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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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



For the quarterly period ended September 30, 2005



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



Commission File Number: 000-25291



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TUT SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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 an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).    Yes ̈No  x



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



As of October 26, 2005, 33,359,226 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):                                                                      |  |   
|           |  |                                                                                                                              
|           |  | Condensed Consolidated Balance Sheets as of December 31, 2004 and September 30, 2005                                          |  | 3 
|           |  |                                                                                                                              
|           |  | Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and September 30, 2005 |  | 4 
|           |  |                                                                                                                              
|           |  | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and September 30, 2005           |  | 5 
|           |  |                                                                                                                              
|           |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                                |  | 6 
|           |  |                                                                                                                              
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                         |  | 14
|           |  |                                                                                                                              
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                                                    |  | 23
|           |  |                                                                                                                              
|Item 4.    |  | Controls and Procedures                                                                                                       |  | 23
|           |  |                                                                                                                              
|PART II.   |  | OTHER INFORMATION                                                                                                             |  |   
|           |  |                                                                                                                              
|Item 1.    |  | Legal Proceedings                                                                                                             |  | 24
|           |  |                                                                                                                              
|Item 2.    |  | Unregistered Sales of Securities and Use of Proceeds                                                                          |  | 24
|           |  |                                                                                                                              
|Item 3.    |  | Defaults Upon Senior Securities                                                                                               |  | 24
|           |  |                                                                                                                              
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                                           |  | 24
|           |  |                                                                                                                              
|Item 5.    |  | Other Information                                                                                                             |  | 24
|           |  |                                                                                                                              
|Item 6.    |  | Exhibits                                                                                                                      |  | 25
|           |  |                                                                                                                              
|Signatures |  |                                                                                                                               |  | 27



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PART I. FINANCIAL INFORMATION



ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



TUT SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)



|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                          |  | December 31,2004 |          |   | September 30,2005 |  
|ASSETS                                                                                                                                    |  |                  |          |   |                   |   |          |  
|Current assets:                                                                                                                           |  |                  |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                 |  | $                | 12,440   |   |                   | $ | 17,613   |  
|Accounts receivable, net of allowance for doubtful accounts of $139 and $114 in 2004 and 2005, respectively                               |  |                  | 6,585    |   |                   |   | 14,483   |  
|Inventories, net                                                                                                                          |  |                  | 3,994    |   |                   |   | 6,399    |  
|Prepaid expenses and other                                                                                                                |  |                  | 1,137    |   |                   |   | 1,371    |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total current assets                                                                                                                      |  |                  | 24,156   |   |                   |   | 39,866   |  
|Property and equipment, net                                                                                                               |  |                  | 1,874    |   |                   |   | 3,377    |  
|Goodwill                                                                                                                                  |  |                  |         |   |                   |   | 1,672    |  
|Intangibles and other assets                                                                                                              |  |                  | 1,935    |   |                   |   | 6,715    |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total assets                                                                                                                              |  | $                | 27,965   |   |                   | $ | 51,630   |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                      |  |                  |          |   |                   |   |          |  
|Current liabilities:                                                                                                                      |  |                  |          |   |                   |   |          |  
|Line of credit                                                                                                                            |  | $                |         |   |                   | $ | 7,000    |  
|Accounts payable                                                                                                                          |  |                  | 2,221    |   |                   |   | 3,812    |  
|Accrued liabilities                                                                                                                       |  |                  | 2,324    |   |                   |   | 5,855    |  
|Deferred revenue                                                                                                                          |  |                  | 226      |   |                   |   | 480      |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total current liabilities                                                                                                                 |  |                  | 4,771    |   |                   |   | 17,147   |  
|Note payable and other long term liabilities                                                                                              |  |                  | 3,816    |   |                   |   | 4,156    |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total liabilities                                                                                                                         |  |                  | 8,587    |   |                   |   | 21,303   |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Commitments and contingencies (Note 10)                                                                                                   |  |                  |          |   |                   |   |          |  
|Stockholders equity:                                                                                                                     |  |                  |          |   |                   |   |          |  
|Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding in 2004 and 2005, respectively               |  |                  |         |   |                   |   |         |  
|Common stock, $0.001 par value, 100,000 shares authorized, 25,180 and 33,341 shares issued and outstanding in 2004 and 2005,
respectively |  |                  | 25       |   |                   |   | 33       |  
|Additional paid-in capital                                                                                                                |  |                  | 315,006  |   |                   |   | 339,451  |  
|Deferred compensation                                                                                                                     |  |                  |         |   |                   |   | (28      | )
|Accumulated other comprehensive loss                                                                                                      |  |                  | (140     | ) |                   |   | (179     | )
|Accumulated deficit                                                                                                                       |  |                  | (295,513 | ) |                   |   | (308,950 | )
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                |  |                  | 19,378   |   |                   |   | 30,327   |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                |  | $                | 27,965   |   |                   | $ | 51,630   |  
|                                                                                                                                          |  |                  |          |   |                   |   |          |  



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 EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                        |  | 2004                            |        |   | 2005                           |   |        | 2004 |  |   | 2005    |  
|Revenue                                                                 |  | $                               | 6,672  |   |                                | $ | 10,039 |      |  | $ | 17,972  |   |  | $ | 26,766  |  
|Cost of goods sold                                                      |  |                                 | 4,462  |   |                                |   | 7,863  |      |  |   | 13,980  |   |  |   | 18,572  |  
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                                                            |  |                                 | 2,210  |   |                                |   | 2,176  |      |  |   | 3,992   |   |  |   | 8,194   |  
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating expenses:                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Sales and marketing                                                     |  |                                 | 2,001  |   |                                |   | 2,663  |      |  |   | 5,838   |   |  |   | 7,895   |  
|Research and development                                                |  |                                 | 1,844  |   |                                |   | 3,892  |      |  |   | 5,526   |   |  |   | 9,229   |  
|General and administrative                                              |  |                                 | 1,044  |   |                                |   | 1,063  |      |  |   | 3,260   |   |  |   | 4,187   |  
|Restructuring costs                                                     |  |                                 |       |   |                                |   | 130    |      |  |   |        |   |  |   | 130     |  
|Amortization of intangible assets                                       |  |                                 | 16     |   |                                |   | 18     |      |  |   | 48      |   |  |   | 51      |  
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                |  |                                 | 4,905  |   |                                |   | 7,766  |      |  |   | 14,672  |   |  |   | 21,492  |  
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                    |  |                                 | (2,695 | ) |                                |   | (5,590 | )    |  |   | (10,680 | ) |  |   | (13,298 | )
|Interest and other (expense), net                                       |  |                                 | (48    | ) |                                |   | (10    | )    |  |   | (148    | ) |  |   | (139    | )
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                |  | $                               | (2,743 | ) |                                | $ | (5,600 | )    |  | $ | (10,828 | ) |  | $ | (13,437 | )
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share, basic and diluted (Note 3)                          |  | $                               | (0.13  | ) |                                | $ | (0.17  | )    |  | $ | (0.53   | ) |  | $ | (0.48   | )
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing net loss per share, basic and diluted (Note 3) |  |                                 | 20,453 |   |                                |   | 32,042 |      |  |   | 20,361  |   |  |   | 27,773  |  
|                                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



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)



|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                                                     |  | Nine Months EndedSeptember 30, |        
|                                                                                                                                                                                     |  | 2004                           |         |   | 2005 |  
|Cash flows from operating activities:                                                                                                                                                |  |                                |         |   |      |   |         |  
|Net loss                                                                                                                                                                             |  | $                              | (10,828 | ) |      | $ | (13,437 | )
|Adjustments to reconcile net loss to net cash used in operating activities:                                                                                                          |  |                                |         |   |      |   |         |  
|Depreciation                                                                                                                                                                         |  |                                | 972     |   |      |   | 843     |  
|Provision for (recovery of) doubtful accounts                                                                                                                                        |  |                                | 5       |   |      |   | (25     | )
|Provision for excess and obsolete inventory and abandoned products                                                                                                                   |  |                                | 1,397   |   |      |   | 820     |  
|Impairment of intangibles                                                                                                                                                            |  |                                | 202     |   |      |   | 192     |  
|Amortization of intangibles                                                                                                                                                          |  |                                | 1,148   |   |      |   | 1,223   |  
|Deferred interest on note payable                                                                                                                                                    |  |                                | 220     |   |      |   | 226     |  
|Non cash compensation                                                                                                                                                                |  |                                |        |   |      |   | 248     |  
|Change in operating assets and liabilities, net of business acquired:                                                                                                                |  |                                |         |   |      |   |         |  
|Accounts receivable                                                                                                                                                                  |  |                                | 1,935   |   |      |   | (7,810  | )
|Inventories                                                                                                                                                                          |  |                                | (1,663  | ) |      |   | (2,692  | )
|Prepaid expenses and other assets                                                                                                                                                    |  |                                | (605    | ) |      |   | 380     |  
|Accounts payable and accrued liabilities                                                                                                                                             |  |                                | 444     |   |      |   | 3,860   |  
|Deferred revenue                                                                                                                                                                     |  |                                | (92     | ) |      |   | 154     |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                                                                                                                                |  |                                | (6,865  | ) |      |   | (16,018 | )
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                                                                                                                |  |                                |         |   |      |   |         |  
|Acquisition of Copper Mountain, net of cash acquired                                                                                                                                 |  |                                |        |   |      |   | 1,529   |  
|Purchase of property and equipment                                                                                                                                                   |  |                                | (1,143  | ) |      |   | (1,640  | )
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Net cash used in investing activities                                                                                                                                                |  |                                | (1,143  | ) |      |   | (111    | )
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                                                                                                                |  |                                |         |   |      |   |         |  
|Proceeds from line of credit                                                                                                                                                         |  |                                | 2,562   |   |      |   | 7,000   |  
|Proceeds from issuances of common stock, net                                                                                                                                         |  |                                | 329     |   |      |   | 14,302  |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                                                                                                                            |  |                                | 2,891   |   |      |   | 21,302  |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Net decrease in cash and cash equivalents                                                                                                                                            |  |                                | (5,117  | ) |      |   | 5,173   |  
|Cash and cash equivalents, beginning of period                                                                                                                                       |  |                                | 14,370  |   |      |   | 12,440  |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                                                                                                             |  | $                              | 9,253   |   |      | $ | 17,613  |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Supplemental schedule of noncash investing and financing activities:                                                                                                                 |  |                                |         |   |      |   |         |  
|The Company purchased all of the common stock of Copper Mountain for $11,729 (Note 5). In conjunction with the acquisition, liabilities were
assumed and assets acquired as follows: |  |                                |         |   |      |   |         |  
|Fair value of assets acquired:                                                                                                                                                       |  |                                |         |   |      | $ | 12,884  |  
|Liabilities assumed                                                                                                                                                                  |  |                                |         |   |      |   | 1,155   |  
|                                                                                                                                                                                     |  |                                |         |   |      |   |         |  
|Net assets acquired                                                                                                                                                                  |  |                                |         |   |      | $ | 11,729  |  



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



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TUT SYSTEMS, INC.



NOTES TO
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share amounts)



NOTE 1DESCRIPTION OF BUSINESS:



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



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



The Company has incurred substantial losses and negative cash flows from operations since inception. For the nine months ended September 30, 2005,
the Company incurred a net loss of $13,437 and negative cash flows from operating activities of $16,018, and has an accumulated deficit of $308,948 at September 30, 2005. Management believes that its cash and cash equivalents and availability
under the credit facility as of September 30, 2005 are sufficient to fund its operating activities and capital expenditure needs for the next twelve months. However, in the event that the Company does not meet its revenue and earnings
expectations, the Company may require additional cash to fund operations. Failure to generate positive cash flow in the future 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, 2004 and September 30, 2005 and
for the three and nine months ended September 30, 2004 and 2005 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim
financial information and, in the opinion of management, reflect all adjustments, which include normal recurring adjustments and purchase accounting adjustments in relation to the acquisition of Copper Mountain on June 1, 2005, necessary to
state fairly the Companys financial position as of December 31, 2004 and September 30, 2005, its results of operations for the three and nine months ended September 30, 2004 and 2005 and its cash flows for the nine months ended
September 30, 2004 and 2005. These condensed consolidated financial statements and the accompanying notes are unaudited and should be read in conjunction with the Companys audited financial statements included in the Companys Annual
Report on Form 10-K/A, filed with the Securities and Exchange Commission on May 2, 2005. The balance sheet as of December 31, 2004 was derived from audited financial statements but does not include all disclosures required by generally
accepted accounting principles. The results for the three and nine months ended September 30, 2005 are not necessarily indicative of the expected results for any other interim period or the year ending December 31, 2005.



Revenue recognition



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



Product revenues



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



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



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



In the case of software arrangements which require significant production, modification or customization of software, which encompasses all of the
Companys turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company recognizes revenue for all turnkey arrangements in accordance
with SOP 97-2 and SOP 81-1. Excluding the post contract support (or PCS) element, for which the Company has established vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally recognized
using the percentage-of-completion method, as stipulated by SOP 81-1. The percentage-of-completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to
the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period.
Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value of the arrangement prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed
upon substantial completion of the project and the balance upon customer acceptance. In connection with these contracts, we may perform the work prior to when the revenue is billable pursuant to the contract. The termination clauses in most of our



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



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



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



Unbilled Receivables



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



Inventories



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



Allowance for doubtful accounts



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



Accounting for long-lived assets



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



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



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



During the nine months ended September 30, 2004, the Company determined that certain of the technology acquired as part
of the purchase of the ViaGate Technologies, Inc. assets in September 2001 had become impaired. As a result, the Company incurred a loss of $202 to write-off the technology. During the three and nine months ended September 30, 2005, the Company
determined that certain of the technology acquired as part of the VTC acquisition in November 2002 had become impaired. As a result, the Company incurred a loss of $192 to write-off the technology. Both of these impairment charges have been recorded
in cost of goods sold in the statement of operations.



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



Goodwill



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



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



7



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##### Table of Contents

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



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



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



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



|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                      |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                                                      |  | 2004                            |        |   | 2005                           |   |        | 2004 |  |   | 2005    |  
|Net loss  as reported                                                                                                                |  | $                               | (2,743 | ) |                                | $ | (5,600 | )    |  | $ | (10,828 | ) |  | $ | (13,437 | )
|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Stock based employee compensation expense included in net loss (net of tax)                                                           |  |                                 |       |   |                                |   | 27     |      |  |   |        |   |  |   | 249     |  
|Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax
effects |  |                                 | (497   | ) |                                |   | (503   | )    |  |   | (1,902  | ) |  |   | (1,550  | )
|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss  pro forma                                                                                                                  |  | $                               | (3,240 | ) |                                | $ | (6,076 | )    |  | $ | (12,730 | ) |  | $ | (14,738 | )
|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share  as reported                                                                                    |  | $                               | (0.13  | ) |                                | $ | (0.17  | )    |  | $ | (0.53   | ) |  | $ | (0.48   | )
|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share  pro forma                                                                                      |  | $                               | (0.16  | ) |                                | $ | (0.19  | )    |  | $ | (0.63   | ) |  | $ | (0.53   | )
|                                                                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



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



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



Recent accounting pronouncements



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



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



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



8



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##### Table of Contents

Reclassifications



Certain reclassifications have been made to prior period balances in order to conform to the current period 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 the 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 and warrants 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 EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                  |  | 2004                            |        |   | 2005                           |   |        | 2004 |  |   | 2005    |  
|Net loss per share, basic and diluted:                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                          |  | $                               | (2,743 | ) |                                | $ | (5,600 | )    |  | $ | (10,828 | ) |  | $ | (13,437 | )
|                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share, basic and diluted                                             |  | $                               | (0.13  | ) |                                | $ | (0.17  | )    |  | $ | (0.53   | ) |  | $ | (0.48   | )
|                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing net loss per share, basic and diluted                    |  |                                 | 20,453 |   |                                |   | 32,042 |      |  |   | 20,361  |   |  |   | 27,773  |  
|                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Antidilutive options and warrants not included in net loss per share calculations |  |                                 | 4,320  |   |                                |   | 7,574  |      |  |   | 4,320   |   |  |   | 7,574   |  
|                                                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



NOTE 4COMPREHENSIVE LOSS:



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



|                                           |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                           |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                           |  | 2004                            |        |   | 2005                           |   |        | 2004 |  |   | 2005    |  
|Net loss                                   |  | $                               | (2,743 | ) |                                | $ | (5,600 | )    |  | $ | (10,828 | ) |  | $ | (13,437 | )
|Unrealized losses on marketable securities |  |                                 | (43    | ) |                                |   | (10    | )    |  |   | (41     | ) |  |   | (27     | )
|Foreign currency translation adjustments   |  |                                 | (8     | ) |                                |   | (5     | )    |  |   | (20     | ) |  |   | (12     | )
|                                           |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net change in other comprehensive loss     |  |                                 | (51    | ) |                                |   | (15    | )    |  |   | (61     | ) |  |   | (39     | )
|                                           |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total comprehensive loss                   |  | $                               | (2,794 | ) |                                | $ | (5,615 | )    |  | $ | (10,889 | ) |  | $ | (13,476 | )
|                                           |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



NOTE 5ACQUISITION



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



On June 1, 2005, the Company acquired 100% of the outstanding common stock of Copper Mountain for approximately $11,729. The purchase price consisted
of 2,470 shares of the Companys common stock valued in aggregate at $9,817, warrants to purchase the Companys common stock valued at $58, acquisition related expenses consisting of legal, insurance and other professional fees of $1,503
and employee severance costs of $351. The value of the Companys common stock was determined based on the average market price over the two day period before and after the acquisition was announced on February 11, 2005. The results of
operations of Copper Mountain have been included in the consolidated statement of operations from June 1, 2005. The Company acquired Copper Mountain for its additional product and engineering resources, which are being refocused to address the
Companys expanding video market opportunities. The Company believes that the acquisition of Copper Mountain is accelerating the Companys plans to address the growing number of opportunities in the market for video processing systems.
During the nine months ended September 30, 2005, the Company recognized revenue of $2,225 from the sale of legacy Copper Mountains products in backlog. The Company will honor Copper Mountains existing customer support agreements but
does not expect significant future revenue from the sale of Copper Mountains historical product lines.



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



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



9



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##### Table of Contents

Completed technology and patents are being amortized over a weighted average life of five years. The amortization has
been included in cost of goods sold. The goodwill of $1,672 will not be deductible for tax purposes.



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



|                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                     |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                     |  | 2004                            |        |   | 2005                           |   |        | 2004 |  |   | 2005    |  
|Revenue                              |  | $                               | 8,486  |   |                                | $ | 10,039 |      |  | $ | 23,880  |   |  | $ | 27,231  |  
|Net loss                             |  | $                               | (6,326 | ) |                                | $ | (5,600 | )    |  | $ | (25,847 | ) |  | $ | (21,762 | )
|Basic and diluted net loss per share |  | $                               | (0.31  | ) |                                | $ | (0.17  | )    |  | $ | (1.27   | ) |  | $ | (0.78   | )



NOTE 6BALANCE SHEET
COMPONENTS:



|                                                                  |  |                  |        |   |                   |   |        |  
|----------------------------------------------------------------- |  | ---------------- | ------ | - | ----------------- | - | ------ | -
|                                                                  |  | December 31,2004 |        |   | September 30,2005 |  
|Accounts receivable:                                              |  |                  |        |   |                   |   |        |  
|Accounts receivable                                               |  | $                | 6,724  |   |                   | $ | 10,388 |  
|Unbilled receivables                                              |  |                  |       |   |                   |   | 4,209  |  
|Allowance for doubtful accounts                                   |  |                  | (139   | ) |                   |   | (114   | )
|                                                                  |  |                  |        |   |                   |   |        |  
|                                                                  |  | $                | 6,585  |   |                   | $ | 14,483 |  
|                                                                  |  |                  |        |   |                   |   |        |  
|Inventories, net:                                                 |  |                  |        |   |                   |   |        |  
|Finished goods                                                    |  | $                | 5,038  |   |                   | $ | 6,964  |  
|Raw materials                                                     |  |                  | 184    |   |                   |   | 1,151  |  
|Allowance for excess and obsolete inventory and abandoned product |  |                  | (1,228 | ) |                   |   | (1,716 | )
|                                                                  |  |                  |        |   |                   |   |        |  
|                                                                  |  | $                | 3,994  |   |                   | $ | 6,399  |  
|                                                                  |  |                  |        |   |                   |   |        |  
|Property and equipment:                                           |  |                  |        |   |                   |   |        |  
|Computers and software                                            |  | $                | 1,811  |   |                   | $ | 2,344  |  
|Test equipment                                                    |  |                  | 3,169  |   |                   |   | 4,953  |  
|Office equipment                                                  |  |                  | 56     |   |                   |   | 68     |  
|                                                                  |  |                  |        |   |                   |   |        |  
|                                                                  |  |                  | 5,036  |   |                   |   | 7,365  |  
|Less: accumulated depreciation                                    |  |                  | (3,162 | ) |                   |   | (3,988 | )
|                                                                  |  |                  |        |   |                   |   |        |  
|                                                                  |  | $                | 1,874  |   |                   | $ | 3,377  |  
|                                                                  |  |                  |        |   |                   |   |        |  
|Accrued liabilities:                                              |  |                  |        |   |                   |   |        |  
|Provision for purchase commitments                                |  | $                | 503    |   |                   | $ | 3,251  |  
|Professional services                                             |  |                  | 369    |   |                   |   | 624    |  
|Compensation                                                      |  |                  | 1,164  |   |                   |   | 1,494  |  
|Other                                                             |  |                  | 288    |   |                   |   | 486    |  
|                                                                  |  |                  |        |   |                   |   |        |  
|                                                                  |  | $                | 2,324  |   |                   | $ | 5,855  |  
|                                                                  |  |                  |        |   |                   |   |        |  



The Company recorded a
provision for inventory within cost of goods sold totaling $800 and $820 in the three and nine months ended September 30, 2005, respectively, and $402 and $1,397 in the three and nine months ended September 30, 2004, respectively, related
to the costs of raw materials and finished goods in excess of what the Company reasonably expected to sell in the foreseeable future as of the end of each respective quarter in the nine months ended September 30, 2005 and 2004.



10



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##### Table of Contents

Intangible and other assets:



|                                 |  |                          |        |                         |   |        |                |  |   |      
|-------------------------------- |  | ------------------------ | ------ | ----------------------- | - | ------ | -------------- |  | - | -----
|                                 |  | As of December 31, 2004 
|                                 |  | GrossCarryingAmount      |        | AccumulatedAmortization |   |        | NetIntangibles
|Intangible and other assets:     |  |                          |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                        | 7,922  |                         | $ | (6,460 | )              |  | $ | 1,462
|Contract backlog                 |  |                          | 247    |                         |   | (247   | )              |  |   |     
|Customer list                    |  |                          | 86     |                         |   | (27    | )              |  |   | 59   
|Maintenance contract renewals    |  |                          | 50     |                         |   | (22    | )              |  |   | 28   
|Trademarks                       |  |                          | 315    |                         |   | (97    | )              |  |   | 218  
|                                 |  |                          |        |                         |   |        |                |  |   |      
|                                 |  | $                        | 8,620  |                         | $ | (6,853 | )              |  |   | 1,767
|                                 |  |                          |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                          |        |                         |   |        |                |  |   | 168  
|                                 |  |                          |        |                         |   |        |                |  |   |      
|                                 |  |                          |        |                         |   |        |                |  | $ | 1,935
|                                 |  |                          |        |                         |   |        |                |  |   |      
|                                 | 
|                                 |  | As of September 30, 2005
|                                 |  | GrossCarryingAmount      |        | AccumulatedAmortization |   |        | NetIntangibles
|Intangible and other assets:     |  |                          |        |                         |   |        |                |  |   |      
|Completed technology and patents |  | $                        | 13,681 |                         | $ | (7,363 | )              |  | $ | 6,318
|Contract backlog                 |  |                          | 247    |                         |   | (247   | )              |  |   |     
|Customer list                    |  |                          | 86     |                         |   | (36    | )              |  |   | 50   
|Maintenance contract renewals    |  |                          | 50     |                         |   | (29    | )              |  |   | 21   
|Trademarks                       |  |                          | 315    |                         |   | (131   | )              |  |   | 184  
|                                 |  |                          |        |                         |   |        |                |  |   |      
|                                 |  | $                        | 14,379 |                         | $ | (7,806 | )              |  |   | 6,573
|                                 |  |                          |        |                         |   |        |                |  |   |      
|Other non-current assets         |  |                          |        |                         |   |        |                |  |   | 142  
|                                 |  |                          |        |                         |   |        |                |  |   |      
|                                 |  |                          |        |                         |   |        |                |  | $ | 6,715
|                                 |  |                          |        |                         |   |        |                |  |   |      



During the three
months ended September 30, 2005, the Company determined that certain of its technology acquired as part of the VTC acquisition in November 2002, had become impaired. As a result, the Company incurred a loss of $192 to write-off the technology.
During the nine months ended September 30, 2004, the Company determined that certain of the technology acquired as part of the purchase of the ViaGate Technologies, Inc. assets in September 2001 had become impaired. As a result, the Company
incurred a loss of $202 to write-off the technology. The losses have been included in cost of goods sold.



The aggregate amortization expense for the three months ended September 30, 2004 and 2005 was $376 and $447, respectively and $1,148 and $1,223 for
the nine months ended September 30, 2004 and 2005. Amortization expense included in cost of goods sold was $360 and $429 for the three months ended September 30, 2004 and 2005, respectively and $1,100 and $1,172 for the nine months ended
September 30, 2004 and 2005, respectively.



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



|                  |  |   |      
|----------------- |  | - | -----
|Remainder of 2005 |  | $ | 424  
|2006              |  |   | 1,694
|2007              |  |   | 1,649
|2008              |  |   | 1,247
|2009              |  |   | 1,115
|2010              |  |   | 444  
|                  |  |   |      
|                  |  | $ | 6,573
|                  |  |   |      



NOTE 7INDEBTEDNESS



Line of Credit



On September 23, 2004, the Company entered into a revolving asset based
credit facility (credit facility), with Silicon Valley Bank (the Bank). This facility has a term of two years and expires on September 23, 2006. Borrowings under the credit facility are formula based and limited to the
lesser of $7.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate, 6.75% as of September 30, 2005, plus 0.5%.
The rate may increase by 1.0% if the Company does not meet certain financial covenants. The credit facility is collateralized by all of the Companys assets, and contains various financial covenants. The Company had $7.0 million in outstanding
borrowings under this credit facility at September 30, 2005. The maximum amount available based on the maximum percentages of eligible accounts receivable and inventory was $7.0 million. The Company was in compliance with all covenants at
September 30, 2005.



Note Payable



As part of the Companys acquisition of VTC from Tektronix, Inc. in
November 2002, the Company issued a note payable to Tektronix, Inc. for $3,232, with repayment in sixty months, or November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is
added to the principal balance of the note. Thereafter, the Company will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and October 31 thereafter until the principal balance is
due in full in November 2007. As of December 31, 2004 and September 30, 2005, this note payable balance, including accrued interest, was $3,816 and $4,042, respectively.



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NOTE 8RESTRUCTURING



In September 2005, the Company announced a restructuring program that included a workforce reduction. As a result of this
restructuring program, the Company recorded restructuring costs of $130 consisting of severance payments. As of September 30, 2005, there were $55 of costs remaining to be paid in the fourth quarter of 2005.



NOTE 9EQUITY FINANCING



On July 22, 2005, the Company completed the private sale of 5,535
shares of its common stock at a price of $2.70 per share for gross proceeds of $14,945. Net proceeds from the offering after issuance costs of $885 were approximately $14,060. Under the terms of the financing, the Company also issued warrants to
purchase an additional 2,767 shares of its common stock. The warrants expire in 2010 and, beginning in 2006, are exercisable at a per share price of $4.25. The Company has the right to call the warrants in the event that the trading price of its
common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would provide an additional $11,760 in proceeds to the Company. Of the net proceeds of $14,060, $5 was recorded as common stock and $14,055
was recorded as additional paid in capital. This additional paid in capital consists of $9,980 additional paid in capital common stock and $4,075 additional paid in capital for warrants.



NOTE 10COMMITMENTS AND CONTINGENCIES:



Lease obligations



The Company leases equipment and office, assembly and warehouse space under non-cancelable operating leases that expire from 2005 through 2008. The
Company also leases certain office equipment under capitalized lease obligations that expire in 2008.



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



|                                  |  |                 |       |               |   |     |  
|--------------------------------- |  | --------------- | ----- | ------------- | - | --- | -
|                                  |  | OperatingLeases |       | CapitalLeases |  
|Remainder of 2005                 |  | $               | 255   |               | $ | 15  |  
|2006                              |  |                 | 933   |               |   | 59  |  
|2007                              |  |                 | 782   |               |   | 59  |  
|2008                              |  |                 | 19    |               |   | 44  |  
|                                  |  |                 |       |               |   |     |  
|                                  |  | $               | 1,989 |               | $ | 177 |  
|                                  |  |                 |       |               |   |     |  
|Less amount representing interest |  |                 |       |               |   | (9  | )
|                                  |  |                 |       |               |   |     |  
|                                  |  |                 |       |               |   | 168 |  
|Less current portion              |  |                 |       |               |   | (54 | )
|                                  |  |                 |       |               |   |     |  
|                                  |  |                 |       |               | $ | 114 |  
|                                  |  |                 |       |               |   |     |  



Included in office
equipment is capitalized lease equipment of $168 with negligible accumulated amortization.



Purchase commitments



The Company had non-cancelable commitments to purchase finished goods inventory totaling $469 and $998 in aggregate at December 31, 2004 and September 30, 2005, respectively.



Contingencies



Whalen v. Tut Systems, Inc. et al



On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants 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 on June 14, 2004 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
the event that all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on behalf of the Company could range from zero to approximately $7.0 million, depending on
plaintiffs recovery from the underwriter-defendants and from other non-settling parties and the amount of insurance available under the Companys applicable insurance policies. If the plaintiffs recover at least $1 billion from the
underwriter-defendants, no settlement payments would be made on behalf of the Company under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion,



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the Company believes that its insurance will likely cover some or all of its share of any payments towards satisfying plaintiffs $1 billion recovery
deficit. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the
amount the Company will ultimately be required to pay, if any, as of September 30, 2005, the Company has not accrued a liability for this matter.



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



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



Copper Mountain, which the Company acquired on
June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now 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 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. At this time, the Company
cannot estimate the amount that the Company may be required to pay the plaintiffs under a final settlement with respect to the Copper Mountain action described in this paragraph, but believes that any such amount will be covered under Copper
Mountains applicable insurance policies.



NOTE 11SEGMENT
INFORMATION:



The Company currently targets its sales and
marketing efforts to both public and private service providers and users across two related markets. The Company currently operates in a single business segment as there is only one measurement of profitability for its operations. Revenues are
attributed to the following countries based on the location of customers:



|                    |  |                                 |       |                                |   |        |  |      |        |  |   |       
|------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                    |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                    |  | 2004                            |       | 2005                           |   | 2004   |  | 2005
|United States       |  | $                               | 4,971 |                                | $ | 7,330  |  | $    | 14,125 |  | $ | 21,278
|International:      |  |                                 |       |                                |   |        |  |      |        |  |   |       
|Canada              |  |                                 | 465   |                                |   | 609    |  |      | 1,279  |  |   | 1,344 
|China               |  |                                 | 390   |                                |   | 1,149  |  |      | 421    |  |   | 1,855 
|Ireland             |  |                                 | 472   |                                |   | 2      |  |      | 1,201  |  |   | 487   
|Qatar               |  |                                 |      |                                |   | 704    |  |      |       |  |   | 713   
|All other countries |  |                                 | 374   |                                |   | 245    |  |      | 946    |  |   | 1,089 
|                    |  |                                 |       |                                |   |        |  |      |        |  |   |       
|                    |  | $                               | 6,672 |                                | $ | 10,039 |  | $    | 17,972 |  | $ | 26,766
|                    |  |                                 |       |                                |   |        |  |      |        |  |   |       



Cavalier Telephone
accounted for 17% and Huawei Technologies Company Ltd. accounted for 10% of the Companys revenue for the three months ended September 30, 2005. One customer, FTC Management, Inc. accounted for 11% of the Companys revenue for the
nine months ended September 30, 2005. No customer accounted for greater than 10% of the Companys revenue for the three and nine months ended September 30, 2004.



Products



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



Revenue related to video processing systems was $4,961 and
$8,098 for the three months ended September 30, 2004 and 2005, respectively and $12,257 and $20,911 for the nine months ended September 30, 2004 and 2005, respectively. Revenue relating to the broadband transport and service management
products was $1,711 and $1,228 for the three months ended September 30, 2004 and 2005, respectively, and $5,715 and $3,630 for the nine months ended September 30, 2004 and 2005, respectively. Revenue related to legacy product sales from
the recently completed Copper Mountain merger was $713 and $2,225 for the three and nine months ended September 30, 2005, respectively.



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



The section entitled Managements Discussion and Analysis of Financial Condition and Results of Operations set forth below contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used herein, the words anticipates,
believes, continue, could, estimates, expects, intends, may, plans, seeks, should, will or the negative of these
terms or similar expressions are generally intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Such forward-looking statements are subject
to various risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date
hereof. The forward-looking statements contained in this quarterly report include statements about the following: (1) our belief that video products will provide most of our growth opportunities for the foreseeable future, (2) our belief
that the number of telco video subscribers will grow significantly between 2005 and 2009 and that this market space will continue to become more competitive, (3) our expectation that we will compete with larger public companies as we begin to
target larger telco customers, (4) our expectation that 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, (5) our expectation that
our sales and marketing expenses will increase for the remainder of 2005, (6) our expectation that sales of broadband transport and service management products will increase upon the expected introductions of next generation service management
products for the multiple dwelling unit and enterprise market expected late during the fourth quarter of the year, (7) our expectation that our research and development expenses will decrease during the remainder of 2005 when compared with the
third quarter of the year, (8) our expectation that capital expenditures for research and development will remain consistent throughout the remainder of 2005, (9) our expectation that capital expenditures in 2005 will be comparable to 2004
and that these capital expenditures will be funded from cash, cash equivalents and availability under the credit facility, (10) our belief that our cash and cash equivalents, and availability under the credit facility as of September 30,
2005 are sufficient to fund our operating activities and capital expenditure needs for the next twelve months, (11) our expectation that we will incur losses in the near future, (12) our expectation that some competitors will market some
of their products for use in TV over DSL applications, (13) our anticipation that our sales and operating margins will continue to fluctuate, (14) our anticipation that we will generally continue to invoice foreign sales in U.S. dollars,
and (15) our expectation that customers outside of the United States will represent a significant and growing portion of our revenue.



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



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



Overview



Our Business



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



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



Our History



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



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



During the years ended December 31, 2002, 2003 and 2004, international sales represented 43.0%, 18.4% and 23.3% of our total sales, respectively.
During the three months ended September 30, 2004 and 2005, international sales represented 25.5% and 27.0% of our total sales, respectively. During the nine months ended September 30, 2004 and 2005, international sales represented 21.4%
and 20.5% of our total sales, respectively.



Material Trends and
Uncertainties



We pay close attention to and monitor
various trends and uncertainties about our business. There is a growing demand by independent operating telephone companies to offer video services to their customer base. According to a recent release from the Multimedia Research Group, Inc. in
October 2005, the number of IPTV subscribers worldwide is expected to increase almost ten-fold over the next few years, from 3.7 million subscribers in 2005 to 36.9 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 are primarily small private companies that are focused on a more narrow product line than ours and thereby may be able to devote substantially more targeted resources to developing, marketing
and selling new products than we are able to. In addition, these companies may become targets for acquisition by larger companies, in which case we would face competitors with substantially greater name recognition, and technical, financial and
marketing resources than we have. This increased competitive pressure may adversely affect the amount and timing of our revenue in future periods, thereby making it more difficult for us to accurately forecast our future revenue, and may also
adversely affect our product and service margins.



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



The emergence of new technologies to serve the digital TV headend market means that we must continue to invest in these technologies to maintain our



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



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 telcos deploying video services and despite the length of the sales cycle, we expect our sales and marketing expenses
to increase for the remainder of 2005 compared to our spending in 2004.



Definitions for Discussion of Results of Operations



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



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



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



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



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



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



Results of Operations



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



|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|------------------------------ |  | ------------------------------- | -- |  | ------------------------------ | -- |  | ----- | -- |  | ----- | --
|                               |  | Three Months EndedSeptember 30, |    |  | Nine Months EndedSeptember 30, |   
|                               |  | 2004                            |    |  | 2005                           |    |  | 2004  |    |  | 2005  |   
|Total revenues                 |  | 100.0                           | %  |  | 100.0                          | %  |  | 100.0 | %  |  | 100.0 | % 
|Total cost of goods sold       |  | 66.9                            |    |  | 78.3                           |    |  | 77.8  |    |  | 69.4  |   
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Gross profit                   |  | 33.1                            |    |  | 21.7                           |    |  | 22.2  |    |  | 30.6  |   
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Operating expenses:            |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Sales and marketing            |  | 30.1                            |    |  | 26.5                           |    |  | 32.5  |    |  | 29.5  |   
|Research and development       |  | 27.6                            |    |  | 38.8                           |    |  | 30.7  |    |  | 34.5  |   
|General and administrative     |  | 15.6                            |    |  | 10.6                           |    |  | 18.1  |    |  | 15.6  |   
|Restructuring costs            |  |                                |    |  | 1.3                            |    |  |      |    |  | 0.5   |   
|Amortization of intangibles    |  | 0.2                             |    |  | 0.2                            |    |  | 0.3   |    |  | 0.2   |   
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Total operating expenses       |  | 73.5                            |    |  | 77.4                           |    |  | 81.6  |    |  | 80.3  |   
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Loss from operations           |  | (40.4                           | )  |  | (55.7                          | )  |  | (59.4 | )  |  | (49.7 | ) 
|Interest and other income, net |  | (0.7                            | )  |  | (0.1                           | )  |  | (0.8  | )  |  | (0.5  | ) 
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   
|Net loss                       |  | (41.1                           | )% |  | (55.8                          | )% |  | (60.2 | )% |  | (50.2 | )%
|                               |  |                                 |    |  |                                |    |  |       |    |  |       |   



Three and Nine Months Ended
September 30, 2004 and 2005



Total Revenues.
Our total revenues increased to $10.0 million and $26.8 million for the three and nine months ended September 30, 2005, respectively, when compared with total revenues of $6.7 million and $18.0 million for the same periods in 2004. For the
three months ended September 30, 2005, our product revenue from video processing systems increased by 63.2% to $8.1 million from $5.0 million for the three months ended September 30, 2004. Included in our total revenues for the



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three and nine months ended September 30, 2005, was revenue related to legacy product sales from the recently completed Copper Mountain merger totaling
$0.7 and $2.2 million, respectively. We do not expect similar revenue contribution from these legacy products in future quarters. For the nine months ended September 30, 2005, our product revenue from video processing systems increased by
70.6%, to $20.9 million from $12.2 million for the same period in 2004. The increases in video processing systems revenue was due primarily to the introduction of our upgraded Astria video processing systems that incorporate recent Motion Pictures
Experts Group (MPEG) advanced video compression technologies or MPEG-4. Our upgraded Astria products enable our customers to address a larger percentage of their geographic market and deliver advanced video services. Sales of broadband transport and
service management products decreased from $1.7 million in the third quarter of 2004 to $1.2 million in the third quarter of 2005 and decreased from $5.7 million for the nine months ended September 30, 2004 to $3.6 million for the nine months
ended September 30, 2005. The decrease in broadband transport and service management products revenue was primarily the result of customers choosing competing products that transmit data via wireless data transmission technologies instead of
our products which transmit data over telephone wires. In future quarters, we expect sales of broadband transport and service management products to increase with the introduction of our next generation service management products expected late in
the fourth quarter of the year.



Cost of Goods Sold.
Beginning in the periods ending September 2005 we determined that it was more appropriate to include amortization of completed technology and patents within cost of goods sold, thus it was reclassed from operating expenses. Amortization expense
included in cost of goods sold was $0.4 million for both the three months ended September 30, 2004 and 2005, respectively and $1.1 million for both the nine months ended September 30, 2004 and 2005, respectively. For the three months ended
September 30, 2005, our cost of goods sold increased by $3.4 million to $7.9 million from $4.5 million for the three months ended September 30, 2004. The increase in cost of goods sold was due to a $2.1 million increase in material costs
relating to higher sales volume and an increase in freight and overhead costs of $0.3 million. In addition, for the three months ended September 30, 2005, cost of goods sold included an increase in inventory reserves of $0.8 million and an
impairment charge of $0.2 million. Cost of goods sold increased by $4.6 million to $18.6 million during the nine months ended September 30, 2005, from $14.0 million for the nine months ended September 30, 2004. The increase in cost of
goods sold was due to a $4.4 million increase in material costs, and a $0.3 increase in freight and overhead. Also included in cost of goods sold during the nine months ended September 30, 2005 was a one time charge of $0.5 million to amortize
the backlog acquired in the Copper Mountain merger. Partially offsetting these increases was a net decrease of $0.6 million in charges to inventory reserves in 2005 when compared with 2004.



Sales and Marketing. For the three months ended September 30,
2005, sales and marketing expense increased by $0.7 million or 33.1% to $2.7 million from $2.0 million for the three months ended September 30, 2004. The $0.7 million increase was due to a $0.4 million increase in personnel related costs, $0.2
million in product demonstration expenses, and $0.1 million in travel expenses. For the nine months ended September 30, 2005, sales and marketing expense increased to $7.9 million from $5.8 million for the nine months ended September 30,
2004. The $2.1 million increase is due to a $1.2 million increase in personnel related costs, $0.2 million in travel expenses, and $0.6 million in promotion and product demonstration expenses.



Research and Development. For the three months ended
September 30, 2005, our research and development expense increased by 111.1% to $3.9 million from $1.8 million for the three months ended September 30, 2004. The $2.1 million increase in our research and development expense for the third
quarter of 2005 when compared with the same period in 2004 was due to an increase of $1.3 million in personnel related costs related in part to our recently completed Copper Mountain merger, $0.4 million in outside service costs, $0.1 million in
facility lease costs, $0.1 million in travel expenditures and $0.2 million in purchases of materials. As a result of our restructuring in September 2005, we expect our research and development expenses to decrease during the fourth quarter of 2005
when compared to the third quarter of 2005. Research and development expense increased by $3.7 million to $9.2 million for the nine months ended September 30, 2005 from $5.5 million for the nine months ended September 30, 2004. The $3.7
million increase was due to an increase of $2.0 million in personnel related costs, $0.5 million in outside service costs, $0.2 million in facility lease costs, and $1.0 million in purchases of materials. Our capital expenditures for research and
development were $0.1 million and $45,000 for the three months ended September 30, 2005 and 2004, respectively and $0.6 million and $0.6 million for the nine months ended September 30, 2005 and 2004, respectively. We expect capital
expenditures for research and development to remain consistent throughout the remainder of 2005.



General and Administrative. For the three months ended September 30, 2005 general and administrative expense increased 1.8% to $1.1 million
from $1.0 million for the three months ended September 30, 2004. The $0.1 million increase in our general and administrative expense for the third quarter of 2005 when compared with the same period in 2004 was due to an increase in $0.2 million
increase in personnel related costs offset by bad debt recoveries of $0.1 million. For the nine months ended September 30, 2005, general and administrative expense increased to $4.2 million from $3.3 million for the nine months ended
September 30, 2004. The increase of $0.9 million was due to a $1.2 million one-time write off of costs relating to CoSines termination of the proposed merger, a $0.1 million increase in supplies and an increase in personnel related costs
of $0.3 million partially offset by bad debt recoveries of $0.4 million and a decrease in outside service cost of $0.3 million.



Restructuring Costs. In September 2005, we announced a restructuring program that included a workforce reduction. As a result of this restructuring
program, we recorded restructuring costs of $0.1 million consisting of severance payments. As of September 30, 2005, we had accrued $55,000 of costs remaining to be paid in the fourth quarter of 2005.



Amortization of Intangible Assets. Amortization of intangible assets
is comprised of intangibles related to the acquisitions of Xstreamis Limited in 2000, VTC in 2002 and Copper Mountain in the second quarter of 2005. The remaining intangible assets subject to amortization from these acquisitions consist primarily of
completed technology and patents. For the three and nine months ended September 30, 2005 and 2004, amortization of intangible assets remained consistent at $0.4 million and $1.2 million respectively of which, $0.4 million and $1.1 million have
been included in cost of goods sold.



Interest and Other
Income, Net. Interest and other income, net consists primarily of interest income and expense and foreign currency exchange gains and losses. For the three and nine months ended September 30, 2005, our interest and other income was $10,000
and $0.1 million, respectively. For the three and nine months ended September 30, 2004, our interest and other income remained flat at $50,000 and $0.1 million, respectively.



Liquidity and Capital Resources



Cash and cash equivalents totaled $17.6 million at September 30, 2005 compared with $12.4 million at December 31, 2004, reflecting a net
increase of $5.2 million.



Cash used in operating activities
was $16.0 million for the nine months ended September 30, 2005, compared with $6.9 million for the nine months ended September 30, 2004. The increased cash used in operating activities included an increase in net loss of $2.6 million, an
increase in accounts receivable and unbilled receivables of $9.7 million and an increase in inventory of $1.0 million. The increase in accounts receivable and unbilled receivables resulted from higher revenue in the third quarter of 2005 and a
lengthening of the collection cycle. Inventories increased to support a higher expected revenue forecast. Partially offsetting these uses of cash was a $3.4 million increase in accounts payable and accrued liabilities balances due to the higher
purchases in the third quarter of 2005 to support the higher revenue and a decrease in prepaid expenses of $1.0 million



Cash used in investing activities was $0.1 million for the nine months ended September 30, 2005, compared with cash used of $1.1 million for the nine
months ended September 30, 2004. Net cash acquired from the Copper Mountain acquisition was $1.5 million, consisting of cash acquired of $3.1 million offset by legal, insurance and other professional fees of $1.6 million. Additions to property
and equipment were $1.6 million in the nine months ended September 30, 2005, compared with $1.1 million in the nine months ended September 30, 2004, primarily reflecting an increased investment in research and development assets. In total
we expect capital expenditures for 2005 to be comparable to 2004. We expect these capital expenditures to be funded from cash, cash equivalents and availability under the credit facility.



Cash from financing activities was $21.3 million in the nine months ended September 30, 2005, compared with $2.9
million for the nine months ended September 30, 2004. The increase is due to the proceeds from the line of credit of $7.0 million, the exercise of stock options of $0.2 million and the net proceeds from the private equity financing of $14.1
million consisting of cash received of $14.9 million offset by legal and other professional fees of $0.8 million.



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



|                            |  |                        |        |                  |   |              |  |            |        |            |   |    |  |   |  
|--------------------------- |  | ---------------------- | ------ | ---------------- | - | ------------ |  | ---------- | ------ | ---------- | - | -- |  | - | -
|                            |  | Payments due by period
|Contractual Obligations     |  | Total                  |        | Remainderof 2005 |   | 2006 to 2007 |  | 2008to2009 |        | Thereafter
|Line of credit              |  | $                      | 7,000  |                  | $ |             |  | $          | 7,000  |            | $ |   |  | $ | 
|Long-Term debt obligations  |  |                        | 4,042  |                  |   |             |  |            | 4,042  |            |   |   |  |   | 
|Capital lease commitments   |  |                        | 177    |                  |   | 15           |  |            | 118    |            |   | 44 |  |   |  
|Operating lease commitments |  |                        | 1,989  |                  |   | 255          |  |            | 1,715  |            |   | 19 |  |   | 
|Purchase obligations        |  |                        | 998    |                  |   | 998          |  |            |       |            |   |   |  |   | 
|                            |  |                        |        |                  |   |              |  |            |        |            |   |    |  |   |  
|Total                       |  | $                      | 14,206 |                  | $ | 1,268        |  | $          | 12,875 |            | $ | 63 |  | $ | 
|                            |  |                        |        |                  |   |              |  |            |        |            |   |    |  |   |  



On September 23,
2004, we entered into a revolving asset based credit facility (credit facility), with Silicon Valley Bank (the Bank). This facility has a term of two years and expires on September 23, 2006. Borrowings under the credit
facility are formula based and limited to the lesser of $7.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the banks prime rate,
6.75% as of September 30, 2005, plus 0.5%. The rate may increase by 1.0% if we do not meet certain financial covenants. The credit facility is collateralized by all of our assets, and contains various financial covenants all of which we were in
compliance with at September 30, 2005. We had $7.0 million in outstanding borrowings under this credit facility at September 30, 2005. The maximum amount available based on the maximum percentages of eligible accounts receivable and
inventory was $7.0 million.



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



We have incurred substantial losses and negative cash flows from operations
since inception. For the nine months ended September 30, 2005, we incurred a net loss of $13.4 million, negative cash flows from operating activities of $16.0 million, and have an accumulated deficit of $308.9 million.



In July 2005, we completed the sale of 5,534,994 shares of our common stock
at a price of $2.70 per share for gross proceeds of $14.9 million. Net proceeds from the offering were approximately $14.1 million. Under the terms of the sale, we also issued warrants to purchase an additional 2.8 million shares of our common
stock. The warrants expire in 2010 and, beginning in 2006, are exercisable at a per share price of $4.25. We also have the right to call the warrants in the event that the trading price of our common stock exceeds $7.44 per share for twenty
consecutive trading days. If exercised in full, the warrants would provide us an additional $11.8 million in cash.



We believe that the cash and cash equivalents and the availability under the credit facility as of September 30, 2005 are sufficient to fund our
operating activities and capital expenditure needs for the next twelve months. However, in the event that we do not meet our business objectives, we may require additional cash to fund our operations. Failure to generate positive cash flow in the
future would have a material adverse effect on our ability to achieve our intended business objectives.



Off Balance Sheet Arrangements



We do not have any material off balance sheet arrangements.



Critical Accounting Policies and Estimates



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



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



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



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



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



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



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



For direct sales of video processing systems component products not included as part of turnkey solutions, direct sale of broadband transport and service management products and the direct 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 management judgments and estimates in connection with the measurement of revenue in a given period. We follow specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, we assess a
number of factors, including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end
user, and current payment terms. Based on the results of the assessment, we may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. In order to recognize
revenue, we must also make a judgment regarding collectibility. Managements judgment of collectibility is applied on a customer-by-customer basis pursuant to our credit review policy. We sell to customers with which we have a history of
successful collection and to new customers for which such history may not exist. New customers are subject to a credit review process, which evaluates the customers financial position and ability to pay. New customers are typically assigned a
credit limit based on a review of their financial position. Such credit limits are only increased after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility
is not probable based upon our credit review process, revenue is recognized on a cash-collected basis, after shipment has occurred or the revenue has been earned under the percentage-of-completion method.



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



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



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



Recent
Accounting Pronouncements



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



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



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



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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 September 30, 2005, we had an accumulated deficit of $308.9 million. We expect to incur losses in the near future. Moreover, we may never achieve
profitability and, even if we do, we may not be able to maintain profitability. We may not be able to generate a sufficient level of revenue to offset our current level of expenses. Moreover, because our expenditures for sales and marketing,
research and development, and general and administrative functions are relatively fixed in the short term, we may be unable to adjust our spending in a timely manner to respond to any unanticipated decline in revenue. If we fail to achieve and
maintain profitability within the timeframe expected by securities analysts or investors, then the market price of our common stock will likely decline.



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



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



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



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



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



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



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



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



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



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



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



Over the
last 12 quarters, our revenue per quarter has fluctuated between $10.0 million and $2.5 million. Over the same periods, our losses from operations as a percentage of revenue have fluctuated between approximately 5.2% and 691.0% of revenue. We
anticipate that our sales and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:



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



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



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



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



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



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



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



The sales cycle for our headend systems can be as long as 12-18 months. Additionally, with respect to the sale of our products to U.S. and foreign government organizations, we may experience long sales cycles as a
result of government procurement processes. As a result, while we continue to incur costs associated with a particular sale prior to payment from the customer, we may not recognize revenue from efforts to sell particular products for extended
periods of time. As a result, our quarter-to-quarter comparisons of our revenue and operating results may not be meaningful and may not provide an accurate indicator of our future performance. Our operating results in one or more future quarters may
fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the 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 possibility of delivering high-definition television over asymmetric digital subscriber lines, or ADSL, for the first time. ADSL is a new technology that allows more data to be transmitted over copper telephone lines than standard DSL. Further
advances in compression technology, or the emergence of new industry standards would require that we further redesign our products to incorporate, and remain compatible with, emerging technologies and industry standards.



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



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



Sales to customers outside of the United States accounted for approximately
43.0%, 18.4% and 23.3% of revenue for the years ended December 31, 2002, 2003 and 2004, respectively and 21.4% and 20.5% for the nine months ended September 30, 2004 and 2005, respectively. Sales and operating activities outside of the
United States are subject to inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies; tariffs, quotas, taxes and other market barriers; political and economic instability; restrictions on the
export or import of technology; potentially limited intellectual property protection; difficulties in staffing and managing international operations and potentially adverse tax consequences. Any of these factors may have a material adverse effect on
our ability to grow or maintain international revenue.



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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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 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. TheWhalen action described and theCopper
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 matterIn re Initial Public Offering Securities Litigation. While we
have reached a settlement with the plaintiffs in theWhalen lawsuit, and prior to the acquisition Copper Mountain reached a settlement in theCopper 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 disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common
stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such
litigation, if instituted against us, could result in substantial costs and a diversion of managements attention and resources.



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



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



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##### Table of Contents

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We are exposed to changes in interest rates primarily from our investments in certain cash equivalents and from our variable rate credit facility. Under
our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially
affect the fair value of our interest-sensitive financial instruments at September 30, 2005. We do not anticipate any near-term changes in the nature of our market risk exposures or in managements objectives and strategies with respect to
managing such exposures.



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



ITEM 4.CONTROLS AND PROCEDURES



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



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



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##### Table of Contents

PART II. OTHER INFORMATION



ITEM 1.LEGAL PROCEEDINGS



Whalen v. Tut Systems, Inc. et al



On
October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants 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 the event that all or substantially all of the issuer-defendants
participate in the final settlement, the amount that may be paid to the plaintiffs on behalf of the Company could range from zero to approximately $7.0 million, depending on plaintiffs recovery from the underwriter-defendants and from other
non-settling parties and the amount of insurance available under the Companys applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement payments would be made on behalf of the
Company under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, we believe that our insurance will likely cover some or all of our share of any payments towards satisfying plaintiffs $1 billion recovery
deficit. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the
amount we will ultimately be required to pay, if any, as of September 30, 2005, we have not accrued a liability for this matter.



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



Copper Mountain, which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and
directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now 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. At this time, we cannot estimate the amount that we may be required to pay the plaintiffs under a final
settlement with respect to the Copper Mountain action described in this paragraph but believes that any such amount will be covered under Copper Mountains applicable insurance policies.



ITEM 2.UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS



On July 22, 2005, the Company completed a private placement of 5,534,994 newly-issued common shares to accredited investors at a price of $2.70 per
share, for net proceeds of approximately $14.1 million. Under the terms of the financing, the Company also issued warrants to purchase an additional 2,767,495 shares of its common stock. The warrants expire in 2010 and, beginning in 2006, are
exercisable at a per share price of $4.25. The Company has the right to call the warrants in the event that the trading price of its common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would
provide an additional $11,759,750 in proceeds to the Company.



The sale of these securities was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof. Under the terms of the agreement between the Company and the accredited investors,
the Company agreed to file a Registration Statement on Form S-3 with the SEC to register for resale the 5,534,994 common shares issued in the financing as well as the 2,767,495 common shares to be issued upon exercise of the warrants. The accredited
investors that will be named as Selling Stockholders in the Registration Statement on Form S-3 will be Greenway Capital and certain of its affiliates, Bonanza Master Fund, and Special Situations Fund and certain of its affiliates. The Selling
Shareholder table that will be filed as part of the registration statement is incorporated by reference into this Item 2 of Part II of this report.



ITEM 3.DEFAULTS UPON SENIOR SECURITIES



None



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



None



ITEM 5.OTHER INFORMATION



None



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Table of Contents



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 with Copper Mountain Networks, Inc. (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         |  | Silicon Valley Bank Loan and Security Agreement dated September 23, 2004.(12)                                                                                                                                                                                                                                                                   
|              | 
|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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



25



---

##### Table of Contents

|(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 for the quarter ended March 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- | -------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference to our Quarterly Report on Form 10-Q 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 dated May 26, 2000, as filed June 9, 2000.
|---- | ------------------------------------------------------------------------------------------------------

|(12) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------

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



26



---

##### Table of Contents

SIGNATURE



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



TUT SYSTEMS, INC.By:

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




Date: October 27, 2005



27



---

##### Table of Contents

INDEX TO 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 with Copper Mountain Networks, Inc. (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         |  | Silicon Valley Bank Loan and Security Agreement dated September 23, 2004.(12)                                                                                                                                                                                                                                                                   
|              | 
|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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



---

##### Table of Contents

|(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 for the quarter ended March 31, 1999.
|--- | ----------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference to our Annual Report on Form 10-K for the year ended December 31, 1999.
|--- | -------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference to our Quarterly Report on Form 10-Q 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 dated May 26, 2000, as filed June 9, 2000.
|---- | ------------------------------------------------------------------------------------------------------

|(12) | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
|---- | --------------------------------------------------------------------------------------------------------

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



29