##### Table of Contents

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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





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




For the quarterly period ended September 30, 2002





Commission File Number: 000-25291





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TUT SYSTEMS, INC.


(Exact name of registrant as specified in its charter)





Delaware (State or other
jurisdiction of incorporation or organization)

94-2958543 (I.R.S.
Employer Identification No.)





5964 W. Las Positas Blvd., Pleasanton, California (Address of principal executive offices)

94588-8540 (Zip
Code)





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





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





As of October 30, 2002, 16,482,428 shares of the
Registrants common stock, par value $0.001 per share, were issued and outstanding.





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TUT SYSTEMS, INC.





FORM 10-Q


INDEX





PART I.    FINANCIAL INFORMATIONItem 1.

Condensed Consolidated Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001

3Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and September 30, 2001

4Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and September 30, 2001

5Notes to Unaudited Condensed Consolidated Financial Statements

6Item 2.

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

13Item 3.

Quantitative and Qualitative Disclosures about Market Risk

34Item 4.

Controls and Procedures

34PART II.    OTHER INFORMATIONItem 1.

Legal Proceedings

35Item 2.

Changes in Securities and Use of Proceeds

35Item 3.

Defaults Upon Senior Securities

35Item 4.

Submission of Matters to a Vote of Security Holders

35Item 5.

Other Information

35Item 6.

Exhibits and Reports on Form 8-K

36Signatures

37Certification

38




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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)





September 30, 2002


December 31, 2001ASSETSCurrent assets:Cash and cash equivalents

$
32,616


$
46,338Short-term investments






3,029Accounts receivable, net of allowance for doubtful accounts of $86 and $6,908 in 2002 and 2001,
respectively


995



550Inventories, net


4,175



11,839Prepaid expenses and other


1,370



1,742Total current assets


39,156



63,498Property and equipment, net


5,931



8,171Intangibles and other assets


5,257



7,323Total assets

$
50,344


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

$
501


$
1,204Accrued liabilities


7,180



9,856Deferred revenue


712



954Total current liabilities


8,393



12,014Deferred revenue, net of current portion


82



553Other liabilities


281



329Total liabilities


8,756



12,896Commitments and contingencies (Note 6)Stockholders equity:Common stock, $0.001 par value, 100,000 shares authorized, 16,482 and 16,411 shares issued and outstanding in 2002 and
2001, respectively


16



16Additional paid-in capital


301,249



301,182Deferred compensation






(17
)Notes receivable from stockholders






(96
)Accumulated other comprehensive loss


(145
)


(78
)Accumulated deficit


(259,532
)


(234,911
)Total stockholders equity


41,588



66,096Total liabilities and stockholders equity

$
50,344


$
78,992





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




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TUT SYSTEMS, INC.





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share amounts)


(unaudited)





Three Months Ended September 30,


Nine Months Ended September 30,2002


2001


2002


2001Revenues:Product

$
1,840


$
3,753


$
6,317


$
10,897License and royalty


195



214



590



679Total revenues


2,035



3,967



6,907



11,576Cost of goods sold:Product


1,249



14,615



9,340



38,905Total cost of goods sold


1,249



14,615



9,340



38,905Gross (loss) margin


786



(10,648
)


(2,433
)


(27,329
)Operating expenses:Sales and marketing


1,830



2,767



6,612



10,093Research and development


3,172



3,028



9,959



11,802General and administrative


642



1,616



3,844



7,770Restructuring costs


870







870



2,092In-process research and development














1,160Impairment of intangible assets






29,859







32,551Amortization of intangible assets


300



2,561



899



7,774Noncash compensation expense






60







182Total operating expenses


6,814



39,891



22,184



73,424Loss from operations


(6,028
)


(50,539
)


(24,617
)


(100,753
)Impairment of certain equity investments










(592
)


Interest and other income, net


161



707



588



2,953Net loss

$
(5,867
)

$
(49,832
)

$
(24,621
)

$
(97,800
)Net loss per share, basic and diluted (Note 3)

$
(0.36
)

$
(3.05
)

$
(1.50
)

$
(6.01
)Shares used in computing net loss per share, basic and diluted (Note 3)


16,482



16,353



16,451



16,286





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 Ended September
30,2002


2001Cash flows from operating activities:Net loss

$
(24,621
)

$
(97,800
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and other


2,599



2,549Provision (recovery) for doubtful accounts


(2,035
)


761Provision for excess and obsolete inventory and abandoned products


5,182



33,302Write-off of certain equity investments


592



Impairment of intangibles






32,551Amortization of intangibles


899



8,741Write-off of in-process research and development






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


1,590



2,804Inventories


2,482



(7,823
)Prepaid expenses and other assets


852



4,137Accounts payable and accrued liabilities


(3,427
)


(23,983
)Deferred revenue


(713
)


(567
)Net cash used in operating activities


(16,600
)


(44,168
)Cash flows from investing activities:Purchase of property and equipment


(331
)


(1,049
)Purchase of short-term investments






(7,002
)Purchase of other assets






(1,186
)Proceeds from maturities of short-term investments


3,105



47,285Acquisition of businesses, net of cash acquired and purchased research and development






(169
)Net cash provided by investing activities


2,774



37,879Cash flows from financing activities:Proceeds from issuances of common stock, net


67



216Repayment of note receivable


37



Net cash provided by financing activities


104



216Net decrease in cash and cash equivalents


(13,722
)


(6,073
)Cash and cash equivalents, beginning of period


46,338



47,307Cash and cash equivalents, end of period

$
32,616


$
41,234Noncash financing activities:Common stock issued in connection with the ActiveTelco acquisition in 2001

$



$
2,944





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




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TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(in thousands, except per share amounts)





NOTE 1DESCRIPTION OF BUSINESS:





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





The Company has incurred substantial
losses and negative cash flows from operations since inception. For the nine months ended September 30, 2002, the Company incurred a net loss of $24,621, and negative cash flows from operations of $16,600, and has an accumulated deficit of $259,532
at September 30, 2002. Management expects the amount of cash used to fund operations to decrease during the year. However, to the extent the Companys business continues to be affected by poor economic conditions impacting the
telecommunications industry, the Company will continue to require cash to fund operations. The Company will seek additional funding for operations from alternative debt and equity sources if necessary to maintain reasonable operating levels. The
Company cannot assure that such funding efforts will be successful. Failure to generate positive cash flow in the future could have a material adverse effect on the Companys ability to achieve its intended business objectives.





NOTE 2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:





Basis of presentation





The accompanying condensed consolidated financial
statements as of September 30, 2002 and December 31, 2001 and for the three and nine months ended September 30, 2002 and 2001 are unaudited. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as
the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Companys financial position as of September 30, 2002 and December 31,
2001, their results of operations for the three and nine months ended September 30, 2002 and 2001 and their cash flows for the nine months ended September 30, 2002 and 2001. These condensed consolidated financial statements and the accompanying
notes are unaudited and should be read in conjunction with the Companys audited financial statements included in the Companys Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 29, 2002. The balance
sheet as of December 31, 2001 was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. The results for the three and nine months ended September 30, 2002 are not
necessarily indicative of the expected results for any other interim period or the year ending December 31, 2002.





Concentrations





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





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




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TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





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





Recent accounting pronouncements





In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and
Other Intangible Assets, which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board (APB) Opinion No. 17, Intangible Assets. It
addresses how intangible assets that are acquired individually or with a group of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how
goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The adoption of SFAS No. 142 did not impact the Companys financial statements. The following table presents the
impact of SFAS No. 142 on net loss and net loss per share had the standard been in effect for the three and nine months ended September 30, 2000, 2001 and 2002:





Three Months Ended September
30,


Nine Months Ended September
30,2002


2001


2000


2002


2001


2000Net lossas reported

$
(5,867
)

$
(49,832
)

$
(611
)

$
(24,621
)

$
(97,800
)

$
(6,027
)Adjustment:Amortization of goodwill






1,878



1,715







5,618



3,580Net lossas adjusted

$
(5,867
)

$
(47,954
)

$
1,104


$
(24,621
)

$
(92,182
)

$
(2,447
)Net loss per share, basic and dilutedas reported

$
(0.36
)

$
(3.05
)

$
(0.04
)

$
(1.50
)

$
(6.01
)

$
(0.42
)Net loss per share, basicas adjusted

$
(0.36
)

$
(2.93
)

$
0.07


$
(1.50
)

$
(5.66
)

$
(0.17
)Net loss per share, dilutedas adjusted

$
(0.36
)

$
(2.93
)

$
0.06


$
(1.50
)

$
(5.66
)

$
(0.17
)





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





In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal
Activities. SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities
that are initiated after December 31, 2002. The adoption is not expected to have a material impact on the Companys financial position and results of operations.





Reclassifications





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




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TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





NOTE 3NET LOSS PER SHARE:





Basic and diluted net loss per share is computed using the weighted average number of common shares outstanding. Options were not included
in the computation of diluted net loss per share because the effect would be antidilutive.





The calculation of net
loss per share follows:





Three Months Ended September
30,


Nine Months Ended September
30,2002


2001


2002


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

$
(5,867
)

$
(49,832
)

$
(24,621
)

$
(97,800
)Net loss per share, basic and diluted

$
(0.36
)

$
(3.05
)

$
(1.50
)

$
(6.01
)Shares used in computing net loss per share, basic and diluted


16,482



16,353



16,451



16,286Antidilutive securities not included in net loss per share calculations


2,811



1,975



2,811



1,975





NOTE 4COMPREHENSIVE LOSS:





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





Three Months Ended September
30,


Nine Months Ended September
30,2002


2001


2002


2001Net loss

$
(5,867
)

$
(49,832
)

$
(24,621
)

$
(97,800
)Unrealized losses on other assets


(7
)


(77
)


(62
)


(122
)Foreign currency translation adjustments


(4
)


(4
)


(5
)


(19
)Net change in other comprehensive loss


(11
)


(81
)


(67
)


(141
)Total comprehensive loss

$
(5,878
)

$
(49,913
)

$
(24,688
)

$
(97,941
)




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##### Table of Contents

TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





NOTE 5BALANCE SHEET COMPONENTS:





September 30,


December 31,2002


2001Short-term investments:US government agency notes

$



$
3,029Inventories, net:Finished goods

$
264


$
872Raw materials


3,911



10,967$
4,175


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

$
41


$
28Prepaid expenses


1,329



1,714$
1,370


$
1,742Property and equipment:Computers and software

$
6,568


$
6,677Leasehold improvements


4,004



4,437Test equipment


3,690



3,624Office equipment


1,395



1,39515,657



16,133Less: accumulated depreciation


(9,726
)


(7,962
)$
5,931


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

$
6,467


$
6,467Less: accumulated amortization


(3,114
)


(2,215
)Net intangibles


3,353



4,252Restricted cash


1,466



1,718Other


438



1,353$
5,257


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

$
4,421


$
4,421Bankruptcy preference item






1,500Compensation


560



1,014Sales tax


441



93Professional services


938



846Restructuring accrual


272



402Warranty reserve


200



326Other


348



1,254$
7,180


$
9,856




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##### Table of Contents




TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





NOTE 6COMMITMENTS AND CONTINGENCIES:





Lease obligations








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





The lease for the Pleasanton facility expires in April 2007, with an option to renew for five years. Under the terms of the lease agreement, the Company was required to issue a letter of credit in the amount of $1,850. The letter of
credit is reduced annually, beginning July 1, 2001, by approximately $250, provided that the Company is not in default under the terms of the lease agreement. Pursuant to these terms, the Companys letter of credit was reduced from $1,850 to
$1,600 in the third quarter of 2001 and from $1,600 to $1,350 effective July 1, 2002. See also Note 11Subsequent Events.





In the fourth quarter of 2001, the Company entered into a lease for engineering facilities in Bridgewater Township, New Jersey. Under the terms of this lease, the Company was required to issue a letter of credit in the amount of
$116. See also Note 10Restructuring Costs.





These two letters of credit are collateralized by restricted
funds in the amount of $1,466, which are included in intangibles and other assets as of September 30, 2002.





Purchase commitments





The Company had noncancellable commitments to purchase finished goods inventory totaling $225 and $531 in
aggregate at September 30, 2002 and December 31, 2001, respectively.





Royalty obligation





In February 1999, the Company paid one of its founders, a former employee of the Company, $2,500 as a lump sum payment for all its future
royalty obligations for the rights, title and interests in two patents. These two patents give the Company exclusive control of the Balun technology required in the Companys products. The Company is amortizing this royalty payment ratably over
the five year period which began February 1999. This period represents the estimated life of the patented technology. As of September 30, 2002, the balance of this payment remaining to be amortized was $667. Amortization expense for the nine months
ended September 30, 2002 was approximately $375.





Contingencies





Beginning July 12, 2001, six putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against Tut
Systems, Inc. and certain of its current and former officers and directors. The complaints were filed on behalf of a purported class of people who purchased the Companys stock during the period between July 20, 2000 and January 31, 2001,
seeking unspecified damages. The complaints allege that the Company and certain of its current and former officers and directors made false and misleading statements about its business during the putative class period. Specifically, the complaints
allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have been consolidated under the name In re Tut Systems, Inc. Securities Litigation, Civil Action No. C-01-2659-JCS. Lead
plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the court granted in part and
denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants have not responded to that complaint. The Company believes the allegations against it are without merit and intends to defend the
action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on the Companys business, results of operations, or financial condition.




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##### Table of Contents




TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





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





On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc. et al., Case
No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19,
2002. The consolidated amended complaint asserts that the prospectuses from the Companys January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the
offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended (the 1933 Act) 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 1933 Act. The complaints also name as defendants the underwriters for the
Companys initial public offering and secondary offering. The Company believes the allegations against it are without merit and intends to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse
effect on the Companys business, results of operations, or financial condition.





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





NOTE 7SEGMENT INFORMATION:





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





Three Months Ended September 30,

Nine Months Ended September
30,2002

2001

2002

2001United States

$
1,283

$
1,512

$
3,614

$
4,839International:Denmark





28


16


552Great Britain


267


146


748


568Japan


357


1,758


1,269


4,838Mexico








404


All other countries


128


523


856


779$
2,035

$
3,967

$
6,907

$
11,576





It is impracticable for the Company to compute product revenues by
product type for the three and nine months ended September 30, 2002 and 2001.




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##### Table of Contents




TUT SYSTEMS, INC.





NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)


(in thousands, except per share amounts)





Three customers, Ingram Micro, BTN
Internetworking, and Kanematsu Computer System Ltd. accounted for 19%, 13% and 12%, respectively, of the Companys revenue for the three months ended September 30, 2002. Two customers, Ingram Micro and BTN Internetworking, accounted for 12% and
10%, respectively, of the Companys revenue for the nine months ended September 30, 2002. Two customers, Kanematsu Computer System Ltd. and RIKEI Corporation, accounted for 28% and 15%, respectively, of the Companys revenue for the three
months ended September 30, 2001 and for 21% and 16%, respectively, of the Companys revenue for the nine months ended September 30, 2001.





NOTE 8PROVISION FOR INVENTORY:





The Company recorded a provision for inventory
totaling $4,859 in the second quarter of 2002, 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 second quarter of 2002. This revised projection was
a result of continued decline in the telecommunications market. In accordance with the Companys policy, declines in expected future revenue resulted in inventory levels for certain products in excess of demand in the foreseeable near term.
There was no such provision in the third quarter of 2002.





NOTE 9IMPAIRMENT OF CERTAIN EQUITY INVESTMENTS:





The Company recorded a write off of an equity investment in a privately-held company totaling $592 during the second quarter of
2002. The value of this investment was impaired due to uncertainty associated with the on-going viability of this business in the current economic climate. As of September 30, 2002, the Company had no remaining investments in privately-held
companies.





NOTE 10RESTRUCTURING COSTS:





In August 2002, the Company announced a restructuring program that included a workforce reduction, closure of its Bridgewater Township, New Jersey research and development
facility and disposal of certain of its fixed assets located in New Jersey. As a result of this restructuring program, the Company recorded restructuring costs of $870. The workforce reduction was approximately 39% of the Companys employees,
resulting in severance and outplacement expenses of approximately $531. The costs to close the New Jersey facility totaled $339. As of September 30, 2002, the Company had paid for all of the expenses and had a remaining accrual of $272, which was
paid in October 2002, related to the termination of the New Jersey facility lease.





NOTE 11SUBSEQUENT EVENTS:





Acquisition





On October 28, 2002, the Company announced it signed a definitive agreement with Tektronix, Inc. (Tektronix) to acquire VideoTele.com, Inc., (VideoTele.com), a subsidiary of Tektronix. The merger is expected
to close in November 2002. Under the terms of the agreement, Tektronix will receive 19.9% of the Companys common stock and a five-year note as total consideration for VideoTele.com. The total transaction value is estimated to be approximately
$7,000. The transaction will be treated as a purchase for accounting purposes. VideoTele.com offers digital headend solutions enabling home entertainment delivery via the broadband Internet.





Lease obligations





The Company is currently in
default on its lease payments for its Pleasanton facility and is currently in negotiations with the landlord to terminate this lease, which expires in June 2007. This negotiation is on-going and the Company anticipates reaching a settlement to
terminate this lease in the fourth quarter of 2002. The Company has offered $3,000 as settlement and is currently awaiting a response from the landlord. The $3,000 cash offer to settle would include forfeiture of the $1,350 letter of credit that is
collateralized by restricted funds of $1,350, which are included in intangibles and other assets as of September 30, 2002. Upon successful termination of this lease, the Company would also abandon approximately $2,500 in leasehold improvements and
networking equipment.










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








Overview





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





We have
incurred net operating losses to date and, as of September 30, 2002, had an accumulated deficit of $259.5 million. Our ability to generate income from operations in the future will primarily depend on increases in sales volume, reductions in
manufacturing costs and the growth of high-speed data access solutions in the NDU and MTU markets. In view of our limited history of product revenue from new markets, our reliance on growth in deployment of high-speed data access solutions and the
unpredictability of orders and subsequent revenue, we believe that period-to-period comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. Failure to generate
significant revenue from existing or new products, whether due to lack of market acceptance, competition, technological change, continued poor economic conditions affecting the telecommunications industry or otherwise, or our inability to reduce
manufacturing costs, will harm our business, financial condition and results of operations.





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




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##### Table of Contents




Sales to customers outside of the United States accounted for 47.7% and 58.2% of
our total sales for the nine months ended September 30, 2002 and 2001, respectively. On average, we expect international sales to represent approximately 50% of our revenue for the remainder of fiscal 2002. However, actual results, both
geographically and in absolute dollars, may vary from quarter to quarter depending on the timing of orders placed by customers. To date, all international sales have been denominated in U.S. dollars.





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





In 2000 and 2001, we made several acquisitions. In fiscal 2000, we acquired FreeGate Corporation (FreeGate), Xstreamis Ltd.
(Xstreamis) and certain assets of OneWorld Systems (OneWorld). In January 2001, we acquired ActiveTelco, Inc. (ActiveTelco) for approximately $4.9 million, consisting of an aggregate of 321,343 shares of our
common stock and 18,657 options to purchase shares of our common stock and acquisition related expenses consisting primarily of legal and other professional fees, assumed ActiveTelco convertible notes in the amount of $0.7 million plus accrued
interest and other assumed liabilities of approximately $1.1 million. This transaction was treated as a purchase for accounting purposes. ActiveTelco was located in Fremont, California. ActiveTelco provided an Internet telephony platform that
enabled Internet and telecommunications service providers to integrate and deliver Web-based telephony applications such as unified messaging, long-distance service, voicemail and fax delivery, call forwarding, call conferencing and callback
services.





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





While we expect to derive benefits from sales of product lines that are designed, developed and marketed as a result of these acquisitions, there can be no assurance that
we will be able to complete the development and commercial deployment of certain of these products. In January 2001, we decided to abandon future sales of the existing OneGate product that we acquired in the FreeGate acquisition. In April 2001, as
part of our cost reduction efforts, we decided not to pursue further incorporation of the related OneGate and other intellectual property acquired from FreeGate into the design of future products. As a result, we took a write down of $2.7 million
for abandonment of the related completed technology and patents in the first quarter of 2001. During our impairment review for the third quarter of 2001, we evaluated the present value of future expected cash flows to determine the fair value of our
long-lived assets. This evaluation resulted in a write down of $29.9 million of goodwill and other intangible assets. The underlying factors contributing to the decline in expected future cash flows include continued adverse conditions in the
telecommunications market and the indefinite postponement of capital expenditures, especially within the hospitality industry. As of September 30, 2002, our net intangible assets remaining to be amortized were $3.4 million, comprised entirely of
completed technology and patents related to the acquisitions of the ViaGate assets and Xstreamis.





In fiscal 2001,
we reduced our total workforce by approximately 50% to control overall operating expenses in response to recent declines and expected slower growth in our sales, and we also closed several of our satellite offices. We incurred restructuring charges
of $2.3 million related to these restructuring activities. In August 2002, we reduced our total workforce by approximately 39% to further control operating expenses in response to the current adverse economic conditions, and we also closed our
satellite research and development facility in Bridgewater Township, New Jersey. We incurred restructuring charges of $0.8 million related to this restructuring.




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##### Table of Contents




Results of Operations





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





Three Months Ended September 30,


Nine Months Ended September 30,2002


2001


2002


2001Total revenues

100.0
%

100.0
%

100.0
%

100.0
%Total cost of goods sold

61.4


368.4


135.2


336.1Gross (loss) margin

38.6


(268.4
)

(35.2
)

(236.1
)Operating expenses:Sales and marketing

89.9


69.8


95.7


87.2Research and development

155.9


76.3


144.2


102.0General administrative

31.5


40.7


55.7


67.1Restructuring costs

42.8





12.6


18.1In-process research and development










10.0Impairment of intangibles




752.7





281.2Amortization of intangibles

14.7


64.6


13.0


67.2Noncash compensation expense




1.5





1.6Total operating expenses

334.8


1,005.6


321.2


634.4Loss from operations

(296.2
)

(1,274.0
)

(356.4
)

(870.5
)Impairment of certain equity investments







(8.6
)

Interest and other income, net

7.9


17.7


8.5


25.5Net loss

(288.3
)%

(1,256.3
)%

(356.5
)%

(845.0
)%





Three and Nine Months Ended September 30, 2002 and 2001





Revenue.    We generate revenue primarily from the sale of hardware products and,
to a lesser extent, through the licensing of our HomeRun technology and from the sale of software products. Our total revenue decreased to $2.0 million and $6.9 million for the three and nine months ended September 30, 2002, respectively, from $4.0
million and $11.6 million for the three and nine months ended September 30, 2001, respectively. Using a year-over-year comparison, the decreases for the three and nine month periods ending September 30, 2002 compared to the same periods in 2001 of
$1.9 million (or 48.7%) and $4.7 million (or 40.3%), respectively, were primarily due to reduced revenue from our Expresso MDU products as a result of the sale of fewer units as well as a lower average selling price per unit. As a result of the
protracted downturn in the telecommunications market, our revenue growth further slowed due to a decrease in the number of customers and potential customers, particularly within the hospitality industry, that have indefinitely postponed capital
expenditures.





License and royalty revenue was $0.2 million and $0.6 million for the three and nine months ended
September 30, 2002, respectively, compared to $0.2 million and $0.7 million for the three and nine months ended September 30, 2001, respectively. We did not enter into any new license or royalty agreements during the first nine months of 2002 or
2001.




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##### Table of Contents




Cost of Goods Sold/Gross (Loss) Margin





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





Three Months Ended September
30,


Nine Months Ended September
30,2002


2001


2002


2001(in thousands) (unaudited)


(in thousands) (unaudited)Total revenues

$
2,035


$
3,967


$
6,907


$
11,576Total cost of goods sold


1,249



14,615



9,340



38,905Gross (loss) margin

$
786


$
(10,648
)

$
(2,433
)

$
(27,329
)Gross (loss) margin as a percentage of revenue


38.6
%


(268.4
)%


(35.2
)%


(236.1
)%Detail of gross margin before certain provisionsTotal cost of goods sold

$
1,249


$
14,615


$
9,340


$
38,905Less:Provision for excess and obsolete inventory






(11,425
)


(4,859
)


(29,925
)Total cost of goods sold excluding provisions for excess and obsolete inventory


1,249



3,190



4,481



8,980Gross margin before the provision for excess and obsolete inventory

$
786


$
777


$
2,426


$
2,596Gross margin before the provision for excess and obsolete inventory as a percentage of revenue


38.6
%


19.6
%


35.1
%


22.4
%




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##### Table of Contents




Cost of goods sold consists of raw materials, contract manufacturing costs,
personnel costs, costs associated with test and quality assurance for products, and the cost of licensed technology included in the products. Excluding the reserves for excess and obsolete inventory of $4.9 million taken in 2002, $29.9 million taken
in 2001, our cost of goods sold decreased to $1.2 million and $4.5 million for the three and nine months ended September 30, 2002, respectively, from $3.2 million and $9.0 million for the three and nine months ended September 30, 2001, respectively.
The decreases for the three and nine month periods ended September 30, 2002 compared to the same periods in 2001 of $1.9 million or (60.8%) and $4.5 million (or 50.1%), respectively, were primarily due to reduced revenue from our Expresso MDU
products as a result of the sale of fewer units as well as a lower average selling price per unit. The decrease was also due to $0.2 million and $1.0 million in cash that we received from the sale of component inventory, which had previously been
reserved for, during the three and nine months ended September 30, 2002, respectively, compared to $0.3 million in cash that we received in the third quarter of 2001 from the sale of component inventory, which had previously been reserved for.





Gross margin before the provisions for excess and obsolete inventory as a percentage of revenue increased to
38.6% and 35.1% of revenue for the three and nine months ended September 30, 2002, respectively, from 19.6% and 22.4% of revenue for the three and nine months ended September 30, 2001, respectively. The increases for the three and nine month periods
ended September 30, 2002 compared to the same periods in 2001 of 19.0% and 12.7% were due primarily to workforce reductions which reduced the overhead component of cost of goods sold, the sale of raw materials previously reserved for through loss on
purchase commitments of $0.2 million and $1.0 million for the three and nine months ended September 30, 2002, respectively, and recognition of revenue on shipments of inventory previously fully reserved of $0.5 million during the second quarter of
2002. These were offset by sales price reductions on some of our Expresso MDU products in response to competitive pricing pressures.





During the first and third quarters of 2001, we recorded a reserve for excess and obsolete inventory of $18.5 million and $11.4 million, respectively. These reserves primarily related to the costs of raw materials and
finished goods in excess of what we reasonably expected to sell in the foreseeable future as of the respective quarter in 2001. Market developments over the past two years, including the write down of significant amounts of inventory by competitors,
the proliferation of products resold as a result of bankruptcies within the industry, continued slowdown in the telecommunications market and, more recently, the indefinite postponement of capital expenditures by our customers, especially within the
hospitality industry, have made it difficult to value these inventories. During the first nine months of 2001, we also recorded additional reserves totaling $3.3 million for excess and obsolete inventory as a part of our normal business operations
and product inventory assessments. All of these inventory adjustments were included in cost of goods sold resulting in an overall negative gross margin of 268.4% and 236.1% for the three and nine months ended September 30, 2001, respectively.





During the second quarter of 2002, we recorded a reserve for excess inventory of $4.9 million. This reserve
primarily related to the costs of raw materials and finished goods in excess of what we reasonably expected to sell in the foreseeable future as of the second quarter of 2002. During the first nine months of 2002, we recorded additional reserves of
$0.2 million for excess and obsolete inventory as a part of our normal business operations and product inventory assessments. All of these inventory adjustments were included in cost of goods sold resulting in an overall gross margin of 38.6% for
the three months ended September 30, 2002 and an overall negative gross margin of 35.2% for the nine months ended September 30, 2002.




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##### Table of Contents




Sales and Marketing.    Sales and marketing expense
primarily consists of personnel costs, including commissions and costs related to customer support, travel, trade shows, promotions and outside services. Our sales and marketing expenses decreased to $1.8 million and $6.6 million for the three and
nine months ended September 30, 2002, respectively, from $2.8 million and $10.1 million for the three and nine months ended September 30, 2001, respectively. The decreases for the three and nine months ended September 30, 2002 when compared to the
same periods in 2001 of $0.9 million (or 33.9%) and $3.5 million (or 34.5%), respectively, were primarily due to a reduction in our marketing programs in order to reduce our costs in light of the difficult market conditions and, to a lesser degree,
to align our sales commission expense with lower revenue in the first nine months of 2002.





Research and
Development.    Research and development expense consists primarily of personnel costs related to engineering and technical support, contract consultants, outside testing services, equipment and supplies associated with
enhancing existing products and developing new products. Research and development costs are expensed as incurred. Our research and development expenses increased to $3.2 million for the three months ended September 30, 2002 and decreased to $10.0
million for the nine months ended September 30, 2002, from $3.0 million and $11.8 million for the three and nine months ended September 30, 2001, respectively. The increase for the three months ended September 30, 2002 when compared to the same
period in 2001 of $0.1 million (or 4.8%) was primarily a result of $0.5 million in expenditures for prototypes of our IntelliPOP 8000 series of products. This increase was offset by our workforce reductions in 2001 and 2002 and our continued focus
on cost saving measures, including the reduction, postponement or abandonment of research and development efforts on certain of our product lines. The decrease for the nine month period ended September 30, 2002 when compared to the same period in
2001 of $1.8 million (or 15.6%) was primarily a result of our workforce reductions in 2001 and 2002 and our continued focus on cost saving measures, including the reduction, postponement or abandonment of research and development efforts related to
certain of our product lines. We expect research and development activities to represent a significant percentage of our overall fixed operating expenses during the remainder of fiscal 2002.





General and Administrative.    General and administrative expense primarily consists of personnel costs for administrative officers and support
personnel, legal, accounting, insurance and consulting fees. Our general and administrative expenses decreased to $0.6 million and $3.8 million for the three and nine months ended September 30, 2002, respectively, from $1.6 million and $7.8 million
for the three and nine months ended September 30, 2001, respectively. These decreases for the three and nine months ended September 30, 2002 when compared to the same periods in 2001 of $1.0 million (or 60.3%) and $3.9 million (or 50.5%),
respectively, were primarily due to the recovery of debt that we had originally classified as bad debt and which totaled $1.3 million and $2.0 million, respectively, for the three and nine month periods ended September 30, 2002, our workforce
reductions in 2001 and 2002, and our continued focus on cost saving measures. Bad debt recovery, net of bad debt expense, was $0.8 million and $1.0 million for the three and nine month periods ended September 30, 2001. We anticipate that general and
administrative expenses will continue to fluctuate during the remainder of fiscal 2002.





Restructuring
Costs.    In April 2001, we announced a restructuring program which included a workforce reduction, closure of excess facilities, and disposal of certain of our fixed assets. As a result of this restructuring program, we
recorded restructuring costs of $2.1 million in the second quarter of 2001. These restructuring costs were comprised of $1.2 million in workforce reduction charges relating primarily to severance and fringe benefits, $0.8 million relating to closure
of excess facilities and $0.1 million in other fixed assets retired as a result of the workforce reductions. In August 2002, we announced a restructuring program which included a workforce reduction, closure of our New Jersey research and
development facility, and disposal of certain of our fixed assets. As a result of this restructuring program, we recorded restructuring costs of $0.9 million in the third quarter of 2002. These restructuring costs were comprised of $0.5 million in
workforce reduction charges relating primarily to severance and fringe benefits and $0.4 million relating to closure of the New Jersey facility.





In-Process Research and Development.    The amount expensed as in-process research and development was $1.2 million for the nine months ended September 30, 2001 and was
related to in-process research and development purchased from ActiveTelco during the first quarter of 2001. The purchased in-process technology was expensed upon acquisition because technological feasibility had not been established and no future
alternative uses existed. The in-process technology percentage of completion was estimated to be 75%. The value of this in-process technology was determined by estimating the cost to develop the purchased in-process technology




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##### Table of Contents

into a commercially viable product, estimating the net cash flows from the sale of the product after the completion of the in-process technology and discounting the net cash flows back to their
present value using a risk-weighted discount rate of 30%. Research and development costs to bring in-process technology from ActiveTelco to technological feasibility will not have a material impact on our future results of operations or cash flows
because the technology was abandoned. There was no such expense during the first nine months of 2002.





Impairment of Intangibles.    Based on the impairment review performed during the third quarter of 2001, we recorded a $29.9 million impairment charge to reduce goodwill and other intangible assets. The
charge was determined based upon estimated discounted future cash flows using a discount rate of 20%. The assumptions supporting future cash flows, including the discount rate, were determined using managements best estimates. The underlying
factors contributing to the decline in expected future cash flows include a continued slowdown in the telecommunications market and the indefinite postponement of capital expenditures by our customers, especially within the hospitality industry. In
the first quarter of 2001, we recorded a $2.7 million impairment charge to reduce completed technology and patents. This resulted from our decision not to pursue further incorporation of the related OneGate product and other intellectual property
acquired from FreeGate into the design of future products. Total impairment of intangibles was $29.9 million and $32.6 million for the three and nine months ended September 30, 2001. There were no such impairments for the three and nine months ended
September 30, 2002.





Amortization of Intangibles.    For the three and nine months
ended September 30, 2001, amortization of intangibles was comprised of the amortization of intangible assets related to the acquisitions of Vintel in fiscal 1999, FreeGate, OneWorld assets and Xstreamis in fiscal 2000, and ActiveTelco in the first
quarter of 2001. These intangible assets consisted primarily of assembled workforce, completed technology and patents, and goodwill, and all were amortized over their estimated useful lives of three, five and five years, respectively. For the three
and nine months ended September 30, 2002, amortization of intangibles was comprised entirely of completed technology and patents related to the acquisitions of Xstreamis and the ViaGate assets and are amortized over their estimated useful lives of
five years. Amortization of intangibles decreased to $0.3 million and $0.9 million for the three and nine months ended September 30, 2002, respectively, from $2.6 million and $7.8 million for the three and nine months ended September 30, 2001,
respectively. The decreases for the three and nine months ended September 30, 2002 when compared to the same periods in 2001 of $2.3 million (or 88.3%) and $6.9 million (or 88.4%), respectively, were primarily due to our recording of an impairment
of these intangibles totaling $32.6 million during fiscal 2001. As of September 30, 2002, intangible assets totaling $3.4 million, which consist entirely of completed technology and patents, remain to be amortized.





Noncash Compensation Expense.    Noncash compensation expense for the three and nine months ended September 30,
2001 consisted of the recognition of expense related to certain employee stock option grants based on the difference between the deemed fair value of our common stock and the stock option exercise price at the date of grant. Our noncash compensation
expense was $0.06 million and $0.2 million for the three and nine months ended September 30, 2001, respectively. There was no such expense during the three and nine months ended September 30, 2002.





Impairment of Certain Equity Investments.    Impairment of certain equity investments for the three and nine
months ended September 30, 2002 consisted of the recognition of expense related to the write off of $0.6 million invested in a privately-held company. The value of this investment was impaired due to uncertainty associated with the on-going
viability of this business in the current economic climate. There was no such impairment of our equity investments for the three and nine months ended September 30, 2001. As of September 30, 2002, we had no remaining investments in privately-held
companies.





Interest and Other Income, Net.    Interest and other income, net consisted
primarily of interest income on our cash, investments and notes receivable balances. Our interest and other income, net decreased to $0.2 million and $0.6 million for the three and nine months ended September 30, 2002, respectively, from $0.7
million and $3.0 million for the three and nine months ended September 30, 2001, respectively. The decreases for the three and nine months ended September 30, 2002 when compared to the same periods in 2001 of $0.5 million or 77.2% and $2.4 million
or 80.1%, respectively, were primarily due to lower interest rates on lower average cash balances.







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##### Table of Contents




Liquidity and Capital Resources





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





Cash and cash equivalents totaled $32.6 million at September 30, 2002, a decrease of $16.8 million or 33.9% from cash, cash equivalents and short-term investments of $49.4 million at December 31, 2001.





The net decrease in cash and cash equivalents of $13.7 million during the nine months ended September 30, 2002 resulted primarily from our
use of $16.6 million for operating activities and the purchase of property and equipment of $0.3 million, offset by maturities of short-term investments of $3.1 million and $0.1 million in proceeds from the issuance of common stock related to
purchases of stock through our stock purchase plan.





The net decrease in cash and cash equivalents of $6.1 million
during the nine months ended September 30, 2001 resulted primarily from our use of $44.2 million for operating activities, purchases of short-term investments of $7.0 million, $1.0 million for the purchase of property and equipment, the purchase of
other assets of $1.2 million (which includes the acquisition of certain ViaGate assets for $0.6 million) and $0.2 million in acquisition costs for ActiveTelco. The decrease was offset by maturities of short-term investments of $47.3 million and $0.2
million in proceeds from the issuance of common stock related to stock options and purchases of stock through our stock purchase plan.





In future periods, we generally anticipate a decrease in working capital expenditures on a period-to-period basis primarily as a result of a general decrease in our operational costs due to our workforce reductions.





We have entered into certain contractual obligations and other purchase commitments that could result in cash
outflows. In the first quarter of 2000, we entered into a lease for administrative and engineering facilities in Pleasanton, California. Under the terms of the lease, we were required to issue a letter of credit in the amount of $1.9 million. The
letter of credit is reduced annually, beginning July 1, 2001, by approximately $0.3 million, provided that we are not in default under the terms of the lease agreement. Pursuant to these terms, our letter of credit was reduced from $1.9 million to
$1.6 million in the third quarter of 2001 and was reduced to $1.4 million effective July 1, 2002. We are currently in default on our lease payments for our Pleasanton facility and are currently in negotiations with the landlord to amend the terms of
this lease which expires in June 2007. This negotiation is on-going, and we anticipate reaching a settlement to terminate this lease in the fourth quarter of 2002. We have offered $3.0 million as settlement and are currently awaiting a response from
the landlord. The $3.0 million cash offer to settle would include forfeiture of the $1.4 million letter of credit that is collateralized by restricted funds of $1.4 million, which are included in intangibles and other assets as of September 30,
2002. In the fourth quarter of 2001, we entered into a lease for engineering facilities in Bridgewater Township, New Jersey. Under the terms of the lease, we were required to issue a letter of credit in the amount of $0.1 million. As part of the
restructuring program announced in August 2002, we entered into an agreement to terminate our lease of engineering facilities in Bridgewater Township, New Jersey for $0.3 million, which consists of forfeiture of the $0.1 million letter of credit and
a cash payment of $0.2 million. The letters of credit securing both of these leases are collateralized by restricted funds in the amount of $1.5 million, which are included in intangibles and other assets as of September 30, 2002.





At September 30, 2002, the remaining accrual for purchase commitments of raw material components was $4.4 million. At this
time, we are involved in litigation related to certain of these commitments. As discussed in Note 6 of our Condensed Consolidated Financial Statements, the outcome of this litigation is uncertain at this time.




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The following summarizes our contractual obligations at September 30, 2002 and
the effect these obligations are expected to have on our liquidity and cash flow in future periods:





Our future
minimum lease payments under operating leases at September 30, 2002 are as follows:





Year

(in millions)The remainder of 2002

$0.52003

1.92004

1.82005

1.82006

1.7Thereafter

0.9$8.6





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





Recent Accounting Pronouncements





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





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





In July 2002, the FASB issued SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146
requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption is not expected to have a material impact on our financial position and 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 losses and expect to continue to incur losses in the future.





We have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. We incurred a net loss of
$24.6 million for the nine months ended September 30, 2002 and a net loss of $104.3 million for the year ended December 31, 2001. As of September 30, 2002, we had an accumulated deficit of $259.5 million. We expect that we will continue to incur
losses for the remainder of fiscal year 2002.





We may never achieve profitability and, if we do so, we may not be
able to maintain profitability. We have spent substantial amounts of money on the development of our Expresso products, HomeRun and LongRun technology, IntelliPOP products and software products. During fiscal 2001 and 2002, we significantly reduced
our workforce in an effort to decrease certain of our operating expenditures, including our sales and marketing, research and development and general and administrative expenditures. However, we may not be able to generate a sufficient level of
revenue to offset the current level of expenditures. Additionally, we may be unable to adjust our spending in a timely manner to respond to any unanticipated decline in revenue due to the fact that our expenditures for sales and marketing, research
and development, and general and administrative functions are relatively fixed in the short term. Our ability to achieve and maintain profitability in the future will primarily depend on our ability to do the following:





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




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




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




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




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




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





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





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




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




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




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




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




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




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




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




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




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




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



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





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








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





The continued poor economic conditions in the world economy and the continued industry-wide downturn in the telecommunications market have affected, and may continue to
affect, our sales in the future. As a result, we may experience a material adverse impact on our business, operating results and financial condition. Comparatively lower sales have resulted in operating expenses increasing as a percentage of revenue
for the nine months ended September 30, 2002 (compared to the nine months ended September 30, 2001) and the year ended December 31, 2001 compared to the years ended December 31, 2000 and 1999. Although we took actions throughout 2001 and 2002 to
create revenue opportunities and reduce operating expenses, a prolonged continuation or worsening of sales trends that we faced in 2001 and continue to face in 2002 may force us to take additional actions and charges in order to reduce our operating
expenses further. If we are unable to reduce operating expenses at a rate and level consistent with future adverse sales trends or if we incur significant special charges associated with such expense reductions that are disproportionate to our
sales, our business, operating results and financial condition could be negatively impacted.





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





We derive a significant portion of our revenue in each period from a limited number of customers. Three customers, Ingram Micro, BTN
Internetworking, and Kanematsu Computer System Ltd. accounted for 19%, 13% and 12%, respectively, of our revenue for the three months ended September 30, 2002. Two customers, Ingram Micro and BTN Internetworking, accounted for 12% and 10%,
respectively, of our revenue for the nine months ended September 30, 2002. Two customers, Kanematsu Computer System Ltd. and RIKEI Corporation, accounted for 28% and 15%, respectively, of our revenue for the three months ended September 30, 2001 and
for 21% and 16%, respectively, of our revenue for the nine months ended September 30, 2001. Many of our past customers have limited or, in some cases, no access to capital and are experiencing significant financial difficulties, including
bankruptcy. In order to meet our revenue targets, we must continue to acquire new customers and increase sales to our existing customers. In addition, our strategy of targeting larger, more established customers may result in longer sales cycles and
delayed revenue. Sales to larger accounts could also result in increased competition from larger and more established competitors. If sales to our largest customers decrease materially below current levels or if we are unable to establish a new base
of customers, such decreases or failures could materially and adversely affect our business, results of operations and financial condition.





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





Beginning July 12, 2001, six putative stockholder class action lawsuits were filed in
the United States District Court for the Northern District of California against us and certain of our current and former officers and directors. The complaints were filed on behalf of a purported class of people who purchased our stock during the
period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that we and certain of our current and former officers and directors made false and misleading statements about our business during the putative
class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have been consolidated under the name In re Tut Systems, Inc. Securities Litigation,Civil Action No. C-01-2659-JCS. Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August
15, 2002, the court granted in part and denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants have not responded to that complaint. We believe the allegations against us are without merit
and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.







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





On October 30, 2001, we and certain of our current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the
United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses
from our January 29, 1999 initial public offering and our March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and
former officers and directors under Section 11 of the 1933 Act and under Section 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934, as amended, and alleges claims against certain of our current and former officers and directors under
Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the underwriters for our initial public offering and secondary offering. We believe the allegations against us are without merit and intend to defend the action
vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.





We face substantial risk in introducing our new IntelliPOP products.





We
introduced our IntelliPOP 8000 on October 31, 2001 and our IntelliHUB  8200 on October 28, 2002. We face significant risks associated with the introduction of these new products which include, but are not limited to:





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




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




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




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




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





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





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




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If our Expresso and IntelliPOP products do not gain broader acceptance in the market, our business,
financial condition and results of operations could be harmed.





We launched our IntelliPOP 5000 series product
in the first half of 2001 and have not yet been successful in generating widespread customer interest in this product. Similarly, our sales of Expresso units have been below what we had anticipated. We must devote a substantial amount of human and
capital resources in order to broaden commercial acceptance of our Expresso products and to gain commercial acceptance of our IntelliPOP products and to expand offerings of these products in the multi-dwelling unit, or MDU, and the multi-tenant
commercial unit, or MCU, markets and to penetrate these markets further. However, to date, this commitment of resources to these product lines has not generated the commercial acceptance that we have sought for these products. Historically, the
majority of our Expresso products has been sold into the MDU market. Our future success depends on our ability to continue to penetrate this market and to expand our penetration into the MCU market. Our success also depends on our ability to educate
existing and potential customers and end-users about the benefits of our Fast Copper and Signature Switch technologies, our LongRun and IntelliPOP products, and about the development of new products to meet changing and expanding demands of service
providers, MTU owners and corporate customers. The future success of our Expresso and IntelliPOP products will also depend on the ability of our service provider customers to market and sell high-speed data services to end-users. If our IntelliPOP
or our Expresso products do not achieve broader commercial acceptance within the MDU market, MCU market, or in any other markets we may enter, our business, financial condition and results of operations could be materially and adversely affected.





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





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





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





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





The market for high-speed data
access products and services is characterized by several competing technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. These competing solutions provide fast access, high reliability and
cost-effective solutions for some users. Many of our products are based on the use of copper telephone wire. Because there are physical limits to the speed and distance over which data can be transmitted over copper wire, our products may not be a
viable solution for customers requiring service at performance levels beyond the current limits of copper telephone wire. To the extent that telecommunications service providers choose to install fiber optic cable or other transmission media in the
last mile, or to the extent that homes and businesses install other transmission media within buildings, we expect that demand for our products that are based on copper telephone wires will decline. Commercial acceptance of any one of these
competing solutions or any technological advancement or product introduction that provides faster access, greater reliability, increased cost-effectiveness or other advantages over technologies that utilize existing copper telephone wires could
decrease the demand for our products and reduce average selling prices and gross margins associated with our products. The occurrence of any one or more of these events could harm our business, financial condition and results of operations.




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





Our operations have changed significantly
due to volatility in our business. In the past, we have rapidly and significantly expanded our operations. However, in fiscal 2001 and 2002, we reduced our workforce by approximately 50% and 39%, respectively, to control overall operating expenses
in response to declines in and the expectation of continued slowing of our sales growth. We anticipate that, in the future, expansion in certain areas of our business may be required to expand our customer base and exploit market opportunities. In
particular, we expect to face numerous challenges in the implementation of our business strategy to focus on selling our products to the larger, more established customers, such as ILECs and PTTs, in both domestic and international markets.





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





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





Sales to customers outside of the United States accounted for approximately 47.7%, and 58.2% of revenue for the nine months ended
September 30, 2002 and 2001, respectively. There are a number of risks arising from our international business, including, but not limited to:





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




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




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




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




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




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




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




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




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





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







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





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





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





Due to increased volatility in equity markets and tightening of lending in the credit markets, we believe that we are exposed to a
significant risk that customers will not pay us the amounts that they owe us in order to conserve their capital. This would lead to increases in our outstanding accounts receivable as a percentage of revenue, extended payback periods and increased
risk of customer default. For example, during the latter part of the fourth quarter of 2000, several key customers experienced a rapid deterioration in their ability to obtain additional capital to fund their businesses. As a result, these customers
declared their inability to make timely payments on their accounts and were unable to demonstrate the ability to pay their existing account balances with us since that time. During fiscal 2001, a significant number of these customers commenced
bankruptcy proceedings. As of September 30, 2002, all of these bankruptcies were finalized and we do not expect that we will collect much, if any, of the amounts owed to us by these customers.





We factor the increased risks of non-payment into our assessment of our customers ability to pay, and, in some instances, these considerations will likely result
in longer revenue deferrals than we had anticipated at the time that we booked sales to those customers. We also believe that certain of our customers will alter their plans to deploy products to meet the constraints imposed on them by changes in
the capital markets. If we are not able to increase sales in other customer segments, or if our sales are otherwise delayed, our sales growth patterns may become increasingly volatile. This would increase the risk that our sales would decline in any
particular quarter and could harm our business, operating results and financial condition.





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





We plan our expense
levels in part based on our expectations about future revenue. These expense levels are relatively fixed in the short-term. However, the number of orders for our products may vary from quarter to quarter. In some circumstances, customers may delay
purchasing our current products in favor of next-generation products. In addition, our new products are generally subject to technical evaluations by potential customers that typically last 60 to 90 days. In the case of IntelliPOP, those evaluations
may take up to six months. If orders forecasted for a specific customer for a particular quarter are delayed or cancelled, our revenue for that quarter may be less than our forecast. Currently, we have minimal risk of loss associated with long-term
customer commitments or penalties for delayed and/or cancelled orders. However, we may be unable to reduce our spending accordingly in the short-term if such a loss occurred, and any such revenue shortfall would have a direct impact on our results
of operations for that quarter. Further, we outsource the manufacturing of our products based on forecasts of sales. If orders for our products exceed our forecasts, we may have difficulty meeting customers orders in a timely manner, which
could damage our reputation or result in lost sales. Conversely, if our forecasts exceed the 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 business, operating results and financial condition.







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





We do not manufacture our products. We rely on contract manufacturers to assemble, test and package our
products. We cannot assure you that these contract manufacturers and suppliers will be able to meet our future requirements for manufactured products, components and subassemblies. In addition, we believe that current market conditions have placed
additional financial strain on our contract manufacturers. Any interruption in the operations of one or more of these contract manufacturers would harm our ability to meet our scheduled product deliveries to customers. We also intend to regularly
introduce new products and product enhancements, which will require that we rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturers to provide
us with adequate supplies of high-quality products or the loss of a current contract manufacturer would cause a delay in our ability to fulfill customer orders while we obtain a replacement manufacturer and would harm our business, operating results
and financial condition. In addition, we have canceled certain finished goods and component orders, which may harm our relationship with certain contract manufacturers. Moreover, if we do not accurately forecast the actual demand for our products,
we may face supply, manufacturing or testing capacity constraints. These constraints could result in delays in the delivery of our products or the loss of existing or potential customers, either of which could harm our business, operating results or
financial condition.





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





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





We rely on third parties to test substantially all of our products; and if for any reason these third parties were unable to or did not adequately assist us
in controlling the quality of our products, this lack of quality control could harm our business, financial condition and results of operations.





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





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





We currently purchase most of the raw materials and components used in our products through our contract manufacturers. In procuring components for our products, we and our
contract manufacturers rely on some suppliers that are the sole source of those components, and we are dependent upon supplies from these sources to meet our needs. For example, field programmable gate array supplies used in our products are
purchased from Xilinx or Altera. We also depend on various sole source offerings from Broadcom, Dallas Semiconductor, Metalink US, Motorola, Flextronics Semiconductor and SaRonix for certain of our products. If there is any interruption in the
supply of any of the key components currently obtained from a single or limited source, our ability to obtain these components from other sources could entail a substantial lead time which could require us to redesign our products or, if we do not
redesign our products to avoid such a lead time, could disrupt our operations and harm our business, financial condition and results of operation in any given period.




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Our business relies on the continued growth of the Internet; any slowdown in or reversal of the
growth of Internet use could materially and adversely impact our business.





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





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





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





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





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





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





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




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





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





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




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




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




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




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




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




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





Fluctuations in currency exchange rates may harm our business.





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





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





Our future success and
ability to compete depends in part on our proprietary technology. We rely on a combination of copyright, patent, trademark and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. We currently hold 27
United States patents and have 25 United States patent applications pending. However, we cannot assure you that patents will be issued with respect to pending or future patent applications that we have filed or plan to file or that our patents will
be upheld as valid or will prevent the development of competitive products or that any actions we have taken will adequately protect our intellectual property rights.





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




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





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





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





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





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





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





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. Moreover, we believe that our IntelliPOP
products will add a significant layer of complexity to the demands on our customer support organizations. We have limited experience with widespread deployment of our products to a diverse customer base, and we cannot assure you that we will have
adequate personnel to provide the levels of support that our customers may require during initial product deployment or on an ongoing basis. In addition, we rely on a third party for a substantial portion of our customer support functions, and
therefore, we may have limited control over the level of support that is provided. Our failure to provide sufficient support to our customers could delay or prevent the successful deployment of our products. Failure to provide adequate support could
also have an adverse impact on our reputation and relationship with our customers, could prevent us from gaining new customers and could harm our business, financial condition or results of operations.




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





We depend on the performance of Salvatore DAuria, our President, Chief Executive Officer, Chairman of the Board, Chief Financial Officer and Secretary, and on other senior management and
technical personnel with experience in the data communications, telecommunications and high-speed data access industries. The loss of any one of them could harm our ability to execute our business strategy. Additionally, we do not have employment
contracts with any of our executive officers. We believe that our future success will depend in large part 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 has fluctuated and is likely to continue to fluctuate, and you may not be able to resell your
shares at or above their purchase price.





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





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




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




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




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




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




| |  |  | our announcement of a significant acquisition, strategic partnership, joint venture or capital commitment;
| | - |  | ----------------------------------------------------------------------------------------------------------




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




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




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




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





Our stock may be delisted from the Nasdaq National Market.





At the closing of the Nasdaq National Market on October 9, 2002, the minimum bid price of a share of our common stock was $0.49. Nasdaq
corporate governance rules require that all shares listed on the Nasdaq National Market maintain a minimum bid price at closing of $1.00 per share. Our failure to maintain such a minimum bid price for a period of thirty or more consecutive trading
days could result in the Nasdaq governing board taking action to remove our shares from the Nasdaq National Market. Since July 26, 2002, the minimum closing bid price of our common stock has consistently been below $1.00 per share. On September 9,
2002, we received a Nasdaq delisting notice because our common stock had closed below $1.00 per share for 30 consecutive trading days. If the bid price of our common stock does not close at $1.00 per share or more for a minimum of 10 consecutive
trading days before December 9, 2002, our stock will be delisted from the Nasdaq National Market. The delisting of our common stock as well as the threat of delisting of our common stock may negatively impact the value of our shares because shares
that trade on the over-the-counter market, rather than the Nasdaq National Market, are typically less liquid and, therefore, trade with larger variations between the bid and asking price.




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





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





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





Sales of a substantial number of shares of our common stock in the public market, or the appearance that these shares are available for sale, could harm the market price of our common stock. These sales also may make it more
difficult for us to sell equity securities or equity-related securities in the future at a time and price that we deem appropriate. As of September 30, 2002, we had 16,482,334 shares outstanding and currently available for sale in the public market,
some of which are subject to volume and other limitations under securities laws.





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





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





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





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




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




We are exposed to changes in interest rates primarily from our investments in certain held-to-maturity securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of interest-sensitive financial instruments at September 30, 2002.





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





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




Evaluation of
disclosure controls and procedures.    Based on the evaluation as of a date within 90 days of the filing date of this quarterly report on Form 10-Q, Salvatore DAuria, our Chief Executive Officer and Chief Financial
Officer, has concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by us in reports that we
file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.





Changes in internal controls.    There were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore, there were no corrective actions taken.




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PART II.    OTHER INFORMATION





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




Beginning July 12, 2001, six
putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against us and certain of our current and former officers and directors. The complaints were filed on behalf of a
purported class of people who purchased our stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that we and certain of our current and former officers and directors made false and
misleading statements about our business during the putative class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have been consolidated under the
name In re Tut Systems, Inc. Securities Litigation,Civil Action No. C-01-2659-JCS. Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants
filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the court granted in part and denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants have not responded to that complaint.
We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.





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





On October 30, 2001, we
and certain of our current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the
Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from our January 29, 1999 initial
public offering and our March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and former officers and directors under
Section 11 of the Securities Act of 1933, as amended (the 1933 Act) and under Section 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934, as amended, and alleges claims against certain of our current and former officers and
directors under Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the underwriters for our initial public offering and secondary offering. We believe the allegations against us are without merit and intend to defend the
action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, or financial condition.





ITEM 2.CHANGES IN SECURITIES AND USE OF PROCEEDS





None





ITEM 3.DEFAULTS UPON SENIOR SECURITIES





None





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





None





ITEM 5.OTHER INFORMATION





None




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ITEM 6.EXHIBITS AND REPORTS ON FORM 8-K





(a)  Exhibits





Exhibit Number

Description2.1

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

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

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

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

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

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

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

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

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

Specimen Common Stock Certificate.(1)10.25

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

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

Calculation of net loss per share (contained in Note 3 of Notes to Condensed Consolidated Financial Statements).99.1

Certification of CEO and CFO.


---

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

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

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

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

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

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

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

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




(b) Reports on Form 8-K.





The Company did not file any reports on Forms 8-K during the quarter ended September 30, 2002.




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SIGNATURE





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





TUT SYSTEMS, INC.By:

LOGOSalvatore DAuria Chairman, President, Chief Executive Officer, Chief Financial Officer and Secretary (Principal Executive, Financial and Accounting Officer and Duly Authorized Officer)





Date:  October 31, 2002




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CERTIFICATION





I, Salvatore DAuria, certify that:





1.  I have reviewed this quarterly report on Form 10-Q of Tut Systems, Inc.;





2.  Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;





3.  Based on my knowledge, the financial statements, and other financial information included in this quarterly
report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;





4.  I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and I have:





a)  designed such disclosure controls and procedures to
ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this quarterly report is being prepared;





b)  evaluated the effectiveness of the registrants disclosure controls and procedures as of a
date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c)  presented in this quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;





5.  I have disclosed, based on my most recent evaluation, to the registrants auditors and the audit committee of registrants
board of directors (or persons performing the equivalent functions):





a)  all
significant deficiencies in the design or operation of internal controls which could adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any
material weaknesses in internal controls; and





b)  any fraud, whether or not material,
that involves management or other employees who have a significant role in the registrants internal controls; and





6.  I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my
most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.





LOGOSalvatore DAuria Chairman, President, Chief Executive Officer, Chief Financial Officer and Secretary





Date: October 31, 2002




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INDEX TO EXHIBITS





Exhibit Number

Description2.1

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

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

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

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

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

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

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

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

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

Specimen Common Stock Certificate.(1)10.25

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

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

Calculation of net loss per share (contained in Note 3 of Notes to Condensed Consolidated Financial
Statements).99.1

Certification of CEO and CFO.


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|(1) |  | Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-60419) as declared effective by the Securities and Exchange Commission on
January 28, 1999.
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|(2) |  | Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
|--- |  | ---------------------------------------------------------------------------------------------------

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

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

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

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

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

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



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