a maximum of 1,000 shares of the Companys common stock. Additions to the Plan may be approved by the Board of Directors. The 1999 Plan has rights and privileges similar to the 1998 Plan. In April 2000, the
1999 Plan was amended to increase the maximum number of shares that may be issued to 1,425. In October 2000, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 1,825. In October 2002, the 1999 Plan was
amended to increase the maximum number of shares that may be issued to 2,625. In August 2005, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 3,125.

Generally, stock options are granted with vesting periods of four years and have an expiration date of ten years from the date of grant. However, in the
event of a change in control, as defined in our Change in Control plans adopted June 2000, employees who are terminated as a direct result of the change in control will be entitled to certain separation benefits including acceleration of
unvested options ranging from six months to full vesting and severance pay ranging from one to eighteen months. Benefits may be limited in certain circumstances due to certain tax code provisions.



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Stock Option Activity

The following is a summary of options activities:



|                           |  |                          |   |                 |                  |  |                     |   |                |   |            |                              |   |        |   |  |   |     
|-------------------------- |  | ------------------------ | - | --------------- | ---------------- |  | ------------------- | - | -------------- | - | ---------- | ---------------------------- | - | ------ | - |  | - | ----
|                           |  | SharesAvailableFor Grant |   |                 | OptionsExercised |  | Outstanding Options
|                           |  |                          |   | Numberof Shares |                  |  | PricePer Share      |   | AggregatePrice |   |            | WeightedAverageExercisePrice
|Balance, December 31, 2005 |  | 1,168                    |   |                 | 2,015            |  | 4,753               |   |                | $ | 0.52-68.25 |                              | $ | 23,404 |   |  | $ | 4.92
|Options authorized         |  | 375                      |   |                 |                 |  |                    |   |                |   |           |                              |   |       |   |  |   |    
|Options granted            |  | (42                      | ) |                 |                 |  | 42                  |   |                |   | 2.99-3.27  |                              |   | 126    |   |  |   | 3.04
|Options exercised          |  |                         |   |                 | 174              |  | (174                | ) |                |   | 1.21-3.02  |                              |   | (251   | ) |  |   | 1.44
|Options expired            |  |                         |   |                 |                 |  |                    |   |                |   |           |                              |   |       |   |  |   |    
|Options terminated         |  | 73                       |   |                 |                 |  | (73                 | ) |                |   | 1.58-41.75 |                              |   | (529   | ) |  |   | 7.28
|                           |  |                          |   |                 |                  |  |                     |   |                |   |            |                              |   |        |   |  |   |     
|Balance, March 31, 2006    |  | 1,574                    |   |                 | 2,189            |  | 4,548               |   |                | $ | 0.52-68.25 |                              | $ | 22,750 |   |  | $ | 5.00
|                           |  |                          |   |                 |                  |  |                     |   |                |   |            |                              |   |        |   |  |   |     

At March 31, 2006 options to purchase 4,548 shares of common stock were unexercised. The
weighted average exercise price of these options was $5.00 per share and the aggregate intrinsic value was $3,469. The weighted-average remaining term was 6.95 years.

At March 31, 2006 vested options to purchase 4,289 shares of common stock were unexercised. The weighted average exercise price of these options was $5.14 per share and the aggregate intrinsic value was $3,371.
The weighted-average remaining contractual term was 6.83 years.

Total unrecognized compensation cost as of March 31, 2006 was $461.
The weighted-average remaining contractual term was 1.18 years.

The weighted average exercise price of options granted during the three
months ended March 31, 2006 was $3.04 per share. The total cash received from employees as a result of employee stock option exercises during the three months ended March 31, 2006 was approximately $248. The intrinsic value of these
options was $277. In connection with these exercises, there was no tax benefit realized by the Company due to the Companys current loss position. The Company issues new shares of common stock upon exercise of stock options.

The following table summarizes information about stock options outstanding at March 31, 2006:



|                         |  |                     |  |                                                   |  |                              |       |                    |       |                              |   |      
|------------------------ |  | ------------------- |  | ------------------------------------------------- |  | ---------------------------- | ----- | ------------------ | ----- | ---------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                              
|Range of Exercise Prices |  | NumberOutstanding   |  | Weighted AverageRemaining ContractualLife (years) |  | WeightedAverageExercisePrice |       | Number Exercisable |       | WeightedAverageExercisePrice
|$0.52 - 1.21             |  | 542                 |  | 6.40                                              |  | $                            | 1.13  |                    | 541   |                              | $ | 1.13 
|1.25 - 1.47              |  | 537                 |  | 6.57                                              |  |                              | 1.43  |                    | 520   |                              |   | 1.43 
|1.49 - 1.49              |  | 500                 |  | 5.24                                              |  |                              | 1.49  |                    | 500   |                              |   | 1.49 
|1.55 - 2.15              |  | 470                 |  | 6.47                                              |  |                              | 1.99  |                    | 452   |                              |   | 2.00 
|2.19 - 3.01              |  | 410                 |  | 7.75                                              |  |                              | 2.79  |                    | 193   |                              |   | 2.68 
|3.02 - 3.02              |  | 617                 |  | 9.17                                              |  |                              | 3.02  |                    | 617   |                              |   | 3.02 
|3.04 - 5.01              |  | 728                 |  | 7.64                                              |  |                              | 4.37  |                    | 722   |                              |   | 4.38 
|5.07 - 22.94             |  | 537                 |  | 6.85                                              |  |                              | 9.62  |                    | 537   |                              |   | 9.62 
|22.94 - 45.00            |  | 159                 |  | 4.04                                              |  |                              | 31.81 |                    | 159   |                              |   | 31.81
|68.25 - 68.25            |  | 48                  |  | 4.30                                              |  |                              | 68.25 |                    | 48    |                              |   | 68.25
|                         |  |                     |  |                                                   |  |                              |       |                    |       |                              |   |      
|                         |  | 4,548               |  |                                                   |  |                              |       |                    | 4,289 |                              |   |      
|                         |  |                     |  |                                                   |  |                              |       |                    |       |                              |   |      

SFAS No.123R

Effective January 1, 2006, the Company adopted SFAS No. 123R on a modified prospective basis. Under the modified prospective application, prior periods are not revised for comparative purposes. The valuation
provisions of SFAS No. 123R apply to new awards and to awards that are outstanding on the effective date and subsequently modified or cancelled. Estimated compensation expense for awards outstanding at the effective date will be recognized over
the remaining service period using the compensation cost calculated for pro forma disclosure purposes under FASB Statement No. 123.

Periods prior to adoption of SFAS No. 123R

Prior to the adoption of SFAS No. 123R, the
Company accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, Financial Accounting
Standards Board Interpretation No. 44 (FIN 44) Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB 25, and complies with the disclosure provisions of SFAS No. 148,
Accounting for Stock-Based Compensation, Transition and Disclosure. The Company generally did not recognize stock-based compensation expense in its statement of operations for periods prior to the adoption of SFAS No. 123R as most
options granted had an exercise price equal



16



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##### Table of Contents

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

The following table illustrates the effect on net loss
and net loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123R to options granted under the Companys stock-based compensation plans prior to the adoption. For the purposes of this pro forma
disclosure, the value of options was estimated using a Black-Scholes valuation model and amortized on a straight-line basis over the vesting periods of the awards. Disclosures for the three months ended March 31, 2006 are not presented because
stock-based payments were accounted for under SFAS No. 123Rs fair value method during this period.



|                                                                                                                                      |  |                                |        |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | -
|                                                                                                                                      |  | Three MonthsEndedMarch 31,2005 |       
|Net loss  as reported                                                                                                                |  | $                              | (3,320 | )
|                                                                                                                                      |  |                                |        |  
|Compensation expense included in net loss                                                                                             |  |                                | 193    |  
|Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax
effects |  |                                | (363   | )
|                                                                                                                                      |  |                                |        |  
|Net loss  pro forma                                                                                                                  |  | $                              | (3,490 | )
|                                                                                                                                      |  |                                |        |  
|Basic and diluted net loss per share  as reported                                                                                    |  | $                              | (0.13  | )
|                                                                                                                                      |  |                                |        |  
|Basic and diluted net loss per share  pro forma                                                                                      |  | $                              | (0.14  | )
|                                                                                                                                      |  |                                |        |  

Adoption of SFAS No. 123R

Under SFAS No. 123R, share-based compensation cost is measured at the grant date, based on the estimated fair value of the awards and is recognized
as expense over the employees requisite service period. The Company has no awards with market or performance conditions.

As required
by SFAS No. 123R, management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

On December 29, 2005, the Board of Directors approved full acceleration of unvested stock options with an exercise price of $3.02 or greater, previously granted under the Companys 1998 Stock Option Plan and
1999 Non-statutory Stock Option Plan held by Company officers and employees. Options to purchase approximately 876,550 shares of the Companys common stock, including approximately 126,390 shares held by the Companys named executive
officers, were subject to acceleration effective as of December 29, 2005. The closing market price per share of the Companys common stock on December 29, 2005 was $3.10 and the exercise price of the approximately 876,550 in unvested
options on that date ranged from $3.02 to $6.16, with a weighted exercise price of $3.95. As a result, stock based compensation expense in periods subsequent to the acceleration will be significantly reduced.

During the three months ended March 31, 2006, the Company granted approximately 41,500 options with an estimated total grant-date fair value of $91.
During the three months ended March 31, 2006, the Company recorded stock-based compensation related to stock options of $101 for the options that vested during the three months ended March 31, 2006. There was no income benefit realized
because of the Companys loss position.

As a result of adopting SFAS No. 123R on January 1, 2006, our net loss for the
three-month ended March 31, 2006, is $101 higher than had we continued to account for stock-based employee compensation under APB No. 25. The adoption of SFAS No. 123R did not have a material impact on basic and diluted net loss per
share for the three months ended March 31, 2006. The adoption of SFAS No. 123R had no impact on cash flows from operations or financing.

Valuation Assumptions

In connection with the adoption of SFAS No. 123R, the Company estimated
the fair value of stock options using a Black-Scholes valuation model. The following table outlines the weighted average assumptions for both the stock options granted and the purchase rights issued:



|                         |  |                                             |   |  |                                                       |   |  |      |   |  |      |  
|------------------------ |  | ------------------------------------------- | - |  | ----------------------------------------------------- | - |  | ---- | - |  | ---- | -
|                         |  | Stock OptionPlansThree MonthsEndedMarch 31, |   |  | Employee StockPurchase PlanThree MonthsEndedMarch 31, |  
|                         |  | 2005                                        |   |  | 2006                                                  |   |  | 2005 |   |  | 2006 |  
|Expected dividend yield  |  | 0.0                                         | % |  | 0.0                                                   | % |  | 0.0  | % |  | 0.0  | %
|Risk-free interest rate  |  | 3.7                                         | % |  | 4.4                                                   | % |  | 3.7  | % |  | 4.4  | %
|Expected volatility      |  | 87.0                                        | % |  | 79.0                                                  | % |  | 87.0 | % |  | 79.0 | %
|Expected life (in years) |  | 4.0                                         |   |  | 6.25                                                  |   |  | 0.5  |   |  | 0.5  |  



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##### Table of Contents

Expected Term: The expected term was calculated in accordance with the simplified method stated in
Staff Accounting Bulletin (SAB) 107. The expected term represents the period that the Companys stock-based awards are expected to be outstanding.

Expected Volatility: The volatility factor was based on the Companys historical stock prices for the four years from 2002 to 2005.

Expected Dividend: The Company has not paid any dividends and does not anticipate paying any dividends. Accordingly, an expected dividend yield of
0% was used.

Risk-Free Interest Rate: The Company bases the risk-free interest rate used in the Black Scholes valuation method on
the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Companys stock-based awards do not correspond with the terms for which interest rates are quoted, the
Company performed a straight-line interpolation to determine the rate from the available maturities.

Estimated Pre-vesting
Forfeitures: When estimating forfeitures, the Company considers historical voluntary and involuntary terminations prior to vesting.

Restricted Stock

In connection with restricted shares granted upon the acquisition of Copper
Mountain, the Company recorded deferred stock compensation which was calculated as the fair market value of the Companys common shares on the dates the awards were granted. This stock compensation was being amortized on a straight-line basis
over the vesting periods of the underlying stock rewards. Through March 31, 2006, the Company had amortized approximately $71 of such compensation expense, with $7 being recorded in the three months ended March 31, 2006. These restricted
shares are expected to fully amortize over the next six months.

A summary of the status of the Companys unvested restricted shares
as of March 31, 2006 and changes during the three months ended March 31, 2006 is presented below:



|                                   |  |                  |   |  |                                       |     
|---------------------------------- |  | ---------------- | - |  | ------------------------------------- | ----
|                                   |  | Restricted Stock
|                                   |  | Number ofshares  |   |  | Weighted-averagegrant-dated fairvalue
|Unvested at December 31, 2005      |  | 4,651            |   |  | $                                     | 3.97
|Awards granted                     |  |                 |   |  |                                       |    
|Awards vested                      |  | (1,783           | ) |  |                                       | 3.97
|Awards cancelled/expired/forfeited |  | (489             | ) |  |                                       | 3.97
|                                   |  |                  |   |  |                                       |     
|Unvested at March 31, 2006         |  | 2,379            |   |  | $                                     | 3.97
|                                   |  |                  |   |  |                                       |     

NOTE 11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. Revenue relating to the private broadband network products was
$1,142 and $999 for the three months ended March 31, 2005 and 2006, respectively. Revenue related to video processing systems was $5,911 and $10,475 for the three months ended March 31, 2005 and 2006, respectively. Revenue related to
legacy product sales from the Copper Mountain merger was $48 for the three months ended March 31, 2006. Revenues are attributed to the following countries based on the location of customers:



|                    |  |                              |       |      |   |       
|------------------- |  | ---------------------------- | ----- | ---- | - | ------
|                    |  | Three Months Ended March 31,
|                    |  | 2005                         |       | 2006
|United States       |  | $                            | 5,786 |      | $ | 9,315 
|International:      |  |                              |       |      |   |       
|Canada              |  |                              | 384   |      |   | 5     
|Qatar               |  |                              |      |      |   | 528   
|China               |  |                              | 208   |      |   | 1,305 
|Japan               |  |                              | 102   |      |   | 208   
|All other countries |  |                              | 573   |      |   | 161   
|                    |  |                              |       |      |   |       
|                    |  | $                            | 7,053 |      | $ | 11,522
|                    |  |                              |       |      |   |       



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Two customers, FTC Management Inc. and Major League Baseball Advanced Media accounted for 23% and 11%,
respectively of the Companys revenue for the three months ended March 31, 2005. Huawei Technologies Company Ltd. and Hutchinson Telephone Company each accounted for 11% of the Companys revenue for the three months ended
March 31, 2006.

Products

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

NOTE 12SUBSEQUENT EVENT:

In April 2006, the Company announced a restructuring program that included a workforce reduction The workforce reduction represents
approximately 8% of the Companys employees. As a result of the restructuring the Company recorded a restructuring charge of $240 in April 2006 which primarily comprised of severance and benefit costs.



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##### Table of Contents

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

The section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations set forth below contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used herein, the words anticipates,
believes, continue, could, estimates, expects, intends, may, plans, seeks, should, will or the negative of these
terms or similar expressions are generally intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Such forward-looking statements are subject
to various risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date
hereof. The forward-looking statements contained in this quarterly report include statements about the following: (1) our belief that the number of IPTV subscribers will grow significantly by the end of 2009 and that this market space will
continue to become more competitive, (2) our expectation that we will compete with larger public companies as we begin to target larger telco customers, (3) our expectation that digital subscriber line or DSL technology will continue to
dominate telco broadband networks for the foreseeable future, (4) our expectation that demand for our products will increase, (5) our expectation that our sales and marketing expenses will increase in 2006, (6) our expectation that
sales of private broadband network products will increase for the remainder of 2006 (7) our expectation that capital expenditures for research and development will be comparable with 2005 expenditures, (8) our expectation that capital
expenditures in 2006 will be comparable with 2005 expenditures and that these capital expenditures will be funded from cash, cash equivalents and availability under the credit facility, (9) our belief that our cash and cash equivalents and
availability under the credit facility as of March 31, 2006 are sufficient to fund our operating activities and capital expenditure needs for the next twelve months, (10) our expectation that we will incur losses in the near future,
(11) our expectation that some competitors will market some of their products for use in TV over DSL applications, (12) our anticipation that our sales and operating margins will continue to fluctuate, (13) our anticipation that we
will generally continue to invoice foreign sales in U.S. dollars, (14) our intention to continue to evaluate new acquisition candidates, divesture and diversification strategies, and (15) our expectation that customers outside of the
United States will represent a significant and growing portion of our revenue, (16) our expectation that research and development expenditures will be less than expenditures incurred in 2005.

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

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

Overview

Our Business

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

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

Our History

In November 2002, we acquired
VideoTele.com, referred to in this report as VTC, from Tektronix, Inc. to extend our product offerings to include digital video processing systems. On June 1, 2005, we acquired Copper Mountain Networks, Inc., referred to in this report as
Copper Mountain, for its technology and engineering resources which we have refocused to further address our expanding video market opportunities for delivering advanced video services over coax and fiber networks.

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

For the three months ended March 31, 2005 and 2006, international sales represented 18.0%, and 19.2% of our total sales,
respectively.



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##### Table of Contents

Material Trends and Uncertainties

We pay close attention to and monitor various trends and uncertainties about our business. There is a growing demand by independent operating telephone companies to offer video services to their customer base.
According to a recent release from Infonetics Research in November 2005, the number of IPTV subscribers worldwide is expected to grow to over 53.7 million by the end of 2009. While this growing market presents opportunities to serve a larger
customer base, we are also encountering increasing competition as more companies compete to sell digital TV headend products. We expect this market space will continue to become more competitive in the future. Our immediate competitors in the
digital TV headend markets have been primarily small private companies that were focused on a narrower product line than ours and thereby may have been able to devote substantially more targeted resources to developing, marketing and selling new
products than we are able to. Certain of these companies have become targets for acquisition by larger companies, in which case we may face competitors with substantially greater name recognition, and technical, financial and marketing resources
than we have. This increased competitive pressure may adversely affect the amount and timing of our revenue in future periods, thereby making it more difficult for us to accurately forecast our future revenue, and may also adversely affect our
product margins.

The emergence of new technologies to serve the digital TV headend market means that we must continue to invest in these
technologies to remain competitive. Digital subscriber line, or DSL, technologies use sophisticated signal blending techniques to transmit data through copper wires. The limitations on the amount of data that can be transmitted in a fixed amount of
time (such limitations are referred to as bandwidth) and the distance data may be transmitted using copper wire constrain both the number of video channels that may be delivered simultaneously and the number of customers that are reachable from a
telco central office over a DSL network. Advancements in video compression technology are now enabling high quality video streams to be transported at lower data transfer rates than has been previously available. These compression advancements also
allow for the delivery of high-definition television over bandwidth constrained asymmetric DSL, or ADSL, lines for the first time. ADSL is a technology that allows more data to be transmitted over existing copper telephone lines compared with
standard DSL. Additionally, DSL advancements are emerging that expand the available bandwidth from the telco to the subscriber thereby supporting higher DSL data transfer rates over longer distances. As our products continue to incorporate new
technological advancements, we expect the demand for our products will increase because our products will enable more telcos to reach more of their customers with a greater number of video channels and features over their DSL networks. However,
because of the increasing competition in the markets in which we compete, regardless of our revenue and product margins in future periods, we will continue to devote significant resources to research and development in future periods in order to
enable us to offer our customers competitive products that incorporate these emerging technologies. We expect our research and development expenses in 2006 to be less than research and development expenditures we incurred in 2005, since we recently
completed a major product development cycle and restructuring.

As we continue to capitalize on the growing number of telcos deploying
video services in the United States and abroad, we will continue to aggressively market our new and existing products and expand our marketing and sales efforts domestically and internationally. Nevertheless, our sales activities have been and will
continue to be subject to competitive market pressure. We believe that in certain competitive markets, our prospective customer purchase decisions continue to be impacted by lengthening of the purchase decision because of several factors that are
affecting the overall digital TV headend market. Such factors include, but are not limited to, the delays in the introduction of advanced compression technology set top boxes, the transition to more efficient data transmission technologies and the
emergence of video signal encryption requirements. Nevertheless, given the opportunities offered by the growing number of our target customers deploying or enhancing video services and despite the length of the sales cycle, we expect our sales and
marketing expenses to increase in 2006 compared to our spending in 2005.

Definitions for Discussion of Results of Operations

Our discussion of our results of operations focuses on the following items from our income statement: Revenue consists of sales of our video processing
systems, which includes both digital TV headend and video transmission systems. Revenue also includes sales of our private broadband network products. Since our acquisition of VTC, a large part of our revenue has been associated with the sale of
digital TV headends. Furthermore, each individual headend sale has represented a significant portion of our revenue. If we were to sell even one less system than our forecasted number of headend sales, our revenue would be materially impacted. Cost
of goods sold, or COGS, consists of costs related to raw materials, contract manufacturing, personnel, overhead, test and quality assurance for products, and the cost of licensed technology included in our products. Raw materials, contract
manufacturing and licensed technology are the principal elements of COGS and vary directly with product sales. Sales and marketing expense consists primarily of selling and marketing personnel costs, including sales commissions, travel, trade shows,
promotions and outside services. Research and development expense consists primarily of personnel and facilities costs, contract consultants, outside testing services, and equipment and supplies associated with enhancing existing products and
developing new products. General and administrative expense consists primarily of personnel costs for administrative officers and support personnel, professional services and insurance expenses. Amortization of intangible assets consists primarily
of expenses associated with the amortization of technology and patents related to prior years acquisitions.



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##### Table of Contents

Results of Operations

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



|                                         |  |                             |    |  |       |   
|---------------------------------------- |  | --------------------------- | -- |  | ----- | --
|                                         |  | Three monthsended March 31, |   
|                                         |  | 2005                        |    |  | 2006  |   
|Total revenues                           |  | 100.0                       | %  |  | 100.0 | % 
|Cost of goods sold                       |  | 64.0                        |    |  | 65.7  |   
|                                         |  |                             |    |  |       |   
|Gross profit                             |  | 36.0                        |    |  | 34.3  |   
|                                         |  |                             |    |  |       |   
|Operating expenses:                      |  |                             |    |  |       |   
|Sales and marketing                      |  | 35.3                        |    |  | 22.3  |   
|Research and development                 |  | 30.1                        |    |  | 27.9  |   
|General and administrative               |  | 16.6                        |    |  | 11.0  |   
|                                         |  |                             |    |  |       |   
|Total operating expenses                 |  | 82.0                        |    |  | 61.2  |   
|                                         |  |                             |    |  |       |   
|Loss from operations                     |  | (46.0                       | )  |  | (26.9 | ) 
|Interest and other income (expense), net |  | (1.1                        | )  |  | (0.3  | ) 
|                                         |  |                             |    |  |       |   
|Net loss                                 |  | (47.1                       | )% |  | (27.2 | )%
|                                         |  |                             |    |  |       |   

Three Months Ended March 31, 2005 and 2006

Total Revenues. For the three months ended March 31, 2006, our total revenues increased by 63.4% to $11.5 million from
$7.1 million for the three months ended March 31, 2005. Sales of video processing system products increased from $5.9 million in the first quarter of 2005 to $10.5 million in the first quarter of 2006. This $4.6 million increase
in video processing system products revenue was due primarily to the introduction of our upgraded Astria video processing systems that incorporate recent Motion Pictures Experts Group (MPEG) advanced video compression technologies or
MPEG-4. Our upgraded Astria products enable our customers to address a larger percentage of their geographic market and deliver advanced video services. Sales of private broadband network products decreased from $1.1 million in the first
quarter of 2005 to $1.0 million in the first quarter of 2006. The decrease in private broadband network products revenue was primarily the result of customers choosing competing products that transmit data via wireless data transmission
technologies instead of our products which transmit data over telephone wires. During the later portion of the first quarter of 2006 we began shipping of our next generation of service management products for the multiple dwelling unit and
enterprise market. Since the introduction of these new products was towards the end of the quarter, these products did not produce significant revenue. We expect product sales of private broadband network products to increase during the remainder of
2006 as these new products gain market acceptance.

Cost of Goods Sold. For the three months ended March 31, 2006, our
cost of goods sold increased by $3.1 million to $7.6 million from $4.5 million for the three months ended March 31, 2005. The increase in cost of goods sold was due to an increase of $2.8 million in materials costs, $0.2 million in
labor and $0.1 million in freight. Our gross profit increased in 2006 due to increased sales volume from our video services processing products.

Sales and Marketing. For the three months ended March 31, 2006, our sales and marketing expenses increased by 3.1% to $2.6 million from $2.5 million for the three months ended March 31, 2005. The $0.1 million
increase for the first quarter of 2006 when compared with the same period in 2005 was due to $0.1 million of travel related costs.

Research and Development. For the three months ended March 31, 2006, our research and development expense increased by 51.3% to $3.2 million from $2.1 million for the three months ended March 31, 2005. The
$1.1 million increase in our research and development expense for the first quarter of 2006 when compared with the same period in 2005 was due to an increase of $0.6 million in personnel related costs from the additional headcount added
from the Copper Mountain acquisition, $0.2 million in outside service costs, $0.2 million in facilities and overhead costs, and $0.1 million in depreciation costs. Our capital expenditures for research and development were $0.3 million and
$0.2 million for the three months ended March 31, 2005 and 2006, respectively. We expect capital expenditures for research and development to be comparable with 2005 expenditures.

General and Administrative. For the three months ended March 31, 2006, our general and administrative expenses increased by 9.0% to $1.3
million from $1.2 million for the three months ended March 31, 2005. The $0.1 million increase in our general and administrative expense for the first quarter of 2006 when compared with the same period in 2005 was due primarily to an
increase in personnel expense.

Amortization of Intangible Assets. Amortization of intangible assets is comprised of
intangibles related to the acquisitions of VTC in 2002 and Copper Mountain in 2005. The intangible assets subject to amortization from these acquisitions consist primarily of completed technology and patents. For the three months ended
March 31, 2005 and 2006, total amortization of intangible assets remained consistent at $0.4 million. Amortization expense included in cost of goods sold was $0.4 million for March 31, 2005 and 2006.

Interest and Other Expense, Net. Interest and other income, net consists primarily of interest income and expense and foreign currency
exchange gains and losses. For the three months ended March 31, 2005 and 2006, our interest and other income was an expense of $0.1 million and $32,000 respectively.

Liquidity and Capital Resources

Cash and cash equivalents totaled $11.4 million at
March 31, 2006, compared with cash and cash equivalents of $12.1 million at December 31, 2005, reflecting a net reduction in cash and cash equivalents of $0.7 million.



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Cash used in operating activities was $3.2 million for the three months ended March 31, 2006,
compared with $2.4 million for the three months ended March 31, 2005. The increased cash used in operating activities was primarily due to an increase in accounts receivable due to higher revenue levels in the first quarter of 2006, an
increase in inventories offset by an increase in accounts payable and accrued liabilities due to an increase in end of quarter purchases.

Cash provided by investing activities included the sale of short term investments of $1.7 million offset by additions to property and equipment of $0.5 million in the first quarter of 2006. In 2006 we expect capital expenditures to be
comparable with 2005 expenditures. We expect these capital expenditures to be funded from cash, cash equivalents and availability under the credit facility.

Cash provided by financing activities included proceeds from the line of credit of $1.1 million and $0.2 million from the issuance of common stock related to the exercise of stock options.

Off Balance Sheet Arrangements

As of March 31,
2006, we did not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating
off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Contractual Obligations

The following table sets
forth our contractual obligations as of March 31, 2006:



|                                               |  |                        |        |                  |   |             |  |            |       |            |   |     |  |   |  
|---------------------------------------------- |  | ---------------------- | ------ | ---------------- | - | ----------- |  | ---------- | ----- | ---------- | - | --- |  | - | -
|                                               |  | Payments due by period
|Contractual Obligations                        |  | Total                  |        | Remainderof 2006 |   | 2007 to2008 |  | 2009to2010 |       | Thereafter
|Line of credit                                 |  | $                      | 8,149  |                  | $ | 8,149       |  | $          |      |            | $ |    |  | $ | 
|Long-Term Debt Obligations, including interest |  |                        | 4,203  |                  |   | 250         |  |            | 3,953 |            |   |    |  |   | 
|Operating Lease Obligations                    |  |                        | 2,715  |                  |   | 839         |  |            | 1,411 |            |   | 465 |  |   | 
|Purchase Obligations                           |  |                        | 586    |                  |   | 586         |  |            |      |            |   |    |  |   | 
|                                               |  |                        |        |                  |   |             |  |            |       |            |   |     |  |   |  
|Total                                          |  | $                      | 15,653 |                  | $ | 9,824       |  | $          | 5,364 |            | $ | 465 |  | $ | 

On September 23, 2004, we entered into a revolving asset based credit facility (credit
facility), with Silicon Valley Bank (the Bank) which was amended on December 29, 2005. This facility expires on September 23, 2007. Borrowings under the credit facility are formula based and limited to the lesser of $10.0
million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate, 7.75% as of March 31, 2006, plus 0.5%. The rate may
increase by 1.0% if we do not meet certain financial covenants. All of our assets are pledged as collateral, and the credit facility contains various covenants. We were in compliance with these financial covenants as of March 31, 2006. Based on
the maximum percentages of eligible accounts receivable and eligible inventory levels, available borrowings under this facility were $9.7 million as of March 31, 2006. In addition, this credit facility allows for long-term borrowings of up to
$1.2 million for purchase of fixed assets. We had outstanding borrowings of $8.1 million against the revolving credit facility at March 31, 2006.

As part of our acquisition of VTC from Tektronix in November 2002, we issued a note payable to Tektronix for $3.2 million, with repayment in sixty months, or by November 2007. The interest rate on this
note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is added to the principal balance of the note. Thereafter, we will pay accrued interest on this note commencing on January 31, 2006 and on each
April 30, July 31 and October 31 thereafter until the principal balance is paid in full in November 2007. Principal and accrued interest on the note payable is $4.2 million at March 31, 2006. Accrued interest during the
first quarter of 2006 was $0.1 million.

We have incurred substantial losses and negative cash flows from operations since inception. For
the three months ended March 31, 2006, we incurred a net loss of $3.1 million, negative cash flows from operating activities of $3.2 million, and have an accumulated deficit of $316.3 million.

We believe that the cash and cash equivalents and availability under the credit facility as of March 31, 2006, are sufficient to fund our operating
activities and capital expenditure needs for at least the next twelve months. However, in the event that general economic conditions worsen, we may require additional cash to fund our operations. Failure to generate positive cash flow in the
future could have a material adverse effect on our ability to achieve our intended business objectives.

Subsequent Event

In April 2006, we announced a restructuring program that included a workforce reduction. The workforce reduction represents approximately 8% of our
employees. As a result of the restructuring we recorded a restructuring charge of $0.2 million in April 2006 which primarily comprised of severance and benefit costs.



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Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting
principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

Revenue recognition. We generate revenue primarily from the sale of hardware products, including third-party products, through
professional services, and through the sale of our software products. We sell products through direct sales channels and through distributors. Generally, revenue is generated from the sale of video processing systems and components and the sale of
private broadband network products.

Revenue is generated primarily from the sale of complete end-to-end video processing systems generally
referred to as turnkey solutions. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyers specifications. Turnkey solutions
are multi-element arrangements, which consist of hardware products, software products, professional services and post contract support.

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

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

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



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

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

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

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

Stock-based Compensation: Effective January 1, 2006, we adopted SFAS No. 123R on a modified
prospective basis. As a result, we have included stock-based compensation costs in our results of operations for the three months ended March 31, 2006, as more fully described in Note 10. We estimate the fair value of stock options granted
using the Black-Scholes option-pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This
option-pricing model requires the input of highly subjective assumptions, including the options expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using historical
volatility of the Companys common stock.



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

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

We have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. As of March 31, 2006, we had an
accumulated deficit of $316.3 million. We expect to incur losses in the near future. Moreover, we may never achieve profitability and, even if we do, we may not be able to maintain profitability. We may not be able to generate a sufficient level of
revenue to offset our current level of expenses. Moreover, because our expenditures for sales and marketing, research and development, and general and administrative functions are relatively fixed in the short-term, we may be unable to adjust our
spending in a timely manner to respond to any unanticipated decline in revenue. If we fail to achieve and maintain profitability within the timeframe expected by securities analysts or investors, then the market price of our common stock will likely
decline.

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

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

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

Our primary competitors in the digital TV headend market have been small private companies that were focused on a more narrow product
line than ours, thereby allowing these competitors to devote substantially more targeted resources to developing and marketing new products than we can. As the market is currently evolving, we are witnessing a consolidation of competitors and in the
future, we expect more competition from large public companies like Harmonic, Inc., Tandberg Television ASA, Scientific Atlanta (SA) and Motorola, Inc., all of which have substantially greater financial, technical and other resources than we do.
These competitors have achieved success in providing TV headend components for cable multiple system operators and satellite TV providers. Although their products have been designed specifically to meet the needs of cable networks, we expect these
competitors to market some of their products for use in TV over DSL applications.

Indirect competition for our video content processing
systems may arise from certain satellite service providers such as SES-Americom that intend to offer pre-compressed, constant-bit-rate video delivered via satellite to local terrestrial networks.

Our competition in the market for surveillance and broadcast video transmission systems primarily comes from small private companies and public companies
such as Tandberg that together offer a wide array of products with special features and functions. A few of these companies also compete with us in the digital TV headend market.

Our private broadband network products business tends to compete against public network equipment providers, such as Zhone Technologies, and private and
foreign companies.

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

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

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



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

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

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

Over the last 12 quarters, our revenue per quarter has fluctuated between $5.1 million and $11.5 million. Over the same periods, our losses from
operations as a percentage of revenue have fluctuated between approximately 5.2% and 71.1% of revenue. We anticipate that our sales and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons,
including:



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



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



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



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



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

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

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

Sales to customers outside of the United States accounted for approximately
18.0% and 19.2% of revenue for the three months ended March 31, 2005 and 2006 respectively. Sales and operating activities outside of the United States are subject to inherent risks, including fluctuations in the value of the United States
dollar relative to foreign currencies; tariffs, quotas, taxes and other market barriers; political and economic instability; restrictions on the export or import of technology; potentially limited intellectual property protection; difficulties in
staffing and managing international operations and potentially adverse tax consequences. Any of these factors may have a material adverse effect on our ability to grow or maintain international revenue.

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

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

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



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investors, which could cause an immediate and significant decline in the market price of our common stock.

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

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

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

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

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

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

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

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

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



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

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

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

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

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

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

Our ability to achieve our planned sales growth and retain customers will depend in part on the quality of our customer support operations. Our customers generally require significant support and training with respect to our products,
particularly in the initial deployment and implementation stage. As our systems and products become more complex, we believe our ability to provide adequate customer support will be increasingly important to our success. We have limited experience
with widespread deployment of our products to a diverse customer base, and we cannot assure you that we will have adequate personnel to provide the levels of support that our customers may require during initial product deployment or on an ongoing
basis. Our failure to provide sufficient support to our customers could delay or prevent the successful deployment of our products. Failure to provide adequate support could also have an adverse impact on our reputation and relationship with our
customers, could prevent us from gaining new customers and could harm our revenue and profitability.

We routinely evaluate acquisition candidates and
other diversification strategies.

We have completed a number of acquisitions as part of our efforts to expand and diversify our
business. For example, we acquired our video content processing and video transmission businesses from Tektronix in November 2002 when we purchased its subsidiary, VTC. In addition, on June 1, 2005, we completed an acquisition with Copper
Mountain Networks, Inc.

We intend to continue to evaluate new acquisition candidates, divestiture and diversification strategies, and if
we fail to manage the integration of acquired companies, it could adversely affect our operations and growth strategy. Any acquisition involves numerous risks, including difficulties in the assimilation of the acquired companys employees,
operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired companys key employees. Additionally, we may incur unanticipated expenses, difficulties and
other adverse consequences relating to the integration of technologies, research and development, and administrative and other functions. Any future acquisitions may also result in potentially dilutive issuances of our equity securities, acquisition
or divestiture related write-offs and the assumption of debt and contingent liabilities. Any of the above factors could adversely affect our revenue, profitability, operations or growth strategy.



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

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



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



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



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



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

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

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

We anticipate that, in the future, we may need to expand certain areas of our business to grow our customer base and
exploit market opportunities. In particular, we expect to face numerous challenges in the implementation of our business strategy to focus on selling our products to the larger, more established service providers. To manage our operations, we must,
among other things, continue to implement and improve our operational, financial and management information systems, hire and train additional qualified personnel, continue to expand and upgrade core technologies and effectively manage multiple
relationships with various customers, suppliers and other third-parties. We cannot assure you that our systems, procedures or controls will be adequate to support our operations or that our management will be able to achieve the rapid execution
necessary to exploit fully the market for our products or systems. If we are unable to manage our operations effectively, our revenue, results of operations and share price could be harmed.

If material weaknesses in our internal control over financial reporting were to develop and we were unable to remedy such weaknesses in an effective and timely
manner, such weaknesses could materially and adversely affect our ability to provide the public with timely and accurate material information about Tut Systems.

In order for investors and the equity analyst community to make informed investment decisions and recommendations about our securities, it is important that we provide them with accurate and timely information in
accordance with the Securities Exchange Act of 1934, as amended (the Exchange Act) and the rules promulgated thereunder. Material weaknesses in our internal control over financial reporting and our disclosure controls and procedures
would hinder the flow of timely and accurate information to investors. If such material weaknesses were to develop and we did not address them in a timely matter, investors might sell our shares and industry analysts might either make incorrect
recommendations about Tut Systems or else end coverage of Tut Systems altogether, any of which results could harm our reputation and adversely impact our share price.

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

We are currently engaged as a defendant in a lawsuit (i.e., Whalen v. Tut Systems, Inc. et al.) that alleges securities law violations against us and
certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. Additionally, our subsidiary Copper Mountain, which we acquired on
June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In
re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5
of the Exchange Act. As a result of the



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acquisition, we have inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability
that may come out of the claims. The Whalen action and the Copper Mountain action are being coordinated with approximately 300 suits before United States District Judge Shira Scheindlin of the Southern District of New York under the matter In re
Initial Public Offering Securities Litigation. While we have reached a settlement with the plaintiffs in the Whalen lawsuit, and prior to the acquisition Copper Mountain reached a settlement in the Copper Mountain action, the settlements are subject
to certain contingencies, including court approval of the terms of settlements. If the court does not approve the settlements, or any other applicable contingencies are not resolved or otherwise addressed, we would be required to resume litigation
in these matters.

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

We and our customers are subject to varying degrees of federal, state and local as well as foreign governmental regulation. Our products must comply with
various regulations and standards defined by the Federal Communications Commission, or FCC. The FCC has issued regulations that set installation and equipment standards for communications systems. Our products are also required to meet certain
safety requirements. For example, Underwriters Laboratories must certify certain of our products in order to meet federal safety requirements relating to electrical appliances to be used inside the home. In addition, certain products must be Network
Equipment Building Standard certified before certain of our customers may deploy them. Any delay in or failure to obtain these approvals could harm our business, financial condition or results of operations. Outside of the United States, our
products are subject to the regulatory requirements of each country in which our products are manufactured or sold. These requirements are likely to vary widely. If we do not obtain timely domestic or foreign regulatory approvals or certificates, we
would not be able to sell our products where these regulations apply, which could prevent us from maintaining or growing our revenue or achieving profitability. In addition, regulation of our customers may adversely impact our business, operating
results and financial condition. For example, FCC regulatory policies affecting the availability of data and Internet services and other terms on which telecommunications companies conduct their business may impede our entry into certain markets. In
addition, the increasing demand for communications systems has exerted pressure on regulatory bodies worldwide to adopt new standards, generally following extensive investigation of competing technologies. The delays inherent in this governmental
approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by our customers, which in turn may harm our sale of products to these customers.

If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to manage our business successfully, which could
materially and adversely affect our growth strategy, reputation and share price.

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

Our stock price is volatile, and, if you invest in Tut Systems, you may suffer a loss of some or all of your investment.

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



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



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



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



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



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



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

Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or



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

Future sales of shares of our common stock could cause our stock price to decline.

Substantially all of our common stock may be sold without restriction in the public markets, subject only in the case of shares held by our officers and directors and affiliates to volume and manner of sale
restrictions (other than as described in the following sentence). The approximately 3.3 million shares of common stock that we issued to Tektronix in connection with our November 2002 acquisition of VTC were restricted securities, as that term
is defined in Rule 144 under the Securities Act, and therefore subject to certain restrictions. However, we are contractually obligated to file and keep effective a registration statement in order to allow Tektronix to sell these shares to the
public. Likewise, Tektronix has the right (subject to certain exceptions) to include these shares in certain registration statements pursuant to which we may sell shares of our common stock. During 2006, Tektronix sold 0.4 million shares of
common stock. At March 31, 2006, Tektronix owns 1.9 million shares of common stock.

Sales of a substantial number of shares of
common stock in the public market, whether or not in connection with this offering, or the perception that these sales could occur could materially and adversely affect our stock price and make it more difficult for us to sell equity securities in
the future at a time and price we deem appropriate.

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,
referred to as the Plans, may have the effect of making it more difficult for a third-party to acquire, or of discouraging a third- party from attempting to acquire, control of us. The provisions of the charter and bylaws and the Plans
could limit the price that certain investors may be willing to pay in the future for shares of our common stock. Our charter and bylaws provide for a classified board of directors, eliminate cumulative voting in the election of directors, restrict
our stockholders from acting by written consent and calling special meetings, and provide for procedures for advance notification of stockholder nominations and proposals. In addition, our board has the authority to issue up to 5,000,000 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.

Recent and proposed regulations related to equity compensation could adversely affect earnings, affect our ability to raise capital and affect our ability to attract and retain key personnel.

Since our inception, we have used stock options as a fundamental component of our employee compensation packages. We believe that our stock option plans
are an essential tool to link the long-term interests of stockholders and employees, especially executive management, and serve to motivate our employees to make decisions that will, in the long run, give the best returns to stockholders. Effective
January 1, 2006, we have adopted SFAS No. 123R. The adoption of this standard may negatively impact our earnings and may affect our ability to raise capital on acceptable terms. To the extent that new accounting standards make it more
difficult or expensive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely
affect our business.

We are exposed to additional costs and risks associated with complying with increasing and new regulation of corporate governance
and disclosure standards.

We are spending an increased amount of management time and external resources to comply with changing laws,
regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules. Particularly, Section 404 of the Sarbanes-Oxley Act, when it becomes
applicable to us, will require managements annual review and evaluation of our internal control over financial reporting, and attestation of the effectiveness of our internal control over financial reporting by management. We expect that our
independent registered public accounting firm will be required to attest to the design and effectiveness of our internal controls over financial reporting beginning with the filing of the annual report on Form 10-K for the fiscal year ended
December 31, 2006, and with each subsequently filed annual report on Form 10-K. We expect to incur significant additional accounting and legal expenses in the process of documenting and testing our internal control systems and procedures and in
making improvements in order for us to comply with the requirements of Section 404. We cannot predict the outcome of our assessment of our internal control over financial reporting. If we conclude in future periods that our internal control
over financial reporting is not effective or if our independent registered public accounting firm is unable to provide an unqualified opinion as of future year-ends, investors may lose confidence in our financial statements, and the price of our
stock may suffer.



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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 cash equivalents. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest
rate changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest-sensitive financial instruments at March 31, 2006.

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.



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

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

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting which occurred during the first
quarter of 2006 and which have materially affected or are reasonably likely to materially affect our internal control over financial reporting.



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PART II. OTHER INFORMATION



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

Whalen v. Tut
Systems, Inc. et al.

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

In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including us, was submitted to the Court in theIn Re Initial
Public Offering Securities Litigation. On August 31, 2005, the Court granted preliminary approval of the settlement. The settlement is subject to a number of conditions, most of which are outside of our control, including final approval by
the Court. The underwriters named as defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the underwriter-defendants), including the underwriters named in theWhalen suit, are not parties to
the stipulation of settlement.

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

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

Copper Mountain, which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors,
named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captionedIn re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation,
Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, we have inherited the
responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability that may come out of the claims. TheCopper Mountain action described in this paragraph, like theWhalen action
described above, has been coordinated for pretrial purposes under the matterIn Re Initial Public Offering Securities Litigation. The individual defendants in theCopper Mountain action were also dismissed without prejudice pursuant to
the October 9, 2002 Order of the Court approving the parties October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order granting in part and denying in part Copper Mountains
motion to dismiss. Thereafter, Copper Mountain entered into the same stipulation of settlement as we did in theWhalen action described above. The Copper Mountain stipulation of settlement is subject to the same terms, conditions and
contingencies as the stipulation of settlement we entered into with respect to theWhalen action described above.

In the event that
all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on our behalf could range from zero to approximately $7.0 million, which consists of the approximately $3.5 million
from theCopper Mountain action described above and approximately $3.5 million from theWhalen action described above, depending on plaintiffs recovery from the underwriter-defendants and from other non-settling parties and the
amount of insurance available under our applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement payments would be made on our behalf under the proposed terms of the settlement. If
the plaintiffs recover less than $1 billion, we believe that our insurance will likely cover some or all of our share of any payments towards satisfying its share of plaintiffs $1 billion recovery amount. Management estimates that its range of
loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount we will ultimately be required to pay, if
any, as of March 31, 2006, we have not accrued a liability for this matter.

We are subject to other legal proceedings, claims and
litigation arising in the ordinary course of business. Our management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.



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|ITEM 1A. | RISK FACTORS
|-------- | ------------

A description of the risk
factors associated with our business is included under Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock in Managements Discussion and Analysis of Financial Condition and
Results of Operations, contained in Item 2 of Part I of this report. This description includes any changes to and supersedes the description of the risk factors associated with our business previously disclosed in Item 1A of our
2005 Annual Report on Form 10-K and is incorporated herein by reference. The only material change to the risk factors described in our Form 10-K is the addition of the following risk factor:

Recent and proposed regulations related to equity compensation could adversely affect earnings, affect our ability to raise capital and affect our ability to attract
and retain key personnel.

Since our inception, we have used stock options as a fundamental component of our employee compensation
packages. We believe that our stock option plans are an essential tool to link the long-term interests of stockholders and employees, especially executive management, and serve to motivate our employees to make decisions that will, in the long run,
give the best returns to stockholders. Effective January 1, 2006 we have adopted SFAS No. 123R. The adoption of this standard may negatively impact our earnings and may affect our ability to raise capital on acceptable terms. To the extent
that new accounting standards make it more difficult or expensive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each
of which could materially and adversely affect our business.



|ITEM 2. | UNREGISTERED SALES OF 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



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

(a) Exhibits



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



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|               |   |  |                                                                                                                                                                                                                   
|-------------- | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |   |  | Description                                                                                                                                                                                                       
|10.17          |   |  | Office Lease Agreement between The Richard Oppenheimer Living Trust, The Maurice Oppenheimer Living Trust, The Helene Oppenheimer Living Trust, and Tut Systems Inc. dated November 2002 and
amended May 2005.(10)
|               |  
|10.18          |   |  | Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of Xstreamis plc and Philip Corbishley dated May 26,
2000.(11)                       
|               |  
|10.19          |   |  | Purchase Agreement by and among the Company and the Investors names therein, dated July 19, 2005. (12)                                                                                                            
|               |  
|10.20          |   |  | Registration Rights Agreement by and among the Company and the Investors named therein, dated July 19, 2005. (12)                                                                                                 
|               |  
|10.21          |   |  | Silicon Valley Bank Loan and Security Agreement dated September 23, 2004 and amended December 29, 2005 (13)                                                                                                       
|               |  
|10.22          |   |  | Form of Acknowledgement of Amendment to Option Agreements dated December 29, 2005 (14)                                                                                                                            
|               |  
|10.23          | * |  | Summary of Non-Management Director Compensation Plan (15)                                                                                                                                                         
|               |  
|10.24          |   |  | Office Lease Agreement between AGSTIRR 5550/5590 Morehouse, L.L.C., and Tut Systems, Inc.                                                                                                                         
|               |  
|11.1           |   |  | Calculation of net loss per share (contained in Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements).                                                                                        
|               |  
|31.1           |   |  | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                            
|               |  
|31.2           |   |  | Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                                                                                            
|               |  
|32.1           |   |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                        
|               |  
|32.2           |   |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                        

---

|(1) | Incorporated by reference to our Current Report on Form 8-K dated October 29, 2002.
|--- | -----------------------------------------------------------------------------------



|(2) | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2005.
|--- | ------------------------------------------------------------------------------------



|(3) | 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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(5) | Incorporated by reference to our Quarterly Report on Form 10-Q (File No. 000-25921) for the quarter ended March 31, 1999.
|--- | -------------------------------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference to our Annual Report on Form 10-K (File No. 000-25921) for the year ended December 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference to our Quarterly Report on Form 10-Q (File No. 000-25921) for the quarter ended June 30, 2000.
|--- | ------------------------------------------------------------------------------------------------------------------------



|(8) | Incorporated by reference to our Schedule TO (File No. 005-58093) filed May 11, 2001.
|--- | -------------------------------------------------------------------------------------



|(9) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002 and our Registration Statement on Form S-3 (File No. 333-127709) as
declared effective by the Securities and Exchange Commission on September 2, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2005.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference to our Current Report on Form 8-K (File No. 000-25921) dated May 26, 2000 as filed June 9, 2000.
|---- | --------------------------------------------------------------------------------------------------------------------------



|(12) | Incorporated by reference to our Current Report on Form 8-K dated July 19, 2005 as filed July 25, 2005.
|---- | -------------------------------------------------------------------------------------------------------



|(13) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------



|(14) | Incorporated by reference to our Current Report on Form 8-K dated December 29, 2005 as filed January 5, 2006.
|---- | -------------------------------------------------------------------------------------------------------------



|(15) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2005
|---- | ------------------------------------------------------------------------------------------------



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



37



---

##### Table of Contents

SIGNATURE

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



TUT SYSTEMS, INC.By:

/s/ SCOTT SPANGENBERGScott Spangenberg Vice-President, Finance and Administration, Chief Financial Officer and Secretary (Principal
Financial and Accounting Officer and Duly Authorized Officer)


Date: May 10, 2006



38



---

##### Table of Contents

INDEX TO EXHIBITS



|               |   |  |                                                                                                                                                                                                                                                                                                                                                 
|-------------- | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |   |  | Description                                                                                                                                                                                                                                                                                                                                     
|2.1            |   |  | Agreement and Plan of Merger by and among Tut Systems, Inc., Tiger Acquisition Corporation, Tektronix, Inc. and VideoTele.com, Inc. dated as of October 28, 2002.(1)                                                                                                                                                                            
|               |  
|2.3            |   |  | Agreement and plan of Merger and Reorganization by and among the Company, Wolf Acquisition Corp and Copper Mountain Networks, Inc. dated February 11, 2005 (2)                                                                                                                                                                                  
|               |  
|3.1            |   |  | Second Amended and Restated Certificate of Incorporation of the Company.(3)                                                                                                                                                                                                                                                                     
|               |  
|3.2            |   |  | Bylaws of the Company, as currently in effect. (4)                                                                                                                                                                                                                                                                                              
|               |  
|4.1            |   |  | Specimen Common Stock Certificate.(3)                                                                                                                                                                                                                                                                                                           
|               |  
|10.1           | * |  | 1992 Stock Plan, as amended, and form of Stock Option Agreement thereunder.(3)                                                                                                                                                                                                                                                                  
|               |  
|10.2           | * |  | 1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase Agreement thereunder.(3)                                                                                                                                                                                                                                                 
|               |  
|10.3           | * |  | 1998 Employee Stock Purchase Plan, as amended.(5)                                                                                                                                                                                                                                                                                               
|               |  
|10.4           | * |  | 1998 Stock Plan Inland Revenue Approved Rules for UK Employees.(6)                                                                                                                                                                                                                                                                              
|               |  
|10.5           |   |  | American Capital Marketing, Inc. 401(k) Plan.(3)                                                                                                                                                                                                                                                                                                
|               |  
|10.6           |   |  | Form of Indemnification Agreement entered into between the Company and each director and officer.(3)                                                                                                                                                                                                                                            
|               |  
|10.8           |   |  | Home Phoneline Promoters Agreement by and between the Company and IBM Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Advanced Micro Devices, Inc., Intel Corporation,
Epigram, Inc., AT&T Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998.(3)
|               |  
|10.9           |   |  | Master Agreement between the Company and Compaq Computer Corporation dated April 21, 1998 including supplements thereto.(3)                                                                                                                                                                                                                     
|               |  
|10.12          | * |  | Executive Retention and Change of Control Plan.(7)                                                                                                                                                                                                                                                                                              
|               |  
|10.13          | * |  | Non-Executive Retention and Change of Control Plan and Summary Plan Description.(7)                                                                                                                                                                                                                                                             
|               |  
|10.14          | * |  | Non-Qualified Stock Option Agreement issued to Mark Carpenter on March 3, 2000.(7)                                                                                                                                                                                                                                                              
|               |  
|10.15          | * |  | 1999 Non-Statutory Stock Option Plan(8)                                                                                                                                                                                                                                                                                                         
|               |  
|10.16          |   |  | Office Lease Agreement between Kruse Way Office Associates Limited Partnership and VideoTele.com dated April 28, 2000 and amended August, 2005.(9)                                                                                                                                                                                              
|               |  
|10.17          |   |  | Office Lease Agreement between The Richard Oppenheimer Living Trust, The Maurice Oppenheimer Living Trust, The Helene Oppenheimer Living Trust, and Tut Systems Inc. dated November 2002 and
amended May 2005.(10)                                                                                                                              
|               |  
|10.18          |   |  | Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of Xstreamis plc and Philip Corbishley dated May 26,
2000.(11)                                                                                                                                                     
|               |  
|10.19          |   |  | Purchase Agreement by and among the Company and the Investors names therein, dated July 19, 2005. (12)                                                                                                                                                                                                                                          
|               |  
|10.20          |   |  | Registration Rights Agreement by and among the Company and the Investors named therein, dated July 19, 2005. (12)                                                                                                                                                                                                                               
|               |  
|10.21          |   |  | Silicon Valley Bank Loan and Security Agreement dated September 23, 2004 and amended December 29, 2005 (13)                                                                                                                                                                                                                                     
|               |  
|10.22          |   |  | Form of Acknowledgement of Amendment to Option Agreements dated December 29, 2005 (14)                                                                                                                                                                                                                                                          
|               |  
|10.23          | * |  | Summary of Non-Management Director Compensation Plan (15)                                                                                                                                                                                                                                                                                       



39



---

##### Table of Contents

|               |  |                                                                                                                                           
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                               
|10.24          |  | Office Lease Agreement between AGSTIRR 5550/5590 Morehouse, L.L.C., and Tut Systems, Inc.                                                 
|               | 
|11.1           |  | Calculation of net loss per share (contained in Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements).                
|               | 
|31.1           |  | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                    
|               | 
|31.2           |  | Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.                                    
|               | 
|32.1           |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|               | 
|32.2           |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---

|(1) | Incorporated by reference to our Current Report on Form 8-K dated October 29, 2002.
|--- | -----------------------------------------------------------------------------------



|(2) | Incorporated by reference to our Current Report on Form 8-K dated February 14, 2005.
|--- | ------------------------------------------------------------------------------------



|(3) | 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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



|(5) | Incorporated by reference to our Quarterly Report on Form 10-Q (File No. 000-25921) for the quarter ended March 31, 1999.
|--- | -------------------------------------------------------------------------------------------------------------------------



|(6) | Incorporated by reference to our Annual Report on Form 10-K (File No. 000-25921) for the year ended December 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------------------------



|(7) | Incorporated by reference to our Quarterly Report on Form 10-Q (File No. 000-25921) for the quarter ended June 30, 2000.
|--- | ------------------------------------------------------------------------------------------------------------------------



|(8) | Incorporated by reference to our Schedule TO (File No. 005-58093) filed May 11, 2001.
|--- | -------------------------------------------------------------------------------------



|(9) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002 and our Registration Statement on Form S-3 (File No. 333-127709) as
declared effective by the Securities and Exchange Commission on September 2, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(10) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2002 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2005.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(11) | Incorporated by reference to our Current Report on Form 8-K (File No. 000-25921) dated May 26, 2000 as filed June 9, 2000.
|---- | --------------------------------------------------------------------------------------------------------------------------



|(12) | Incorporated by reference to our Current Report on Form 8-K dated July 19, 2005 as filed July 25, 2005.
|---- | -------------------------------------------------------------------------------------------------------



|(13) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------



|(14) | Incorporated by reference to our Current Report on Form 8-K dated December 29, 2005 as filed January 5, 2006.
|---- | -------------------------------------------------------------------------------------------------------------



|(15) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 2005
|---- | ------------------------------------------------------------------------------------------------



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



40