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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                ---------------

                                   FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934
  For the fiscal year ended December 31, 2000

[_] Transition Report pursuant to Section 13 or 15(d) of the Securities
    Exchange Act of 1934
  For the transition period from          to

                       Commission File Number: 000-25291

                                ---------------

                               TUT SYSTEMS, INC.
             (Exact name of Registrant as specified in its charter)

<TABLE>
<S>                                <C>
            Delaware                                 94-2958543
  (State or other jurisdiction                    (I.R.S. Employer
of incorporation or organization)                Identification No.)
</TABLE>

<TABLE>
<S>                                       <C>
      5964 West Las Positas Blvd.
         Pleasanton, California                               94588
(address of principal executive offices)                    (zip code)
</TABLE>

       Registrant's telephone number, including area code: (925) 460-3900

        Securities registered pursuant to Section 12(b) of the Act: None

   Securities registered pursuant to Section 12(g) of the Act: Common Stock,
                                $0.001 par value
                                                         (Title of Class)

                                ---------------

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

   Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

   The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $130,349,604 as of December 31, 2000 based on the
closing price of the Common Stock as reported on The Nasdaq Stock Market for
December 29, 2000. There were 15,910,796 shares of the Registrant's Common
Stock issued and outstanding on December 31, 2000.

                      DOCUMENTS INCORPORATED BY REFERENCE

   Certain information called for by Part III is incorporated by reference to
the definitive proxy statement for the annual meeting of the stockholders,
which will be filed with the Securities and Exchange Commission not later than
120 days after December 31, 2000.

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                               TUT SYSTEMS, INC.
                           ANNUAL REPORT ON FORM 10-K
                               TABLE OF CONTENTS

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<CAPTION>
                                                                           Page
                                                                           ----

ITEM NO.

PART I

<S>                                                                        <C>
  1.   BUSINESS..........................................................    1
  2.   FACILITIES........................................................   11
  3.   LEGAL PROCEEDINGS.................................................   12
  4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............   12

PART II

  5.   MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED  STOCKHOLDER
        MATTERS..........................................................   13
  6.   SELECTED CONSOLIDATED FINANCIAL DATA..............................   14
  7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
       RESULTS OF OPERATIONS.............................................   15
  7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........   35
  8.   CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..........   36
  9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.............................................   61

PART III

  10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................   61
  11.  EXECUTIVE COMPENSATION............................................   61
  12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....   61
  13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................   61

PART IV

  14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
        FORM 8-K.........................................................   61
</TABLE>
<PAGE>

                                     PART I

                IMPORTANT NOTE ABOUT FORWARD-LOOKING STATEMENTS

   This Annual Report on Form 10-K contains "forward-looking statements." These
forward-looking statements include, but are not limited to, statements about
our plans, objectives, expectations and intentions and other statements
contained in this Annual Report on Form 10-K that are not historical facts.
When used in this Annual Report on Form 10-K, the words "anticipates,"
"believes," "continue," "could," "estimates," "expects," "intends," "may,"
"plans," "seeks," "should" or "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. Such risks and
uncertainties include those set forth in Part II, Item 7--Management's
Discussion and Analysis of Financial Condition and Results of Operations. 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 relating to our operations, results of operations, growth strategy
and liquidity. 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.

ITEM 1. BUSINESS

Overview

   Our principal executive offices are located at 5964 West Las Positas
Boulevard, Pleasanton, California 94588. Our telephone number is (925) 460-
3900. We were incorporated in California in August 1983, began operations in
August 1991, and reincorporated in Delaware in September 1998.

   We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access to multi-tenant
buildings. We use our proprietary FastCopper technologies to deliver cost-
effective, scalable and easy to deploy solutions that exploit the underutilized
bandwidth of copper telephone wires within these buildings. Our products also
provide service providers with enhanced capabilities such as subscriber
management, bandwidth management, plug and play installation, portal
redirection, internet protocol address management, or IP address management,
service authorization and network address translation. In addition, we recently
introduced our IntelliPOPTM product which utilizes our proprietary Signature
SwitchTM technology and is designed to allow service providers to manage and
guarantee bandwidth and service performance across applications such as IP
telephony, virtual private networking, or VPN networking, videoconferencing,
video-on-demand, file transfer and Internet access and to efficiently configure
IntelliPOP for the delivery of these services according to the unique market
requirements of multi-tenant building owners and end-user subscribers on an
individual or collective basis. Our systems and related services are designed
with the specific requirements of the multi-tenant unit, or MTU, market in mind
and enable service providers in this market to increase their revenue by
providing additional services and increase customer retention through bundled
service offerings.

Industry Background

 Increasing Demand for High-Speed Internet Access

   In recent years, there has been a dramatic increase in demand by businesses
and consumers for high-speed data access to the Internet and to private
corporate networks. This demand is being driven by the growth in users who are
accessing networks for a variety of applications, including communications via
the Internet and corporate intranets, electronic commerce, and telecommuting.
This growth is projected to continue to increase rapidly over the next several
years. As an example of the growth in high-speed access, the Vertical Systems
Group has projected that total digital subscriber line, or DSL, connections in
the United States will increase from 560 thousand in 1999 to over 7.7 million
in 2003. Vertical Systems Group also projected that worldwide DSL connections
would grow from 637 thousand in 1999 to over 16 million in 2003.

                                       1
<PAGE>

   To meet this increasing need for high-speed access, telecommunications
service providers have significantly upgraded both backbone and local networks
with broadband fiber optic facilities and high-speed switches, routers, and
multiplexers. In some cases, these service providers are bringing fiber optic
links all the way to residential neighborhoods or to the basements of
commercial office buildings. In addition, other service providers are building
wireless broadband access networks using recently available radio spectrum, or
are using hybrid fiber coaxial cable networks that are traditionally used to
provide cable TV service. Service providers may also use the copper-based
infrastructure of an incumbent local exchange carrier, or ILEC, or a government
controlled post, telephone and telegraph company, or PTT, to offer DSL-based
services. These new networks offer speeds more than 20 times faster than
today's 56 kbps dial-up modems.

   Although service providers are bringing broadband facilities closer to
residential and commercial end users, they remain challenged by the cost and
logistics associated with extending this bandwidth all the way to Internet
devices in a consumer's home or to the local area network, or LAN, of a small
business office. These challenges are particularly acute in MTU complexes where
the end-user typically does not directly own the network infrastructure in
place, and where the majority of the existing infrastructure tends to be the
copper wires being used to provide existing telephone service.

   The MTU market can be separated into two markets: residential and
commercial. The residential MTU market, also known as the multi-dwelling unit,
or MDU, market, consists primarily of apartments, hotels, and university
dormitories. Data from the U.S. Census Bureau indicates that the domestic
apartment market totals over 21 million individual tenant units, with 9 million
of these units being located in buildings or complexes of 50 or more units.
Data from the U.S. Department of Commerce indicates that the domestic hotel
market consists of 1.7 million rooms, with 1.4 million rooms in buildings of
more than 100 rooms. We believe that these larger buildings and complexes are
the initial target for high-speed Internet access. The commercial MTU market,
also known as the multi-tenant commercial unit, or MCU, market, represents
office complexes and other business-related facilities. According to data from
Torto Wheaton Research, there is more than 2.5 billion square feet of rentable
commercial office space in the 54 largest metropolitan markets across the
United States.

 MTU Market Characteristics

   Since the demand for high-speed Internet access has increased significantly
over the last couple of years, we believe that owners and managers of
apartments, hotels and commercial properties have begun to view high-speed
Internet access as a critical enhanced service for their residents, guests and
tenants. There is demand from owners of MTU complexes and buildings to offer
Internet access and other broadband services as an amenity that effectively
attracts and retains occupants, thereby increasing revenue and profitability.

   Given the complexity and cost of deploying broadband services, many property
owners prefer to outsource ownership, installation, operation and management of
high-speed Internet solutions to an MTU-focused service provider. In exchange
for granting a service provider the ability to market and provide
telecommunications services to their properties, these MTU owners have an
opportunity to offer new Internet-enabled services and to potentially share in
some of the service revenues generated from their buildings. These services
enable on-line reservation of building amenities, community message boards, e-
commerce and electronic payment of rent.

   A set of specialized service providers and divisions of incumbent service
providers have emerged over the last few years to fill the growing demand for
high-speed Internet service to the MTU market. While high-speed Internet access
is the primary service delivered by these service providers today, we believe
that the delivery of multiple services, such as high-speed corporate
networking, packet voice and IP video, will be the key to meeting future
customer needs and driving service provider profitability through bundled
service offerings. The MTU market is attractive to these service providers
because of the efficiency of delivering multiple services, often on an
exclusive basis, to a geographically concentrated and demographically similar
customer base.

                                       2
<PAGE>

 Infrastructure Requirements for MTU Service Providers

   Service providers marketing to MTU owners and tenants typically concentrate
their networks, as well as sales and marketing efforts within major
metropolitan areas. In each local service area, a service provider will locate
a metropolitan point-of-presence, or metro POP, that will concentrate high-
speed, last mile access links from multiple MTUs, provide value-added services
such as web hosting and e-mail, manage subscriber access, centralize billing,
and provide an efficient link to backbone Internet or intranet networks.

   The high-speed links from a service provider's metro POP to individual MTU
buildings or complexes may consist of local T1 facilities sourced from an ILEC,
xDSL facilities sourced from a competitive local exchange carrier, or CLEC, or
self-provisioned fiber, coaxial cable, or radio facilities.

   Once broadband access is brought to the MTU, another broadband distribution
network needs to be created within the building to bring the offered services
to tenants. Alternatives for creating this network include rewiring the
building with Category 5 copper wire for Ethernet, laying a new fiber-based
infrastructure or reusing the copper infrastructure that is already in place to
provide telephone service. Rewiring with Category 5 wire or laying new fiber
links can be prohibitively expensive on a per-subscriber basis because in most
cases a service provider will only have demand from a limited number of tenants
in the building, yet the entire building will need to be rewired to accommodate
future and changing requirements. Similarly, carrier class DSL access
multiplexers, known as DSLAMs, which are designed to serve hundreds of
subscribers over the existing telephone wires, are prohibitively expensive when
only serving a limited number of tenants.

   We believe that service providers for the MTU market require systems that:

  .  deliver reliable high-quality broadband access services in a cost
     effective manner;

  .  are easy to deploy and provision, and are economically scalable from as
     few as four subscribers in small buildings to hundreds of subscribers in
     large complexes;

  .  support and manage the bandwidth for multiple services such as voice,
     video, and VPN networking so as to maximize both the network
     infrastructure and the sales, marketing and operations infrastructure of
     the service provider; and

  .  are remotely controlled, maintained and upgraded as required.

   We believe that systems with these characteristics enable service providers
to increase their revenue by providing additional services and increase
customer retention through bundled service offerings.

The Tut Systems Solution

   We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access over the existing
copper telephone infrastructure found in MTU complexes, such as apartment
buildings, hotels, business parks and commercial office buildings. Our systems
also provide service providers with enhanced capabilities such as subscriber
management, bandwidth management, plug and play installation, portal
redirection, IP address management, service authorization and network address
translation. Our systems are designed with the specific requirements of the MTU
market in mind and provide the following benefits to our customers:

  .  Reliable, high performance, cost-effective, broadband access. Our access
     products use our proprietary FastCopper technology to exploit the
     underutilized bandwidth of existing MTU infrastructures by reducing the
     noise, radio frequency interference and signal cross talk inherent in
     high-speed data transmission over copper telephone wires. Our technology
     enables cost-effective Ethernet LANs to be quickly implemented over
     these telephone wires, without interfering with existing telephone
     service that may be running over these same wires. Our proprietary
     HomeRun technology has been adopted as the first generation standard for
     home networking over copper telephone wires by the Home Phone Network
     Alliance, or HomePNA, and is licensed to leading semiconductor, computer
     hardware and consumer

                                       3
<PAGE>

     electronics manufacturers. Our proprietary LongRun technology is similar in
     operation to our HomeRun technology, but provides higher performance in the
     presence of noise and cross-talk, and transmits over longer distances than
     HomeRun.

  .  Easy-to-deploy, scalable systems. Our Expresso GS, MDU and MDU Lite
     systems, which are integrated with our proprietary FastCopper
     technologies, provide low cost, high-speed bandwidth to multiple tenants
     within an MTU complex or building while meeting our service provider
     customers' ease-of-use and scalability requirements. The Expresso MDU
     unit is intended for deployment in the basements of apartment buildings,
     in wiring rooms of hotels and in other residential locations where
     access lines are centrally concentrated. Our compact MDU Lite product
     extends the delivery of high-speed services to tenants living in the
     smaller buildings typically found in garden style apartment complexes.

  .  Multiple value-added, revenue-enhancing services. Our Expresso SMS 2000
     and Expresso OCS systems provide plug-and-play functionality, subscriber
     management, community web pages, credit card billing and other functions
     for the MDU market. When used to provide high-speed Internet access to
     hotel guests, the Expresso SMS 2000 system interfaces with our Expresso
     MDU system to provide a simple plug-and-play experience for the guest
     without disturbing normal phone service or requiring computer
     reconfiguring by the guest. Our recently introduced IntelliPOP product
     is designed to allow service providers to manage and guarantee bandwidth
     and service performance across applications such as IP telephony, VPN
     networking, videoconferencing, video-on-demand, file transfer and
     Internet access and to efficiently configure the delivery of these
     services according to the unique market requirements of multi-tenant
     building owners and end-user subscribers on an individual or collective
     basis.

  . Our recently introduced IntelliPOP product is designed to allow service
    providers to manage and guarantee bandwidth and service performance
    across applications such as IP telephony, VPN networking,
    videoconferencing, video-on-demand, file transfer and Internet access and
    to efficiently configure the delivery of these services according to the
    unique market requirements of multi-tenant building owners and end-user
    subscribers on an individual or collective basis.

  . Our products use industry-standard protocols for interoperability with
    third-party systems and are based on industrial-grade computing platforms
    for continuous industry-driven improvements in price and performance.

Strategy

   Our objective is to be the dominant provider of advanced multi-service
broadband access systems that exploit the large existing infrastructure of
copper telephone wires within multi-tenant complexes, such as apartment
buildings, hotels, office buildings, business parks, university dormitories
and other buildings. Key elements of our business strategy are as follows:

   Facilitate Rapid Growth in MDU Markets. We market our Expresso MDU and
related products to service providers that are focused on the residential MDU
market and can benefit from highly-scalable Internet access solutions with low
initial deployment costs. We actively work with our customers both to deploy
systems in additional properties as well as to facilitate the adoption of
broadband access services by tenants in buildings in which our systems are
already deployed. We intend to continue to focus our direct sales and
marketing efforts on establishing additional customer relationships with large
MDU service providers. In addition, we intend to reach smaller service
providers through our network of value added resellers, or VARs, and systems
integrators.

   Accelerate Penetration in MCU Markets. We plan to accelerate our
penetration of the commercial MCU market with our IntelliPOP system that has
been designed to offer speeds greater than 10 Mbps over single-pair,
telephone-grade wire. Using a patent-pending Signature Switch architecture,
IntelliPOP is designed to allow service providers to quickly and cost-
effectively deliver multiple, high-performance broadband services

                                       4
<PAGE>

through classification and prioritization of device and/or application-specific
network traffic. IntelliPOP is currently being evaluated by several potential
customers.

   Enhance the Service Capabilities Provided by our Products and Systems. By
adding higher-level features and functions above the basic data transport
layer, such as subscriber management, network address translation, traffic
prioritization, bandwidth limiting, IP telephony and VPN networking support to
our product line, we enable our service provider customers to expand the range
of services that they can market and deploy to their customers. Service
providers, in turn, can leverage their sales and marketing efforts, reduce
customer turnover, and have a higher revenue-to-cost portfolio of services. We
intend to lower the total cost of system ownership for our customers by
reducing manufacturing costs, expanding the self-provisioning features of our
systems, and enhancing network management capabilities. In addition, we expect
to utilize technology obtained from our FreeGate, Xstreamis and ActiveTelco
acquisitions in the further development of our IntelliPOP product platform.

   Expand International Presence. We believe that our Expresso and IntelliPOP
product lines, which have been developed in conformance with international
standards, can serve a substantial market for high-speed data access products
outside of the United States. We are adding personnel in several key
international markets and are actively seeking to add new international
distributors who focus on the MTU market.

Core Technologies and Products

   We have developed a broad base of proprietary FastCopper technology to
address noise and distortion problems so that high-speed data access can be
achieved over a single pair of ordinary copper telephone wires used in
corporate and educational campuses, apartment buildings, hotels and single
family homes. Our FastCopper technology encompasses three main areas of
expertise to maximize transmission rates at minimum costs over existing copper
telephone wires: noise reduction, analog and digital signal processing to
reduce distortion, and digital modulation techniques. Our FastCopper expertise
is deployed in our HomeRun, LongRun and other transmission technologies.

   HomeRun creates a cost-effective Ethernet LAN over the random topology of
home telephone wires, without disturbing existing telephone service and/or
G.lite asymmetrical DSL, or G.lite ADSL, service running simultaneously over
these same wires. With HomeRun, multiple devices can share peripherals and/or a
single high-speed Internet access connection on a 1 Mbps Ethernet LAN. HomeRun
supports Internet connections through integrated services digital network, or
ISDN, or xDSL wireline technologies, a wireless modem or a cable modem. LongRun
shares similar modulation techniques with HomeRun, but operates at lower
baseband frequencies to provide improved performance in the presence of intra-
system crosstalk and coverage of longer distances that may be found in many
apartment, hotel, and university dormitory complexes. HomeRun is designed to
operate at distances up to 500 feet, while LongRun is intended to operate at
distances up to 2,500 feet.

   The following products are based in part on this FastCopper technology
foundation and are augmented by additional technologies that allow for enhanced
capabilities:

 Expresso System Platforms

   Our Expresso MDU products are designed to be used by ILECs, PTTs, CLECs and
other service providers to provide high-speed advanced data services to large
numbers of end users over private copper network infrastructures. Expresso MDU
is AC-powered and, when integrated with our HomeRun or LongRun technology,
provides owners of private copper networks with an easy to deploy and scalable
means to distribute high-speed data access to tenants over the copper telephone
wires found in MTUs. In addition, we offer our Expresso GS system, which is DC-
powered and intended for use by service providers to serve last mile
applications using xDSL technologies.


                                       5
<PAGE>

   An Expresso MDU or Expresso GS system consists of a compact, modular
central-site shelf with a simple network management protocol, or SNMP,
management card, optional switching, multiplexing and wide-area network, or
WAN, interface cards, and up to 17 xDSL, HomeRun or LongRun line cards. The 10
1/2 inch high system is available with two mounting options, either 19 inches
wide for data center and international installations or 23 inches wide for
telephone company installations.

   Each Expresso MDU and Expresso GS shelf can support up to 136 line-side
subscriber connections, making the Expresso MDU and Expresso GS platforms among
the highest density xDSL platforms in the industry. Multiple Expresso MDU and
Expresso GS shelves can be interconnected via 10 or 100Base-T Ethernet
connections, allowing the systems to accommodate hundreds of subscribers on a
common WAN interface.

 Expresso MDU

   Expresso MDU integrates our HomeRun and LongRun technologies with our
flexible Expresso platform to provide owners of MDUs with easy to deploy,
scalable and cost-effective solutions to distribute high-speed data access to
multiple tenants over the private copper networks within MDUs. The Expresso MDU
platform has been designed for deployment in residential locations, such as in
the basement wiring room of an apartment building. Expresso MDU can be equipped
with HomeRun and/or LongRun line cards to provide a secure Ethernet LAN for
each living unit within an MDU. We have developed HomeRun and LongRun adapters
that convert HomeRun/LongRun signals to a standard 10Base-T Ethernet interface.
Consumer products, such as PCs, peripherals, Internet telephones and
television-based web browsers, that are compatible with either version 1.0 or
version 2.0 of HomePNA can directly connect to the Expresso MDU without the
need for any additional adapter or network interface card.

 Expresso MDU Lite

   To provide service to small apartment buildings spread across a garden-style
complex in which there is no central wiring point, we developed the Expresso
MDU Lite and the Expresso LongRun MDU Lite. The former is intended for domestic
and international markets, while the latter is primarily intended for
international markets. The Expresso MDU Lite contains either eight ports of
HomeRun or eight ports of LongRun. Multiple units may be connected together to
support more than eight subscribers and these units may be connected back to a
central point via LongRun copper-based products, coax-based cable modems, or
radio-based modems.

 Expresso GS

   For local loop applications, we offer the Expresso GS system, which consists
of xDSL line cards connected to MXL-2300 series routers. The MXL-2300 series
routers, when used with a synchronous DSL, or SDSL, 2.3 line card, will provide
access at 2.3 Mbps. Our dynamic SmartWire SDSL rate adaptation enables all
subscribers to be served at the highest attainable speeds over each loop.
Through Expresso's All-Rate DSL feature, a service provider can offer tiered
access services in increments of 64 Kbps to meet the varying bandwidth and
price requirements of each subscriber. Expresso's All-Rate DSL feature also
allows service providers to offer a low cost, low bandwidth, entry level
service that can expand to higher bandwidth capabilities as each subscriber's
need for bandwidth expands. Our MXL-2300 routers provide a standard 10Base-T
interface for connection to users' PCs or LANs.

 Expresso SMS 2000

   Our Expresso SMS 2000 and companion Expresso OCS system provide plug-and-
play functionality, subscriber management, network address translation, credit
card billing, and other functions for the MDU market. The compact 1 3/4 inch
high Expresso SMS 2000 system runs on a Red Hat Linux operating system, is
typically located on the premises of an MDU complex and supports up to 800
simultaneous user sessions per unit. The companion Expresso OCS operations
center software is intended to be located at a metro POP or

                                       6
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central network operations center. The Expresso OCS system is a software
package that runs on a standard PC computing platform. Each Expresso OCS system
can manage up to 300 remote Expresso SMS systems, providing central credit card
billing interfaces, accounting records, and access to the accounting and policy
data bases most often used by CLECs and Internet Service Providers, or ISPs.

 IntelliPOP System

   The recently introduced IntelliPOP system, currently under evaluation by
potential customers, includes the 5212 12-port Service Gateway and the 5101
Service Access Unit. A comprehensive Tut Management System is under development
that will allow full utilization of the service management aspects of
IntelliPOP. The IntelliPOP 5212 Service Gateway is a small service platform,
less than two inches high, that combines the functionality of an edge router, a
high-speed switch, and an access multiplexer with powerful bandwidth management
tools to distribute multiple IP-based services to individual tenants throughout
a small or mid-sized commercial building. The IntelliPOP 5212 Service Gateway
incorporates 12 very high speed DSL-based, or VDSL-based, line-side ports, each
of which can deliver up to 15 Mbps of symmetric bandwidth to a 5101 customer
premises unit. The 5101 Service Access Unit includes two 10Base-T ports for
interfacing to a variety of end-user devices and/or networks.

   Subsequent versions of IntelliPOP are under development that will
incorporate higher access speeds, higher port capacities, and features
specifically tailored for the apartment and hospitality markets.

 XL Products

   We use our FastCopper technology, along with commercially available
components, to build high-speed data access products. In the XL600 product
series, we applied our noise reduction and signal processing expertise to build
a 10Mbps, 600 foot Ethernet LAN extension product to operate over a single pair
of copper telephone wires. For other XL products, we pioneered the use of rate
adaptive SDSL technology in products that extend transmission distances up to
24,700 feet without the use of repeaters. For HomeRun, we developed a
proprietary modulation technique to transmit high-speed data signals over the
random tree and branch networks typically found in single family homes. In the
XL 4000 product, we applied our noise reduction and signal processing expertise
to enable a 10 Mbps Ethernet LAN extension at distances up to 4,000 feet over a
single copper pair.

Customers and Markets

   We target our development, marketing and sales efforts to service providers
in both the MDU and MCU markets.

 MDU Market

   Service providers, including ILECs, PTTs, CLECs, ISPs and multiple system
operators for the cable industry, can recognize substantial economies of scale
by providing high-speed services to MDU tenants from a single point of service.
MDUs include apartment complexes, hotels, university dormitories and military
housing complexes. We believe that the potential international MDU market
represents a strategic opportunity for us.

   Our potential customers in the MDU market include both service providers who
seek to sell services to MDU tenants and owners of MDU complexes who seek to
offer advanced amenities to their tenants, increase property value, and/or gain
additional revenue from the property. Our Expresso SMS 2000 system has been
designed with features to specifically address the needs of this market. Among
our Expresso MDU customers throughout most of the calendar year 2000 were CAIS,
Inc., Darwin Networks, Inc., I-Quest Corporation, Reflex Communications, Inc.,
and Velocity HSI, Inc. Abrupt changes in the capital markets have led each of
these companies to narrow the focus of their market activities and severely
curtail previous levels of operations including their deployment of our
product. In the case of Darwin Networks, Inc., in January 2001, they filed for

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Chapter 11 bankruptcy protection. In the case Reflex Communications, Inc., in
March 2001, they filed for Chapter 7 bankruptcy protection. We also saw a fall
off in sales to customers in the Korean market, including sales to TriGem
InfoComm, as a result of regulatory and other changes within that marketplace.
As a result, we are depending more heavily on the development of our
relationships with other international customers and the business divisions of
ILECs, CLECs and PTTs.

 MCU Market

   For some time there have been service providers focused on delivering voice
services to tenants in multi-tenant commercial buildings, but over the last few
years, a new class of service providers and business divisions of ILECs and
PTTs have emerged that plan to use broadband IP-based infrastructures to
provide a wide array of bundled services, including high-speed Internet access,
email, web hosting, firewall protection, local and long distance voice, and
business TV to tenants in multi-tenant commercial buildings. These MCU service
providers are demanding a low-cost, multi-service, broadband platform on which
to deliver this array of services to the small and medium size businesses that
tend to locate in MCUs. Among our current MCU customers are Cygcom Integrated
Technologies, Inc., Newcom Americas, Inc., Rikei Corporation and Rycom CCI,
Inc.

   The initial version of our IntelliPOP system has been designed to
specifically address the needs of the MCU market in terms of performance, size,
and ease of installation. We believe that IntelliPOP incorporates the high-
speed access technologies, high-performance processing technologies, and
sophisticated bandwidth management techniques required by business end users.
At the same time, the IntelliPOP Service Gateway is designed to be an easy-to-
deploy rack-mountable or wall-mountable unit that is less than two inches high
allowing for easy and cost-effective deployment in the smallest of multi-tenant
buildings. Several existing and potential customers are currently evaluating
the IntelliPOP product.

   For simple point-to-point applications, we market our XL products to
domestic and international end users for LAN extensions over existing copper
telephone wires. We have several hundred domestic and international customers
for our XL product line.

 Home Networking

   The growth in the demand for high-speed data access, the decreasing cost of
personal computers and the proliferation of Internet access devices in homes
are creating an emerging demand for home networking and access solutions. Home
networks must be designed to allow the sharing of files, the sharing of
peripherals, such as printers, the simultaneous, uninterrupted use of voice
service and, perhaps most importantly, the sharing of Internet and remote
corporate network access. Home network consumers desire a low cost, easy to
implement network solution that does not require new wires to be installed
throughout the home.

   We are licensing our HomeRun technology to members of the HomePNA and
others. In 1998, the HomePNA selected HomeRun as the initial specification for
a home networking standard. The founding members of the HomePNA were 3Com
Corporation, Advanced Micro Devices, Inc., Agere Systems (assigned from Lucent
Technologies, Inc.), AT&T Wireless Services, Broadcom Corporation (purchased
Epigram Corporation), Compaq Computer Corporation, Conexant Systems, Inc.,
Hewlett-Packard Co., Intel Corporation, International Business Machines and Tut
Systems. The HomePNA currently includes over 200 members.

Marketing, Sales and Customer Support

 Marketing

   We seek to increase demand for our products, expand company and product
visibility in the market and establish cooperative marketing programs. In
addition to customer-specific sales efforts, our marketing activities include
attendance at major industry trade shows and conferences, such as NetWorld +
InterOp, DSLcon, HiTech, National Multihousing Conference, and SuperComm, the
distribution of sales and product literature,

                                       8
<PAGE>

operation of a web site, advertising in trade journals and catalogs, direct
marketing and ongoing communications with our customers, the press and industry
analysts. As appropriate, we enter into cooperative marketing and/or
development agreements with strategic partners that may include key customers,
semiconductor manufacturers, radio, fiber, or cable equipment manufacturers,
set-top box manufacturers, and others.

 Sales

   We sell our products through multiple sales channels in the United States,
including a select group of regional VARs, systems integrators and
distributors, data networking catalogs and directly to service providers.
Internationally, we sell and market our products through sales agents, systems
integrators and distributors. In 1999 and 2000, we established new sales
channels in Canada, Europe, South America, Australia and Asia. In 1999, we
opened a sales office in the United Kingdom. For the year ended December 31,
2000, we derived approximately 41% of our revenue from customers in
international markets. We believe that our products can serve a substantial
market for high-speed data access products outside of the United States.

 Customer Support

   We believe that consistent high-quality service and support is a key factor
in attracting and retaining customers. Service and technical support of our
products is coordinated by our customer support organization located in
Pleasanton, California. Telecommunications and Networking Systems Engineers
provide critical technical support to our customers. Our Systems Application
Engineers, located in each of our sales regions, support pre- and post-sales
activities. We also employ a nationwide third party support organization to
handle inquiries from a large number of customers and provide first level
telephone technical support and on-site installation and support services.
Customers can also access technical information and receive technical support
through the Internet.

 Research and Development

   Our research and development efforts are focused on enhancing our existing
products and developing new products. Our research and development organization
emphasizes early stage system engineering. The product development process
begins with a comprehensive functional product specification based on input
from the sales and marketing organizations. We incorporate feedback from end
users and distribution channels, and through participation in industry events,
industry organizations and standards development bodies. Key elements of our
research and development strategy include:

  . Core Designs. We seek to develop platform architectures and core designs
    that allow for cost-effective deployment and flexible upgrades that meet
    the needs of multiple markets and applications. These designs emphasize
    quick time to market and future cost reduction potential. The Expresso
    GS/MDU and IntelliPOP platforms are a direct result of this strategy.

  . Product Line Extensions. We seek to extend our existing product lines
    through product modifications and enhancements in order to meet the needs
    of particular customers and markets. Products resulting from our product
    line extension efforts include the Expresso MDU Lite.

  . Use of Industry Standard Components. Our design philosophy emphasizes the
    use of industry standard hardware and software components whenever
    possible to reduce time to market, decrease the cost of goods and lessen
    the risks inherent in new design. We maximize the use of third party
    software for operating systems and certain protocol stacks which allows
    our software engineers to concentrate on hardware-specific drivers, user
    interface software and advanced features.

  . New Technologies. We seek to enhance our product lines by incorporating
    additional xDSL technologies, such as VDSL, higher speed WAN interfaces
    and new network management software features. Our IntelliPOP suite of
    products currently under customer evaluation is designed to utilize

                                       9
<PAGE>

   technology from our FreeGate, Xstreamis and ActiveTelco acquisitions and
   to incorporate components of our existing products, technologies and
   designs. We also seek to develop new product capabilities through software
   upgrades to our Expresso SMS 2000 platform.

Manufacturing

   We do not manufacture any of our own products. We rely on contract
manufacturers to assemble, test and package our products. We require ISO 9002
registration for these contract manufacturers as a condition of qualification.
We audit each contractor's manufacturing process performance through audits,
testing and inspections and monitor each contractor's quality through incoming
testing and inspection of packaged products received from each contractor. In
addition, we monitor the reliability of our products through in-house repair,
reliability audit testing and field data analysis.

   We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. We and our contract manufacturers
have experienced difficulty in obtaining some components used in our products.
We forecast our product requirements to maintain sufficient product inventory
to allow us to meet the short delivery times demanded by our large and diverse
customer base, which is typically one to four days from receipt of order to
shipment to the customer. However, because of recent changes in the industry,
we have had to cancel certain finished goods and component orders which may
have a negative impact on our ability to diversify our product manufacturing
across a larger base of contract manufacturers. Our future success will depend
in significant part on our ability to obtain manufacturing on time, at low
costs and in sufficient quantities to meet demand.

Competition

   The markets for our products are intensely competitive, continually
evolving and subject to rapid technological change. We believe that we and our
products face the following competitive factors:

  . conformance to industry standards;

  . breadth of product lines;

  . implementation of additional product features and enhancements, including
    improvements in product performance, reliability, size, and scalability;

  . low cost and ease of deployment and use;

  . sales and distribution capability;

  . technical support; and

  . service and general industry and economic conditions.

   Although we believe that we currently compete favorably with respect to all
of these factors, there can be no assurance that we will have the financial
resources, technical expertise or marketing, manufacturing, distribution and
support capabilities to compete successfully in the future. We expect that
competition in each of our markets will increase in the future. Our principal
competitors include or are expected to include Cisco Systems, Inc., Copper
Mountain Networks, Inc., Elastic Networks, Inc., Paradyne Networks, Inc., and
a number of other public and private companies. Many of our competitors and
potential competitors have substantially greater name recognition and
technical, financial and marketing resources than us. These competitors may
undertake more extensive marketing campaigns, adopt more aggressive pricing
policies and devote substantially more resources to developing new products
than us. There can be no assurance that we will be able to compete
successfully against current or future competitors or that competitive
pressures faced will not harm our business, financial condition and results of
operations. In addition, some of our licensees may sell aspects of our
technology to our competitors or potential competitors. These competitors may
cause an erosion in the

                                      10
<PAGE>

potential market for our products. This competition could result in price
reductions, reduced profit margins and loss of market share, which would harm
our business, financial condition and results of operations.

   We also compete with technologies using alternative transmission media such
as coaxial cable, wireless facilities and fiber optic cable. 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 homeowners and
businesses install other transmission media within buildings, we expect that
demand for our copper telephone wire-based products will decline. These
competitive pressures from alternative transmission technologies may further
necessitate price reductions of our existing and future products.

Proprietary Rights

   Our success and ability to compete is dependent in part upon our proprietary
technology. We rely on a combination of patent, copyright and trade secret laws
and non-disclosure agreements to protect our proprietary technology. We
currently hold 20 United States patents and have 24 United States patent
applications pending. There can be no assurance that patents will be issued
with respect to pending or future patent applications or that our patents will
be upheld as valid or will prevent the development of competitive products. We
seek to protect our intellectual property rights by limiting access to the
distribution of our software, documentation and other proprietary information.
In addition, we enter into confidentiality agreements with our employees and
certain customers, vendors and strategic partners. The steps taken by us in
this regard may be inadequate to prevent misappropriation of our technology and
our competitors may independently develop technologies that are substantially
equivalent or superior to our technologies. We are also subject to the risk of
adverse claims and litigation alleging infringement of the intellectual
property rights of others. In this regard, there can be no assurance that third
parties will not assert infringement claims in the future with respect to our
current or future products or that any of these claims will not require us to
enter into license arrangements or result in protracted and costly litigation,
regardless of the merits of those claims. No assurance can be given that any
necessary licenses will be available or that, if available, these licenses can
be obtained on commercially reasonable terms.

Employees

   As of February 19, 2001, we employed 223 persons, including:

  . 23 in operations;

  . 75 in sales, marketing and customer support;

  . 88 in research and development; and

  . 37 in finance, administration, and information technology support.

   We also employ a number of contract employees, especially for technical
publications and systems verification. None of our employees are represented by
a labor union and we have experienced no work stoppages to date.

ITEM 2. FACILITIES

   Our principal administrative and engineering facilities are located in
facilities totaling approximately 89,000 square feet located in Pleasanton,
California. In addition, we lease sales and administrative facilities totaling
approximately 2,600 square feet in Beaverton, Oregon, and engineering and
administrative facilities totaling approximately 20,200 square feet in
Sunnyvale, California. We also lease engineering facilities in Ann Arbor,
Michigan. The lease for the Pleasanton facility expires in April 2007, with an
option to renew for five years, the lease for the Oregon facility expires in
March 2002, the lease for the Sunnyvale facility expires in August 2002 and the
lease for the Ann Arbor facility expires in December 2001. We recently vacated
offices in Pleasant Hill, California and Oakland, California. The lease for the
Pleasant Hill facility expires in May 2001 and the lease for the Oakland
facility expires in April 2001. We currently sublet certain of our facilities.
We

                                       11
<PAGE>

believe that our facilities will be adequate to meet our requirements for the
foreseeable future and that suitable additional or substitute space will be
available as needed.

ITEM 3. LEGAL PROCEEDINGS

   We are not a party to any material litigation and we are not aware of any
pending or threatened litigation that could have a material adverse effect upon
our business, operating results or financial condition.

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

   None.

                                       12
<PAGE>

                                    PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
        MATTERS

   Our common stock has been quoted on the Nasdaq National Market under the
symbol "TUTS" since our initial public offering in January 1999. The following
table sets forth, for the periods indicated, the high and low closing sales
prices per share of the common stock, as reported on the Nasdaq National
Market.

<TABLE>
<CAPTION>
                                                                 High     Low
                                                                ------- -------
<S>                                                             <C>     <C>
1999:
  First Quarter (from January 29, 1999)........................ $ 76.13 $ 39.75
  Second Quarter...............................................   70.19   38.00
  Third Quarter................................................   47.25   22.44
  Fourth Quarter...............................................   56.50   24.94
2000:
  First Quarter................................................   72.38   39.00
  Second Quarter...............................................   63.13   31.38
  Third Quarter................................................  115.50   55.44
  Fourth Quarter...............................................   79.25    6.16
</TABLE>

   On March 19, 2001, the last reported sale price of our common stock on the
Nasdaq National Market was $3.81 per share. As of March 19, 2001, there were
16,241,973 shares of our common stock outstanding and approximately 276 holders
of record of our common stock.

   We have not paid dividends in the past and we intend to retain earnings, if
any, and will not pay dividends in the foreseeable future. Any future
determination to pay dividends will be at the discretion of the board of
directors and will be dependent upon our financial condition, results of
operations, capital requirements, general business conditions and such other
factors as our Board of Directors may deem relevant.

Recent Sales of Unregistered Securities

   On January 11, 2001, we issued 321,343 shares of our common stock and
options to purchase 18,657 shares of our common stock to finance in part our
acquisition of ActiveTelco, Inc. The issuance of the securities in this
transaction was exempt from registration under the Securities Act in reliance
upon Section 4(2) of the Securities Act or Regulation D promulgated thereunder.

                                       13
<PAGE>

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

   Our selected consolidated financial data set forth below as of December 31,
2000 and 1999, and for each of the three years ended December 31, 2000, are
derived from our consolidated financial statements that have been audited by
PricewaterhouseCoopers LLP, independent accountants, and are included elsewhere
in this report. Our selected consolidated financial data set forth below as of
December 31, 1998, 1997 and 1996 and for each of the two years ended December
31, 1998 are derived from our audited consolidated financial statements not
included elsewhere herein. The data set forth below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations and the consolidated financial statements and related
notes included elsewhere in this report.

<TABLE>
<CAPTION>
                                         Years Ended December 31,
                               ------------------------------------------------
                                 2000       1999      1998      1997     1996
                               ---------  --------  --------  --------  -------
                                  (in thousands, except per share data)
                                               (unaudited)
<S>                            <C>        <C>       <C>       <C>       <C>
Statement of Operations Data:
Total revenues...............  $  71,991  $ 27,807  $ 10,555  $  6,221  $ 4,454
Total cost of goods sold.....     69,983    15,459     5,809     3,228    2,198
                               ---------  --------  --------  --------  -------
Gross margin.................      2,008    12,348     4,746     2,993    2,256
                               ---------  --------  --------  --------  -------
Operating expenses:
  Sales and marketing........     19,945    10,523     8,462     5,147    3,068
  Research and development...     17,149     7,618     6,200     3,562    2,012
  General and
   administrative............     11,503     4,194     2,703     2,362    1,746
  In-process research and
   development...............        800     2,600       --        --       --
  Amortization of
   intangibles...............      7,623        52       --        --       --
  Noncash compensation
   expense...................        438       455     1,233     1,260      --
  Provision for doubtful
   accounts..................     22,546       235       104        13       37
                               ---------  --------  --------  --------  -------
    Total operating
     expenses................     80,004    25,677    18,702    12,344    6,863
                               ---------  --------  --------  --------  -------
Loss from operations.........    (77,996)  (13,329)  (13,956)   (9,351)  (4,607)
Other income (expense), net..      3,899     1,596       210       195      181
                               ---------  --------  --------  --------  -------
Loss before income taxes.....    (74,097)  (11,733)  (13,746)   (9,156)  (4,426)
Income tax expense...........          1         1         1         1        1
                               ---------  --------  --------  --------  -------
Net loss.....................    (74,098)  (11,734)  (13,747)   (9,157)  (4,427)
Dividend accretion on
 preferred stock.............        --        235     2,584     1,627    1,137
                               ---------  --------  --------  --------  -------
Net loss attributable to
 common stockholders.........  $ (74,098) $(11,969) $(16,331) $(10,784) $(5,564)
                               =========  ========  ========  ========  =======
Net loss per share
 attributable to common
 stockholders, basic and
 diluted.....................  $   (4.98) $  (1.12) $ (60.62) $ (59.36) $(37.51)
                               =========  ========  ========  ========  =======
Shares used in computing net
 loss per share attributable
 to common stockholders,
 basic and diluted...........     14,866    10,729       269       182      148
                               =========  ========  ========  ========  =======
<CAPTION>
                                               December 31,
                               ------------------------------------------------
                                 2000       1999      1998      1997     1996
                               ---------  --------  --------  --------  -------
                                              (in thousands)
                                               (unaudited)
<S>                            <C>        <C>       <C>       <C>       <C>
Balance Sheet Data:
Cash, cash equivalents and
 short-term investments......  $ 102,614  $ 32,236  $  4,452  $ 10,285  $ 8,950
Working capital..............    110,920    44,416     7,173    11,066    8,357
Total assets.................    205,588    65,356    15,257    15,168   10,689
Redeemable convertible
 preferred stock and
 warrants....................        --        --     45,995    38,871   24,684
Long-term debt, net of
 current portion.............        --        --      4,262       140      190
Accumulated deficit..........   (130,585)  (56,487)  (44,434)  (28,103) (17,319)
Total stockholders' equity
 (deficit)...................    166,173    51,522   (41,839)  (26,444) (15,694)
</TABLE>

                                       14
<PAGE>

   The following table presents certain unaudited consolidated quarterly
financial information for each of the eight quarters ended December 31, 2000.
In the opinion of management, this quarterly information has been prepared on
the same basis as the consolidated financial statements and includes all
adjustments necessary to present fairly the information for the periods
presented. The results of operations for any quarter are not necessarily
indicative of results for the full year or for any future period.

<TABLE>
<CAPTION>
                                               Quarter Ended
                  ------------------------------------------------------------------------------------------------------
                  Dec. 31,       Sep. 30,       Jun. 30,       Mar. 31,       Dec. 31,       Sep. 30,      Jun. 30,
                    2000           2000           2000           2000           1999           1999          1999
                  --------       --------       --------       --------       --------       --------      --------
                                   (in thousands, except per share data)
                                                (unaudited)
<S>               <C>            <C>            <C>            <C>            <C>            <C>           <C>
Total revenues    $ 5,936        $28,567        $21,014        $16,474        $10,642         $8,264        $5,010
Gross margin      (28,612)        13,503          9,780          7,337          4,687          3,923         2,089
Net loss
 attributable to
 common
 stockholders     (68,071)(/1/)     (611)(/2/)   (1,180)(/3/)   (4,236)(/4/)   (4,161)(/5/)   (1,566)(/6/)  (2,695)(/6/)
Net loss per
 share
 attributable to
 common
 stockholders,
 basic and
 diluted           $(4.28)(/1/)  $ (0.04)(/2/)  $ (0.08)(/3/)  $ (0.34)(/4/)  $ (0.35)(/5/)   $(0.13)(/6/)  $(0.23)(/6/)
Shares used in
 computing net
 loss per share
 attributable to
 common
 stockholders,
 basic and
 diluted           15,900         15,751         15,302         12,435         11,822         11,670        11,498
<CAPTION>
                  Mar. 31,
                    1999
                  -------------
<S>               <C>
Total revenues     $3,891
Gross margin        1,649
Net loss
 attributable to
 common
 stockholders      (3,547)(/7/)
Net loss per
 share
 attributable to
 common
 stockholders,
 basic and
 diluted           $(0.45)(/7/)
Shares used in
 computing net
 loss per share
 attributable to
 common
 stockholders,
 basic and
 diluted            7,872
</TABLE>
--------
(/1/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include
     amortization of goodwill and purchased intangibles of $2,535. Alternative
     measure of net loss attributable to common stockholders and net loss per
     share attributable to common stockholders, basic and diluted excluding
     these items were $(65,536) and $(4.12), respectively.
(/2/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include
     amortization of goodwill and purchased intangibles of $2,528. Alternative
     measure of net income attributable to common stockholders and net income
     per share attributable to common stockholders, basic excluding these items
     were $1,917 and $0.12, respectively. Alternative measure of net income per
     share attributable to common stockholders, diluted excluding these items
     was $0.11. Shares used in computing alternative measure net income per
     share, diluted was 17,346.
(/3/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include
     amortization of goodwill and purchased intangibles of $1,814. Alternative
     measure of net income attributable to common stockholders and net income
     per share attributable to common stockholders, basic and diluted excluding
     these items were $634 and $0.04, respectively. Shares used in computing
     alternative measure net income per share, diluted was 16,547.
(/4/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include in-process
     research and development expenses of $800 and amortization of goodwill and
     purchased intangibles of $746. Alternative measure of net loss
     attributable to common stockholders and net loss per share attributable to
     common stockholders, basic and diluted excluding these items were $(2,690)
     and $(0.22), respectively.
(/5/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include in-process
     research and development expenses of $2,600 and amortization of goodwill
     and purchased intangibles of $52. Alternative measure of net loss
     attributable to common stockholders and net loss per share attributable to
     common stockholders, basic and diluted excluding these items were $(1,509)
     and $(0.13), respectively.
(/6/)There were no items that would generate a difference between net loss
     attributable to common stockholders and net loss per share attributable to
     common stockholders, basic and diluted, and alternative measure of net
     loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted.
(/7/)Net loss attributable to common stockholders and net loss per share
     attributable to common stockholders, basic and diluted include dividend
     accretion of preferred stock of $235. Alternative measure of net loss
     attributable to common stockholders and net loss per share attributable to
     common stockholders, basic and diluted excluding this item were $(3,312)
     and $(0.32), respectively.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

   The following discussion of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and the related Notes included in this Annual Report on Form 10-K.
This discussion contains, in addition to historical information, forward-
looking statements that involve risks and uncertainties including but not
limited to statements regarding customer and geographic mix, gross margins and
operating costs and expenses. Our actual results could differ materially from
the results discussed in the forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed below, as well as those discussed in our Registration Statements on
Form S-1, as filed with the SEC on September 20, 2000, those discussed in our
other reports and filings with the SEC and

                                       15
<PAGE>

those discussed under "Additional Risk Factors That Could Affect Our Operating
Results and the Market Price of Our Stock" elsewhere in this Annual Report on
Form 10-K. We disclaim any obligation to update information contained in any
forward-looking statement.

Overview

   We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access to multi-tenant
buildings. We use our proprietary FastCopper technology to deliver cost-
effective, scalable and easy to deploy solutions that exploit the underutilized
bandwidth of copper telephone wires within these buildings. Our collection of
FastCopper technologies includes HomeRun, which was selected as the initial
specification for a home networking standard promoted by the HomePNA, and
LongRun, a proprietary extension of HomeRun providing superior performance at
longer distances. These technologies are deployed through our Expresso high-
bandwidth access multiplexers and associated routers. In addition to our
Expresso access multiplexers are our products that provide service providers
with enhanced capabilities such as subscriber management, bandwidth management,
IP address management, and network address translation. Recently, we introduced
our IntelliPOP product line with proprietary Signature Switch technology. Our
proprietary Signature Switch technology is designed to allow service providers
to manage and guarantee bandwidth and service performance across applications
such as IP telephony, VPN networking, videoconferencing, video-on-demand, file
transfer and Internet access, and to efficiently configure IntelliPOP for the
delivery of these services according to the unique market requirements of
multi-tenant building owners and end-user subscribers on an individual or
collective basis.

   We commenced operations in August 1991. Through the third quarter of 1998,
substantially all of our revenue was derived from the sale of our XL Ethernet
LAN extension products to the corporate and university segments of the MCU
market. In early 1997, we introduced the first products in our Expresso product
line aimed at service provider markets. During the first quarter of 1998, we
began licensing our HomeRun technology to certain leading semiconductor,
computer hardware and consumer electronics manufacturers for incorporation into
integrated circuits and consumer products including PCs, peripherals, modems
and other Internet appliances. In the third and fourth quarters of 1998, we
commenced selling our Expresso GS products, which are configured for local loop
applications, and Expresso MDU products, which incorporate our HomeRun
technology to a broader range of service providers, primarily those serving
apartment complexes, hotels, university dormitories and military complexes in
the MDU market. In the first quarter of 1999, we commenced selling Expresso MDU
products incorporating our LongRun technology and Expresso MDU Lite into
additional segments of the MDU market. During the fourth quarter of 1999, we
commenced selling our Expresso SMS 2000 and companion Expresso OCS system
providing subscriber management, bandwidth management, credit card billing and
other functions to the MDU market. During the first quarter of 2000, we
commenced selling our OneGate Internet server appliances, acquired as a result
of our FreeGate acquisition, to the MCU market. During the last quarter of
2000, our new IntelliPOP product was under evaluation by several potential
customers.

   We generate revenue primarily from the sale of hardware products and, to a
lesser extent, through the licensing of our HomeRun technology and the sale of
our software products. We generally recognize product revenue when persuasive
evidence of an arrangement exists, delivery has occurred, the fee is fixed or
determinable, and collectibility is probable. Revenue from service obligations
included in product revenues is deferred and generally recognized ratably over
the period of the obligation. We also maintain accruals and allowances for all
cooperative marketing and other programs. Estimated sales returns, and warranty
costs based on historical experience by product, are recorded at the time
revenue is recognized. Our products generally carry a one year to two year
warranty from the date of purchase. Estimated sales returns, and warranty costs
based on historical experience by product, are recorded at the time revenue is
recognized.

                                       16
<PAGE>

   License and royalty revenue consists of nonrefundable up-front license fees,
some of which may offset initial royalty payments, and royalties. Currently,
the majority of our license and royalty revenue is comprised of non-refundable
license fees paid in advance. Such revenue is recognized ratably over the
period during which post-contract customer support is expected to be provided
or upon delivery and transfer of agreed upon technical specifications in
contracts where essentially no further support obligations exist. Future
license and royalty revenue is expected to consist primarily of royalties based
on products sold by our licensees. We do not expect that such license and
royalty revenue will constitute a substantial portion of our revenue in future
periods. With the introduction of our IntelliPOP product line, we expect that
revenue from the sale of software products and maintenance fees will constitute
a substantial portion of revenue in future periods.

   We expect that sales price reductions on some of our products will be
necessary to remain competitive and to reduce 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 cost reductions. In
addition, some of our licensees may sell products based on our technology to
our competitors or potential competitors. There can be no assurance that our
HomeRun technology will be successfully deployed on a widespread basis or that
such licensing will not result in an erosion of the potential market for our
products.

   Sales to customers outside of the United States accounted for approximately
41.0%, 32.3% and 18.5% of revenue for the years ended December 31, 2000, 1999
and 1998, respectively. On average, we expect international sales to represent
approximately one-half or less of our revenue. However, actual results, both
geographically and in absolute dollars, may vary from quarter to quarter
depending on the timing of orders placed by customers. To date, all
international sales have been denominated in U.S. dollars.

   We expect to continue to evaluate product line expansion and new product
opportunities, engage in extensive research, development and engineering
activities and focus on cost-effective design of our products. Accordingly, we
will continue to make significant expenditures on sales and marketing, and
research and development activities.

   In June 1999, we acquired PublicPort, Inc. in exchange for 168,679 shares of
our common stock. This transaction was treated as a pooling of interests for
accounting purposes. PublicPort was located in Ann Arbor, Michigan. PublicPort
designed and developed subscriber management systems that enabled businesses in
the MDU market to provide mobile computer users access to the public Internet
or private corporate networks without having to reconfigure their computer's
network access software.

   In November 1999, we acquired Vintel Communications, Inc. ("Vintel") for
$4.8 million, consisting of $0.5 million cash, 116,370 shares of our common
stock and 40,500 options to acquire our common stock. This transaction was
treated as a purchase for accounting purposes. Vintel was located in Oakland,
California. Vintel designed and developed high-performance integrated service
routers that allowed service providers to offer bundles of services, including
voice-over-IP and high speed Internet services over a common IP infrastructure
to customers in the MTU market.

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

   In April 2000, we acquired certain assets of OneWorld Systems, Inc.
("OneWorld") for approximately $2.4 million in cash. This transaction was
treated as a purchase of assets for accounting purposes.


                                       17
<PAGE>

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

   In January 2001, we acquired ActiveTelco, Inc. ("ActiveTelco") for
approximately $4.9 million, consisting of an aggregate of 321,343 shares of the
Company's common stock and 18,657 options to purchase shares of the Company's
common stock and acquisition related expenses consisting primarily of legal,
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 is being 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.

   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 or expand sales of those products which
have already been completed. In January 2001, we decided to abandon future
sales of the existing OneGate product that we acquired in the FreeGate
acquisition. The related OneGate and other intellectual property acquired from
FreeGate is being incorporated into the design of future products.

   Through these completed transactions, we have added approximately 80 people
to our workforce. The costs associated with personnel including rent for
additional facilities and related general and administrative costs as well as
costs associated with research and development, and sales and marketing
activities substantially increased our operating costs in fiscal year 2000 when
compared to related costs expended in fiscal year 1999. In January 2001, we
reduced our total workforce by 10% in efforts to control overall operating
expenses in response to recent declines in and expected slowing of our sales
growth.

   We have incurred net operating losses to date and, as of December 31, 2000,
had an accumulated deficit of $130.6 million. Our ability to generate income
from operations will be primarily dependent on increases in sales volume,
reductions in manufacturing costs and the growth of high-speed data access
solutions in the service provider and MTU markets. In view of our limited
history of product revenue from new markets, 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 new products, whether due to lack of market acceptance, competition,
technological change or otherwise, or the inability to reduce manufacturing
costs, will harm our business, financial condition and results of operations.

                                       18
<PAGE>

Results of Operations

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

<TABLE>
<CAPTION>
                                                        Year Ended December
                                                                31,
                                                       ------------------------
                                                        2000     1999    1998
                                                       -------  ------  -------
   <S>                                                 <C>      <C>     <C>
   Total revenues.....................................   100.0%  100.0%   100.0%
   Total cost of goods sold...........................    97.2    55.6     55.0
                                                       -------  ------  -------
     Gross margin.....................................     2.8    44.4     45.0
                                                       -------  ------  -------
   Operating expenses:
     Sales and marketing..............................    27.7    37.8     80.2
     Research and development.........................    23.8    27.4     58.7
     General administrative...........................    16.0    15.1     25.6
     In-process research and development..............     1.1     9.4      --
     Amortization of intangibles......................    10.6     0.2      --
     Noncash compensation expenses....................     0.6     1.6     11.7
     Provision for doubtful accounts..................    31.3     0.8      1.0
                                                       -------  ------  -------
       Total operating expenses.......................   111.1    92.3    177.2
                                                       -------  ------  -------
   Loss from operations...............................  (108.3)  (47.9)  (132.2)
   Impairment of certain equity investments...........    (4.3)    --       --
   Interest expense...................................    (0.5)   (2.2)    (1.1)
   Interest income....................................    10.2     7.9      3.1
   Other income, net..................................     --      --       --
                                                       -------  ------  -------
   Loss before income taxes...........................  (102.9)  (42.2)  (130.2)
   Income tax expense.................................     --      --       --
                                                       -------  ------  -------
   Net loss...........................................  (102.9)  (42.2)  (130.2)
   Dividend accretion on preferred stock..............     --      0.8     24.5
                                                       -------  ------  -------
   Net loss attributable to common stockholders....... (102.9)% (43.0)% (154.7)%
                                                       =======  ======  =======
</TABLE>

 Years Ended December 31, 2000, 1999 and 1998

   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 increased to $72.0
million for the year ended December 31, 2000 from $27.8 million for the year
ended December 31, 1999, and from $10.6 million for the year ended December 31,
1998. Using a year-over-year comparison, the increases in 2000 and 1999 were
primarily due to increased sales of our Expresso MDU products. However, during
the fourth quarter of 2000, revenue growth slowed substantially due to several
key customers who, in the latter part of the fourth quarter experienced a rapid
deterioration in their ability to obtain additional capital and, as a result,
severely curtailed or halted their purchases of our product, and also due to a
fall-off in sales to the Korean market. This resulted in fourth quarter
revenues of $5.9 million compared with revenues of $66.1 million for the first
three quarters of 2000 in aggregate and $10.6 million for the fourth quarter of
1999. License and royalty revenue increased to $2.0 million for the year ended
December 31, 2000, from $1.5 million for the year ended December 31, 1999, and
from $0.8 million for the year ended December 31, 1998. The increase in 2000
was primarily due to increases in royalty payments. The increase in 1999 was
primarily due to increases in up-front license fees recognized during the year
and receipt of related royalty payments. There was one new license and royalty
agreement signed during fiscal year 2000.


                                       19
<PAGE>

   Cost of Goods Sold/Gross Margin. Cost of goods sold consists of raw
materials, contract manufacturing, personnel costs, test and quality assurance
for products, and cost of licensed technology included in the products. Our
cost of goods sold before provision for loss on purchase commitments and
abandoned products increased to $42.8 million for the year ended December 31,
2000, from $15.5 million for the year ended December 31, 1999, and from $5.8
million for the year ended December 31, 1998. The increases in 2000 and 1999
were primarily due to increased production of our Expresso MDU products. Our
gross margin before provision for loss on purchase commitments and abandoned
products on an absolute basis increased to $29.2 million for the year ended
December 31, 2000, from $12.3 million for the year ended December 31, 1999, and
from $4.7 million for the year ended December 31, 1998. Gross margin before
provision for loss on purchase commitments and abandoned products as a
percentage of revenue decreased to 40.6% of revenue for the year ended December
31, 2000, from 44.4% of revenue for the year ended December 31, 1999, and from
45.0% of revenue for the year ended December 31, 1998. The decrease in gross
margin before such provisions as a percentage of revenue in 2000 was due
primarily to fourth quarter introductions of new products in the Expresso MDU
product line which had lower than average gross margins, increases in inventory
reserves related to estimated losses on custom built products and older product
versions that were not upgraded in light of fourth quarter industry slowdowns,
higher costs of scarce component parts which could not be offset by further
product cost reductions, and fixed manufacturing costs which could not be
reduced in correlation with the rapid decline of revenue in the fourth quarter.
During the fourth quarter of 2000, we recognized a charge related to provision
for loss on purchase commitments and abandoned product lines of $27.2 million.
The provision covers estimated costs for the cancellation of inventory purchase
commitments that resulted from industry slow downs of large scale deployments
in the MTU market and actual costs for inventory of abandoned product lines no
longer deemed essential to our core technologies in the future. The cost of
these abandoned products was $8.2 million and included OneGate products,
certain Expresso GS line cards and routers, and certain subscriber management
software. This charge was included in cost of goods sold resulting in an
overall gross margin of 2.8% for 2000. The decrease in gross margin as a
percent of revenue in 1999 from 1998 was primarily due to the change in product
mix, as we sold a larger percentage of Expresso products that had lower average
gross margins than the XL products.

   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 increased to $19.9 million for the year ended December 31, 2000, from
$10.5 million for the year ended December 31, 1999, and from $8.5 million for
the year ended December 31, 1998. The increases in both 2000 and 1999 were
primarily due to increased hiring of sales and marketing personnel. These
increases were also due to travel, attendance at trade shows, as well as
increases in personnel related to customer support activities and expanded
efforts in international markets.

   Research and Development. Research and development expense primarily
consists 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 $17.1 million for the year ended December 31,
2000, from $7.6 million for the year ended December 31, 1999, and from $6.2
million for the year ended December 31, 1998. The increase in 2000 was
primarily due to further development of the Expresso MDU products, development
of HomeRun-related products, continued development of the subscriber management
system portion of the Expresso MDU product line and initial development of our
IntelliPOP platform. The research and development expenses of FreeGate and
Xstreamis were consolidated with our expenses for the periods subsequent to the
respective February 2000 and May 2000 acquisitions. Additionally, in 2000 we
amortized $2.0 million of deferred compensation and notes receivable to
research and development related to restricted stock granted to certain
FreeGate and OneWorld employees. Approximately $1.3 million of the remaining
deferred compensation and notes receivable have been recorded as a reduction of
equity in the balance sheet. We intend to recognize the expense ratably over
the remaining period in which the restrictions lapse, currently estimated at
eight and ten months for each of FreeGate and OneWorld, respectively. The
increase in 1999 was primarily due to further development of the Expresso GS
and Expresso MDU products,

                                       20
<PAGE>

development of HomeRun-related products, enhancement of certain XL products,
and continued development of the subscriber management system portion of the
Expresso MDU product line. The research and development expenses of PublicPort
and Vintel were consolidated with our expenses for the periods subsequent to
the respective June 1999 and November 1999 acquisitions. We intend to increase
investment in research and development programs in future periods for the
purpose of enhancing current products to provide advanced Internet service
applications for both domestic and international markets, reducing the cost of
current products, and developing and acquiring new products.

   General and Administrative. General and administrative expense primarily
consists of personnel costs for administrative officers and support personnel,
and legal, accounting and consulting fees. Our general and administrative
expenses increased to $11.5 million for the year ended December 31, 2000, from
$4.2 million for the year ended December 31, 1999, and from $2.7 million for
the year ended December 31, 1998. The increases in both 2000 and 1999 were
primarily due to additions of administrative personnel and increases in other
costs related to our growth. We intend to increase general and administrative
expenditures and infrastructure costs as we expand our business.

   In-Process Research and Development. Amounts expensed as in-process research
and development were $0.8 million in 2000 and $2.6 million in 1999 and were
related to in-process research and development purchased from FreeGate and
Vintel, respectively. There were no such costs prior to 1999.

   In-Process Research and Development, FreeGate. Amounts expensed as in-
process research and development were $0.8 million for the year ended December
31, 2000 and were related to in-process research and development purchased from
FreeGate. 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 costs to develop the purchased in-process technology into a
commercially viable product, estimating the resulting net cash flows from the
sale of the product resulting from 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 FreeGate to technological feasibility are not expected
to have a material impact on the Company's future results of operations or cash
flows.

   In-Process Research and Development, Vintel. Amounts expensed as in-process
research and development were $2.6 million for the year ended December 31, 1999
and were related to in-process research and development purchased from Vintel.
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 costs to develop the purchased in-process technology into a commercially
viable product, estimating the resulting net cash flows from the sale of the
product resulting from 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 Vintel to technological feasibility are not expected to
have a material impact on the Company's future results of operations or cash
flows.

   Amortization of Intangibles. Amortization of intangibles consists of the
periodic amortization of intangible assets related to the purchase acquisitions
of Vintel, FreeGate, OneWorld and Xstreamis. These assets consist primarily of
assembled workforce, completed technology and patents, and goodwill, and each
are amortized over their estimated useful lives of three, five and five years,
respectively. Amortization of intangibles increased to $7.6 million for the
year ended December 31, 2000, from $0.1 million for the year ended December 31,
1999. There were no such costs in the year ended December 31, 1998. The
increase in 2000 relates to the acquisitions completed in the year for
FreeGate, OneWorld and Xstreamis and a full year of amortization of the Vintel
acquisition completed in November 1999. The increase in 1999 relates to the
Vintel acquisition.

                                       21
<PAGE>

   Noncash Compensation Expense. Noncash compensation expense in 2000 and 1999
consisted of the recognition of expense related to certain employee stock
option grants, based on the difference between the deemed fair value of common
stock and the option exercise price at the date of grant. Noncash compensation
expense in 1998 primarily consisted of expenses related to the grant of a
warrant to purchase up to 666,836 shares of common stock in consideration for
technology endorsement, marketing and certain development support by Microsoft
with respect to our HomeRun technology and related products. Noncash
compensation expense in 1998 also consisted of the recognition of expense
related to certain employee stock option grants. Our noncash compensation
expense was $0.4 million, $0.5 million and $1.2 million for the years ended
December 31, 2000, 1999 and 1998, respectively. We intend to recognize $0.3
million in additional expenses related to employee stock options ratably over
the remaining vesting period of the related options. Such deferred expense has
been recorded as a reduction of equity in the balance sheet.

   Provision for Doubtful Accounts. Provision for doubtful accounts consisted
of the recognition of bad debt expense related to past due accounts receivable
balances. The provision for doubtful accounts increased to $22.5 million for
the year ended December 31, 2000, from $0.2 million for the year ended December
31, 1999, and from $0.1 million for the year ended December 31, 1998. The
increase in 2000 was primarily due to provisions recorded on past due accounts
receivable from several key customers who, during the latter part of the fourth
quarter of 2000, experienced a rapid deterioration in their ability to obtain
additional capital to fund their business models, declared their inability to
make timely payments on their accounts, and, as of the date of this report,
have not been able to demonstrate wherewithal to pay their outstanding account
balances. In January 2001, one of these customers filed for Chapter 11
bankruptcy protection. In March 2001, another one of these customers filed for
Chapter 7 bankruptcy protection. The other customers may be forced to follow
similar protection options in the event capital funding does not materialize.

   Impairment of Certain Equity Investments. Impairment of certain equity
investments consisted of the recognition of expense related to the write off of
$3.1 million invested in three nonpublicly traded companies. The value of these
investments was impaired due to uncertainty associated with the on-going
viability of each of the businesses in the current network infrastructure
industry. There was no such impairment of our equity investments in 1999 or
1998.

   Interest Expense. Interest expense consisted of interest expense associated
with credit facilities. Our interest expense decreased to $0.4 million for the
year ended December 31, 2000, from $0.6 million for the year ended December 31,
1999, and increased from $0.1 million for the year ended December 31, 1998. The
decrease in 2000 was primarily due to our paying off the principal owed on our
credit facilities. The increase in 1999 was primarily due to higher average
principal owed on our credit facilities during fiscal 1999 as compared to
fiscal 1998.

   Interest Income. Interest income consisted of interest income on our cash,
investments and notes receivable balances, offset by the amortization of
premiums paid on investments. Our interest income increased to $7.4 million for
the year ended December 31, 2000, from $2.2 million for the year ended December
31, 1999, and from $0.3 million for the year ended December 31, 1998. The
increases in 2000 and 1999 were primarily due to interest income on higher
average cash and investment balances.

Liquidity and Capital Resources

   From our inception through January 1999, we have financed our operations
primarily through the sale of preferred equity securities for an aggregate of
$46.2 million net of offering costs. In January 1999, we completed our initial
public offering and issued 2,875,000 shares of our common stock at a price of
$18.00. We received approximately $46.9 million in cash, net of underwriting
discounts, commissions and other offering costs. We also received approximately
$6.7 million as a result of the exercise of a warrant to purchase 666,836
shares of Series G convertible preferred stock at a price of $10.00 per share.
In March 2000, we completed our secondary offering and issued 2,500,000 shares
of our common stock at a price of $60.00 and we received approximately $141.7
million in cash, net of underwriting discounts, commissions and other offering
costs.


                                       22
<PAGE>

   As of December 31, 2000, we had cash, cash equivalents, and short-term
investments of $102.6 million compared to $32.2 million as of December 31,
1999.

   The net increase in cash and cash equivalents of $33.9 million during the
year ended December 31, 2000 resulted primarily from net proceeds from our
secondary offering of $141.7 million and proceeds from the issuance of common
stock related to stock options and employee stock purchases of $4.9 million.
The increases in cash and cash equivalents from these sources were offset by
uses in operating activities of $63.8 million, the purchase of property and
equipment of $8.6 million, the purchase of investments and other assets, net of
maturities and sales of investments, of $36.6 million, the payoff of borrowings
under a credit facility of $1.5 million, the acquisition costs for FreeGate,
OneWorld and Xstreamis of $1.8 million and other financing activities of $0.4
million.

   The net increase in cash and cash equivalents of $9.0 million during the
year ended December 31, 1999 resulted primarily from net proceeds from our
initial public offering of $46.9 million, net proceeds from the exercise of a
warrant for convertible preferred stock of $6.7 million, proceeds from the
issuance of common stock related to stock options and employee stock purchase
plan of $0.7 million, and proceeds from the acquisition of Vintel of $0.4
million. The increases in cash and cash equivalents from these sources were
offset by uses in operating activities of $19.8 million, the purchase of
investments net of proceeds from sales and maturities of investments of $20.7
million, the purchase of property and equipment of $2.5 million, the payoff of
borrowings under a credit facilities of $2.7 million.

   The net decrease in cash and cash equivalents of $0.9 million during the
year ended December 31, 1998 resulted primarily from uses for operating
activities of $12.7 million and the purchase of property and equipment of $1.0
million. These decreases in cash and cash equivalents were offset by proceeds
from sales and maturities of short term investments net of purchases of short-
term investments of $5.1 million, proceeds from the sale of preferred
securities of $3.8 million and borrowings from credit facilities net of
repayments of $3.9 million.

   In the first quarter of 2000, we entered into a lease for administrative and
engineering facilities. Under the terms of the lease, we were required to issue
a letter of credit in the amount of $1.8 million. The letter of credit is
collateralized by restricted funds in the amount of $3.2 million, which are
included in intangibles and other assets as of December 31, 2000. The letter of
credit is reduced annually by $0.25 million provided we are not in default
under the terms of the lease agreement.

   For future periods, we generally anticipate moderate increases in working
capital on a period to period basis primarily as a result of higher relative
levels of inventory. In 2000, we leased and improved facility space for
administrative and engineering requirements to accommodate future growth needs
through 2001. We foresee limited increases for expenditures of property and
equipment related to the expansion of systems infrastructure, office equipment
and lab and test equipment through 2001.

   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.

Option Exchange Program

   We are offering our employees the opportunity to cancel certain outstanding
stock options in return for new options to purchase shares of our common stock
equal to the number of options canceled on or about April 24, 2001. These new
options will be issued to participants in the exchange program six months and
two days from the day that the offer ends. The exercise price of the new
options will not be determined until the date of grant, and will be set at the
closing price reported on the Nasdaq National Market for our common stock on
the date that is six months and one day from the end of the option exchange
offer period.


                                       23
<PAGE>

   All options held by eligible employees currently outstanding under our 1992
Stock Plan, 1998 Stock Plan and the 1999 Nonstatutory Stock Plan are included
in the option exchange program. If all eligible employees participate in the
program, options for a total of 1,711,963 shares of our common stock will be
exchanged for new options. Employees of Tut Systems UK Limited, members of the
Board of Directors, executive officers and vice-presidents will be excluded
from the option exchange program.

   The primary purpose of the option exchange program is to provide our
employees who hold options that are currently "out-of-the-money" with an
opportunity, so long as they are employees on the date of the replacement
grant, to exchange those old options for new stock options to be granted on or
about October 26, 2001. Employees who choose to cancel options will receive
credit for past vesting as well as vesting during the waiting period before the
new options are issued. In addition, the vesting period for the new options
will be shortened by approximately six months. However, the replacement stock
options will not be exercisable prior to the grant date on or about October 26,
2001.

Recent Accounting Pronouncements

   In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as
required by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement
No. 133," effective January 1, 2001. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly does not believe that the
adoption of SFAS No. 133 will have a material impact on the financial reporting
and related disclosures of the Company.

   In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements," which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
Management evaluated the guidance in SAB 101 and the current interpretations
and believes that it has complied with the guidance contained therein.

   In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25." FIN 44 clarifies
the application of Opinion No. 25 for (a) the definition of employee for
purposes of applying Opinion No. 25, (b) the criteria for determining whether a
plan qualifies as a noncompensatory plan, (c) the accounting consequences of
various modifications to the terms of a previously fixed stock option or award,
and (d) the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 was effective July 1, 2000, but certain
conclusions covered specific events that occurred after either December 15,
1998, or January 12, 2000. The adoption of FIN 44 did not have a material
effect on the financial statements.

Additional Risk Factors That Could Affect Our Operating Results and the Market
Price Of Our Stock

 We have a history of losses and expect future losses.

   We have incurred substantial net losses and experienced negative cash flow
each quarter since our inception. We incurred net losses attributable to common
stockholders of $74.1 million for the fiscal year ended December 31, 2000 and
$12.0 million for the fiscal year ended December 31, 1999. As of December 31,
2000,

                                       24
<PAGE>

we had an accumulated deficit of $130.6 million. We expect that we will
continue to incur losses in 2001 and we may incur losses in future periods as
well.

   To achieve or sustain profitability, we must increase sales of our Expresso
products, successfully launch our IntelliPOP product, reduce manufacturing
costs, sell excess component parts obtained as a result of canceled purchase
commitments and successfully introduce enhanced versions of our existing and
new products.

   We may never achieve or sustain profitability. We have spent substantial
amounts of money on the development of our Expresso products, HomeRun
technology, IntelliPOP product and software products. We intend to continue
increasing certain of our operating expenditures, including our sales and
marketing, research and development and general and administrative
expenditures. We cannot assure you that we will generate a sufficient level of
revenue to offset these expenditures, or that we will be able to adjust
spending in a timely manner to respond to any unanticipated decline in revenue
due to the fact that our expenditures for sales and marketing, research and
development, and general administrative functions are, in the short term,
relatively fixed. Our ability to increase revenue or achieve profitability in
the future will primarily depend on our ability to increase sales of our
Expresso products, successfully launch our IntelliPOP product, 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 products and new products.

   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;

  . market acceptance of our products;

  . competitive pressures, including pricing pressures from our partners and
    competitors;

  . the timing or cancellation of orders from, or shipments to, existing and
    new customers;

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

  . variations in our sales or distribution channels;

  . variations in the mix of products offered by us;

  . changes in the pricing policies of our suppliers;

  . the availability and cost of key components; and

  . the timing of personnel hiring.

   We anticipate that average selling prices for our products will decrease in
the near future due to volume pricing agreements and the need to reduce
relatively high levels of inventory. 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 competition and rapid technological change. Decreasing average
selling prices could cause us to experience decreased revenue despite an
increase in the number of units sold. We cannot assure you that we will be able
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 trading price of our common stock
would likely decline.

                                       25
<PAGE>

Purchases by past customers have decreased dramatically and we must establish a
new base of customers.

   Many of our past customers have been unable to continue to access capital
and are experiencing significant financial difficulties, including bankruptcy.
Our 10 largest customers accounted for 72.2% of net sales for the year ended
December 31, 2000 and 62% of net sales for the year ended December 31, 1999.
Trigem Infocomm, Inc., Reflex Communications, Inc. and Darwin Networks, Inc.
accounted for 18%, 12% and 11%, respectively, of our net sales for the year
ended December 31, 2000. CAIS, Inc. and Rycom CCI, Inc. accounted for 12% and
10%, respectively, of our net sales in 1999. We do not expect to see similar
levels of sales, if any, from the majority of these particular customers in
2001. In order to meet our revenue targets, we must establish a new customer
base and increase sales to existing customers who have not been our lead
customers in the past. Our strategy of targeting larger, more established
customers may result in longer sales cycles and delayed revenue. Sales into
larger accounts could also result in increased competition from larger and
better established competitors.

We face substantial risk in launching our new IntelliPOP product.

   We are in the process of launching our new IntelliPOP product. Risks
associated with the launch include delays in shipping including software bugs,
delays in product hardware and software testing, and delays in production build
of the product. The complexity of the product will require additional customer
support resources. Since the product will include major software components, we
plan to sell software maintenance agreements. Accordingly, revenue associated
with such maintenance agreements will be deferred and recognized over the life
of the underlying support. The launch of our IntelliPOP product may also cause
customers to delay purchases of our existing products. In addition, the
introduction of a new, more complex product, coupled with a search for larger,
more established customers may result in longer sales cycles and delayed
revenue.

We must reduce our inventory and future purchase commitments.

   Changes in our business have resulted in the accumulation of a substantial
inventory of finished goods and components. We have provided for losses related
to the cancellation of purchase commitments. However, we must sell existing
finished goods inventory and delay or sell finished goods inventory from future
purchase commitments as well as sell component inventory resulting from
deliveries on already canceled purchase commitments. Failure to decrease
current and future inventory and/or to sell component parts 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 the
year 2001 will be negatively impacted.

Our ability to attract and retain our personnel may be negatively impacted by
the drop in our stock price.

   The drop in our stock price has resulted in most of our outstanding employee
stock options being "underwater" or priced substantially above current market
price. While we currently have an offer out to the majority of our employees to
cancel their existing options and have such options reissued at a date at least
six months and two days later than the date of cancellation, the effectiveness
of such a plan cannot be predicted. Accounting and other regulatory concerns
will prevent or limit our ability to issue additional stock options to these
employees during the period between cancellation and reissuance. If certain
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.

Changes in capital markets may negatively impact our business.

   Due to recent changes in the capital markets including increased volatility
in equity markets and tightening of lending in the credit markets, we believe
that we are exposed to a greater risk that customers will alter their

                                       26
<PAGE>

payment practices to conserve capital. These changes may lead to increases in
outstanding accounts receivable, longer payback periods and increased risk of
default. For example, we increased our provisions recorded on past due accounts
receivable from several key customers who, during the latter part of the fourth
quarter of 2000, experienced a rapid deterioration in their ability to obtain
additional capital to fund their business models, declared their inability to
make timely payments on their accounts, and, as of the date of this report,
have not been able to demonstrate wherewithal to pay their existing account
balances. Two of these customers have filed bankruptcy proceedings. These
increased risks will be considered when assessing our customers' wherewithal to
pay and will likely result in longer revenue deferrals than previously
experienced. We also believe that certain of our customers will alter their
deployment plans to meet the constraints imposed by changes in the capital
markets. If we are not able to increase sales to other customer segments and/or
sales are otherwise delayed, we may experience volatility in expected sales
growth patterns which would increase the risk of declining sales growth in any
particular quarter.

Difficulties in forecasting product sales could negatively impact our business.

   We base our expense levels in part upon our expectations concerning future
revenue and these expense levels are relatively fixed in the short-term. Orders
for our products, however, 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 that typically last 60 to 90 days, in the case of
IntelliPOP, those evaluations may increase to six months. If orders forecasted
for a specific customer for a particular quarter do not occur in that quarter,
our revenue for that quarter would be reduced. If we have lower revenue in a
quarter than expected, we may not be able to reduce our spending in the short-
term in response to this shortfall and reduced revenue would have a direct
impact on our results of operations for that quarter. Further, we purchase
components and contract manufacture our products based on forecasts of sales.
If orders for 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 orders are less than our forecasts, we may
have difficulty in canceling future purchase commitments in a timely manner
which may result in greater than expected inventory levels and exposure to
losses related to slow moving and obsolete inventory.

We depend on contract manufacturers to manufacture all of our products and rely
upon them to deliver high-quality products in a timely manner.

   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. 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 have a negative impact on our ability to diversify
our product manufacturing across a larger base of contract manufactures. In
addition, our inability to accurately forecast the actual demand for our
products could result in 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.

   We currently purchase all 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 is dependent in part on our ability to
provide our contract manufacturers and their

                                       27
<PAGE>

suppliers with accurate forecasts of our future needs. If we or our
manufacturers were unable to obtain a sufficient supply of components from
current sources, we could experience difficulties in obtaining alternative
sources 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 a
failure to adequately control quality could harm our business.

   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
costs of manufacturing, assembling or testing our products and could harm our
business, financial condition and results of operation. Moreover, defects in
products that are not discovered in the quality assurance process could damage
customer relationships and result in product returns or liability claims, each
of which could harm our business, financial condition and results of
operations.

We purchase several key components from single or limited sources and could
lose sales if these sources fail to fill our needs.

   We currently purchase all of the raw materials and components used in our
products through our contract manufacturers. In procuring components, our
contract manufacturers rely on some suppliers that are the sole source of those
components, and we are dependent upon supply from these sources to meet our
needs. For example, all of the field programmable gate array supplies used in
our products are purchased from Xilinx and the switching integrated circuit
supplies used in the majority of our products are purchased from Texas
Instruments. Our products are also dependent on various sole source offerings
from Dallas Semiconductor, Metalink US, Motorola, Flextronics Semiconductor,
SaRonix, Siemens and Wind River Systems. If there is any interruption in the
supply of any of the key components currently obtained from a single or limited
source, obtaining these components from other sources could take a substantial
period of time which could cause us to redesign our products or could disrupt
our operations and harm our business in any given period.

Our market is subject to rapid technological change and if we do not address
these changes, our products will become obsolete, harming our business and
ability to compete.

   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. In addition, the market for high-speed data access products is
dependent 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. We cannot assure you that we will be able to respond quickly and
effectively to technological change. If we do not address these technological
changes and challenges by regularly introducing new products, our product line
will become obsolete, which would harm our business, financial condition and
results of operations.

Our success depends on our ability to continually introduce new products that
achieve broad market acceptance.

   We must also continually improve the performance, features and reliability
of our products, particularly in response to competitive product offerings. To
remain competitive we need to introduce products in a timely manner that
incorporate or are compatible with these new technologies as they emerge. We
may have only a limited amount of time to penetrate certain markets and we
cannot assure you that we will be successful in

                                       28
<PAGE>

achieving widespread acceptance of our products before competitors offer
products and services similar or superior to our products. Any delay in product
introduction 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 operating results by unexpectedly decreasing
sales, increasing our inventory levels of older products and exposing us to
greater risk of product obsolescence.

Our success depends on continued market acceptance of our Expresso products and
the successful launch of our IntelliPOP product.

   We must devote a substantial amount of human and capital resources in order
to maintain commercial acceptance of our Expresso products and to expand
offerings of the Expresso product line and the launch of our IntelliPOP product
in the MDU and MCU markets and to further penetrate these markets.
Historically, the majority of our Expresso products have been sold into the MDU
market. Our future success depends on the ability to continue to penetrate this
market and to expand our penetration into the MCU market. Our success also
depends on our ability to educate existing and potential customers and end
users about the benefits of our Fast Copper technology, including HomeRun and
LongRun, and our IntelliPOP product and about the development of new products
to meet changing and expanding demands of service providers, MTU owners and
corporate customers. The success of our Expresso and IntelliPOP products will
also depend on the ability of our service provider customers to market and sell
high-speed data services to end users. We cannot assure you that our IntelliPOP
or our Expresso products will achieve or maintain broad commercial acceptance
within the MDU market, MCU market, or in any other market we enter.

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

   The market for multi-service broadband access systems is intensely
competitive and we expect that this market will become increasingly competitive
in the future. Our most immediate competitors include Cisco, Copper Mountain,
Elastic Networks, Paradyne and a number of other public and private companies.
Many of these competitors are offering or may offer technologies and services
that directly compete with some or all of our high-speed access products and
related software products. 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
business and ability to compete.

   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 are cost-effective for some users.
Because many of our products are based on the use of copper telephone wire, and
because there are physical limits to the speed

                                       29
<PAGE>

and distance over which data can be transmitted over this 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 telephone copper 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.

Manufacturing or design defects in our products could harm our reputation and
business.

   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 in order to develop 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 will
harm our business.

   We will not be competitive unless we continually introduce new products and
product enhancements that address changing industry standards. The emergence of
new industry standards, whether through adoption by official standards
committees or widespread use by telephone companies or other service providers,
could require redesign of our products. If these standards become widespread
and our products are not in compliance, 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 standard 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 the market
price of our stock.

We may not be able to effectively integrate our recent acquisitions into our
existing business.

   In February 2000, we acquired FreeGate, in May 2000, we acquired Xstreamis
and in January 2001, we acquired ActiveTelco. We will need to overcome
significant issues in order to realize any benefits from these transactions.
These issues include:

  . integrating the operations of the geographically dispersed businesses
    acquired into our own operations;

  . incorporating acquired technology, rights and products into our products
    and services;

  . developing new products and services that utilize the assets of all
    entities;

  . the potential disruption of our ongoing business and the distraction of
    our management; and

  . the potential impairment of relationships with employees, suppliers and
    customers.

                                       30
<PAGE>

We may engage in future acquisitions of companies, technologies or products and
the failure to integrate any future acquisitions could harm our business.

   As a part of our business strategy, we expect to make additional
acquisitions of, or significant investments in, complementary companies,
products or technologies. Any future acquisitions would be accompanied by the
risks commonly encountered in acquisitions of companies. These risks include:

  . difficulties in assimilating the operations and personnel of the acquired
    companies;

  . diversion of management's attention from ongoing business concerns;

  . 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 may acquire in the
future, and our failure to do so could harm our business, operating results and
financial condition.

Failure to effectively manage operations in light of our changing revenue base
will adversely affect our business

   In the past, we have rapidly and significantly expanded our operations and
anticipate that, in the future, expansion in certain areas of our business may
be required to address potential growth in our customer base and market
opportunities. In particular, we expect to face numerous challenges in the
implementation of our business strategy to focus on the larger, more
established customers such as ILECs and PTTs in both domestic and international
markets. In addition, the volatility in our business has placed a significant
strain on our managerial and operational resources. For example, in January
2001 we cut our workforce by 10% in an effort to control overall operating
expenses in response to recent declines in and expected slowing of our sales
growth.

   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.

   Sales to customers outside of the United States accounted for approximately
41.0% and 32.3% of revenue for the years ended December 31, 2000 and 1999,
respectively. There are a number of risks arising from our international
business, including:

  . longer receivables collection periods;

  . increased exposure to bad debt write-offs;


                                       31
<PAGE>

  . 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 can give you no
assurance that foreign markets for our products will not develop more slowly
than currently anticipated. Any failure to increase sales to customers outside
of the United States could harm our business, financial condition and results
of operations.

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

Fluctuations in currency exchange rates may harm our business.

   All of our foreign sales are invoiced in U.S. dollars. As a result,
fluctuations in currency exchange rates could cause our products to become
relatively more expensive for international customers and reduce demand for our
products. We anticipate that foreign sales will generally continue to be
invoiced in U.S. dollars. Accordingly, we do not currently engage in foreign
currency hedging transactions. However, as we expand our current international
operations, we may allow payment in foreign currencies and, as a result,
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 is dependent in part upon our
proprietary technology. We rely on a combination of copyright, patent,
trademark and trade secrets laws and nondisclosure agreements to establish and
protect our proprietary technology. We currently hold 20 United States patents
and have 24 United States patent applications pending. However, we cannot
assure you that patents will be issued with respect to pending or future patent
applications 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, strictly limit
access to and distribution of our software, and further limit the disclosure
and use of other 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. We also cannot assure you that our
competitors will not 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 do the
laws of the United States.

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

   We are also subject to the risk of adverse claims and litigation alleging
infringement of the intellectual property rights of others. We cannot assure
you that third parties will not assert infringement claims in the

                                       32
<PAGE>

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

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

Our success is dependent on our ability to provide adequate customer support.

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

                                       33
<PAGE>

If we lose key personnel or are unable to hire additional qualified personnel
as necessary, we may not be able to successfully manage our business.

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

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

   The trading price of our common stock has been and is likely to continue to
be highly volatile. Our stock price could fluctuate widely in response to
factors such as the following:

  . actual or anticipated variations in operating results;

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

  . changes in financial estimates or recommendations by stock market
    analysts regarding us or our competitors;

  . conditions or trends in the telecommunications industry, including
    regulatory developments;

  . growth of the Internet;

  . announcements by us of significant acquisitions, strategic partnerships,
    joint ventures or capital commitments;

  . additions or departures of key personnel;

  . future equity or debt offerings or our announcements of these offerings;
    and

  . general market and general 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 in recent months. 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 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

                                       34
<PAGE>

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 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 December 31, 2000,
we had 15,910,796 shares outstanding. Of these shares, 15,780,549 shares of
common stock are currently available for sale in the public market, some of
which are subject to volume and other limitations under securities laws.

ITEM 7A. 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 December 31, 2000.

   At December 31, 2000, we held an investment in commercial paper issued by
Southern California Edison Company. This investment is included in short-term
investments at a carrying value of approximately $9.2 million which matured in
January 2001 and is currently in default. We believe that the fair value of
this investment has declined since the balance sheet date, however, the
ultimate amount of the decline and the net realizable value of this investment
is not currently practicably determinable.

   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 US dollars. An increase in the value of
the US dollar relative to foreign currencies could make our products more
expensive and, therefore, reduce the demand for our products.



                                       35
<PAGE>

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                               TUT SYSTEMS, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                       <C>
Report of Independent Accountants........................................  37

Consolidated Balance Sheets as of December 31, 2000 and 1999.............  38

Consolidated Statements of Operations for the years ended December 31,
 2000, 1999, and 1998....................................................  39

Consolidated Statements of Stockholders' Equity (Deficit) for the years
 ended December 31, 2000, 1999, and 1998.................................  40

Consolidated Statements of Cash Flows for the years ended December 31,
 2000, 1999, and 1998....................................................  41

Notes to Consolidated Financial Statements...............................  42
</TABLE>

                                       36
<PAGE>

                       REPORT OF INDEPENDENT ACCOUNTANTS

To the Stockholders and Board of Directors of
Tut Systems, Inc.

   In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 61 present fairly, in all material
respects, the financial position of Tut Systems, Inc. and its subsidiaries at
December 31, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2000 in
conformity with accounting principles generally accepted in the United States
of America. In addition, in our opinion, the financial statement schedule
listed in the index appearing under Item 14(a)(2) on page 62 presents fairly,
in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

/s/ PricewaterhouseCoopers LLP

San Jose, California
March 26, 2001

                                       37
<PAGE>

                               TUT SYSTEMS, INC.

                          CONSOLIDATED BALANCE SHEETS
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                               December 31,
                                                            -------------------
                                                              2000       1999
                                                            ---------  --------
<S>                                                         <C>        <C>
                          ASSETS
Current assets:
  Cash and cash equivalents...............................  $  47,307  $ 13,405
  Short-term investments..................................     55,307    18,831
  Accounts receivable, net of allowance for doubtful
   accounts of $21,167 and $335 in 2000 and 1999,
   respectively...........................................      6,124    11,742
  Inventories, net........................................     36,285     8,401
  Prepaid expenses and other..............................      3,526     3,746
                                                            ---------  --------
    Total current assets..................................    148,549    56,125
Property and equipment, net...............................     10,578     3,476
Intangibles and other assets (including restricted cash of
 $3.2 million and $0 in 2000 and 1999, respectively)......     46,461     5,755
                                                            ---------  --------
    Total assets..........................................  $ 205,588  $ 65,356
                                                            =========  ========
           LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable........................................  $   9,446  $  5,859
  Accrued liabilities.....................................     27,129     3,551
  Line of credit..........................................        --      1,529
  Deferred revenue........................................      1,054       770
                                                            ---------  --------
    Total current liabilities.............................     37,629    11,709
Deferred revenue, net of current portion..................      1,454     2,125
Other liabilities.........................................        332       --
                                                            ---------  --------
    Total liabilities.....................................     39,415    13,834
                                                            ---------  --------
Commitments and contingencies (Note 8)

Stockholders' equity:
  Preferred stock, $0.001 par value, 5,000 shares
   authorized, no shares issued and outstanding in 2000
   and 1999, respectively.................................        --        --
  Common stock, $0.001 par value, 100,000 shares
   authorized, 15,911 and 11,941 shares issued and
   outstanding in 2000 and 1999, respectively.............         16        12
  Additional paid-in capital..............................    298,332   108,969
  Deferred compensation...................................     (1,041)     (972)
  Notes receivable from stockholders......................       (555)      --
  Accumulated other comprehensive income..................          6       --
  Accumulated deficit.....................................   (130,585)  (56,487)
                                                            ---------  --------
    Total stockholders' equity............................    166,173    51,522
                                                            ---------  --------
    Total liabilities and stockholders' equity............  $ 205,588  $ 65,356
                                                            =========  ========
</TABLE>

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

                                       38
<PAGE>

                               TUT SYSTEMS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                  ----------------------------
                                                    2000      1999      1998
                                                  --------  --------  --------
<S>                                               <C>       <C>       <C>
Revenues:
  Product........................................ $ 69,981  $ 26,266  $  9,790
  License and royalty............................    2,010     1,541       765
                                                  --------  --------  --------
    Total revenues...............................   71,991    27,807    10,555
                                                  --------  --------  --------
Cost of goods sold:
  Product........................................   42,760    15,454     5,733
  License and royalty............................      --          5        76
  Provision for loss on purchase commitments and
   abandoned products (Note 11)..................   27,223       --        --
                                                  --------  --------  --------
    Total cost of goods sold.....................   69,983    15,459     5,809
                                                  --------  --------  --------
Gross margin.....................................    2,008    12,348     4,746
                                                  --------  --------  --------
Operating expenses:
  Sales and marketing............................   19,945    10,523     8,462
  Research and development.......................   17,149     7,618     6,200
  General and administrative.....................   11,503     4,194     2,703
  In-process research and development............      800     2,600       --
  Amortization of intangibles....................    7,623        52       --
  Noncash compensation expense...................      438       455     1,233
  Provision for doubtful accounts................   22,546       235       104
                                                  --------  --------  --------
    Total operating expenses.....................   80,004    25,677    18,702
                                                  --------  --------  --------
Loss from operations.............................  (77,996)  (13,329)  (13,956)
Impairment of certain equity investments.........   (3,100)      --        --
Interest expense.................................     (379)     (608)     (117)
Interest income..................................    7,412     2,203       327
Other income (expense), net......................      (34)        1       --
                                                  --------  --------  --------
Loss before income taxes.........................  (74,097)  (11,733)  (13,746)
Income tax expense...............................        1         1         1
                                                  --------  --------  --------
Net loss.........................................  (74,098)  (11,734)  (13,747)
Dividend accretion on preferred stock............      --        235     2,584
                                                  --------  --------  --------
Net loss attributable to common stockholders..... $(74,098) $(11,969) $(16,331)
                                                  ========  ========  ========
Net loss per share attributable to common
 stockholders, basic and diluted (Note 2)........ $  (4.98) $  (1.12) $ (60.62)
                                                  ========  ========  ========
Shares used in computing net loss per share
 attributable to common stockholders, basic and
 diluted (Note 2)................................   14,866    10,729       269
                                                  ========  ========  ========
</TABLE>

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

                                       39
<PAGE>

                               TUT SYSTEMS, INC.

           CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
                                 (in thousands)

<TABLE>
<CAPTION>
                           Convertible                                         Notes  Accumu-
                            Preferred                                         Receiv-  lated               Total
                              Stock                                            able    Other              Stock-
                            Series A-G     Common Stock  Additional Deferred   from   Compre-  Accumu-   holders'
                          ---------------  -------------  Paid-in   Compen-   Stock-  hensive   lated     Equity
                          Shares  Amount   Shares Amount  Capital    sation   holders Income   Deficit   (Deficit)
                          ------  -------  ------ ------ ---------- --------  ------- ------- ---------  ---------
<S>                       <C>     <C>      <C>    <C>    <C>        <C>       <C>     <C>     <C>        <C>
Balance, January 1,
 1998...................   1,098  $ 1,567     218 $ --    $     92  $   --     $ --    $ --   $ (28,103) $(26,444)
Net loss................     --       --      --    --         --       --       --      --     (13,747)  (13,747)
Common stock issued for
 cash upon exercise of
 stock options .........     --       --      129   --          63      --       --      --         --         63
Common stock warrant
 issued.................     --       --      --    --         480      --       --      --         --        480
Unearned compensation
 related to stock
 options ...............     --       --      --    --       1,820   (1,820)     --      --         --        --
Amortization related to
 unearned compensation..     --       --      --    --         --       393      --      --         --        393
Dividend accretion......     --       --      --    --         --       --       --      --      (2,584)   (2,584)
                          ------  -------  ------ -----   --------  -------    -----   -----  ---------  --------
Balance, December 31,
 1998...................   1,098    1,567     347   --       2,455   (1,427)     --      --     (44,434)  (41,839)
Net loss................     --       --      --    --         --       --       --      --     (11,734)  (11,734)
Common stock issued in
 initial public
 offering, net..........     --       --    2,875     3     46,864      --       --      --         --     46,867
Conversion of Series A-C
 convertible preferred
 stock and Series D-G
 redeemable convertible
 preferred stock to
 common stock in
 conjunction............  (1,098)  (1,567)  8,120     8     54,464      --       --      --         --     52,905
Common stock issued in
 conjunction with Public
 Port pooling of
 interest acquisition...     --       --      169   --         160      --       --      --         (84)       76
Common stock issued in
 conjunction with Vintel
 Corporation purchase
 acquisition............     --       --      116   --       4,254      --       --      --         --      4,254
Common stock issued for
 cash upon exercise of
 stock options .........     --       --      268     1        507      --       --      --         --        508
Common stock issued
 under employee stock
 purchase plan..........     --       --        8   --         239      --       --      --         --        239
Exercise of common stock
 warrant................     --       --       37   --         --       --       --      --         --        --
Common stock issued for
 consulting services....     --       --        1   --          26      --       --      --         --         26
Amortization related to
 unearned compensation..     --       --      --    --         --       455      --      --         --        455
Dividend accretion......     --       --      --    --         --       --       --      --        (235)     (235)
                          ------  -------  ------ -----   --------  -------    -----   -----  ---------  --------
Balance, December 31,
 1999...................     --       --   11,941    12    108,969     (972)     --      --     (56,487)   51,522
                                                                                                         --------
Components of
 comprehensive loss:
 Unrealized gains on
  other assets..........     --       --      --    --         --       --       --       26        --         26
 Foreign currency
  translation
  adjustment............     --       --      --    --         --       --       --      (20)       --        (20)
 Net loss...............     --       --      --    --         --       --       --      --     (74,098)  (74,098)
                                                                                                         --------
Total comprehensive
 loss...................                                                                                  (74,092)
                                                                                                         --------
Common stock issued in
 secondary offering,
 net....................     --       --    2,500     3    141,688      --       --      --         --    141,691
Common stock issued in
 conjunction with
 FreeGate purchase
 acquisition............     --       --      511     1     21,887      --       --      --         --     21,888
Common stock issued in
 conjunction with
 Xstreamis purchase
 acquisition............     --       --      439   --      19,231      --       --      --         --     19,231
Common stock issued for
 cash upon exercise of
 stock options..........     --       --      450   --       4,281      --       --      --         --      4,281
Common stock issued
 under employee stock
 purchase plan..........     --       --       24   --         662      --       --      --         --        662
Unearned compensation
 related to the issuance
 of restricted stock....     --       --       46   --       1,614   (1,614)     --      --         --        --
Amortization related to
 unearned compensation..     --       --      --    --         --     1,545      --      --         --      1,545
Notes receivable issued
 to stockholders........     --       --      --    --         --       --      (555)    --         --       (555)
                          ------  -------  ------ -----   --------  -------    -----   -----  ---------  --------
Balance, December 31,
 2000...................     --   $   --   15,911 $  16   $298,332  $(1,041)   $(555)  $   6  $(130,585) $166,173
                          ======  =======  ====== =====   ========  =======    =====   =====  =========  ========
</TABLE>

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

                                       40
<PAGE>

                               TUT SYSTEMS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                  Years Ended December 31,
                                                 -----------------------------
                                                   2000       1999      1998
                                                 ---------  --------  --------
<S>                                              <C>        <C>       <C>
Cash flows from operating activities:
 Net loss....................................... $ (74,098) $(11,734) $(13,747)
 Adjustments to reconcile net loss to net cash
  used in operating activities:
 Depreciation ..................................     2,267       894       606
 Noncash interest income and amortization of
  discounts on investments......................    (4,375)     (484)     (204)
 Provision for allowance for doubtful
  accounts......................................    22,546       235       104
 Provision for excess and obsolete inventory
  and abandoned products........................    14,468       340       203
 Write off of certain equity investments........     3,100       --        --
 Amortization of intangible assets and noncash
  compensation expense..........................    10,057       533     1,233
 Write-off of in-process research and
  development...................................       800     2,600       --
 Gain on sale of other assets...................      (103)      --        --
 Change in operating assets and liabilities:
  Accounts receivable...........................   (17,613)   (9,239)   (1,672)
  Inventories...................................   (42,151)   (4,954)   (2,566)
  Prepaid expenses and other assets.............    (1,979)   (3,373)   (1,066)
  Accounts payable and accrued liabilities......    24,112     5,168     1,792
  Deferred revenue..............................      (826)      235     2,660
                                                 ---------  --------  --------
   Net cash used in operating activities........   (63,795)  (19,779)  (12,657)
                                                 ---------  --------  --------
Cash flows from investing activities:
 Purchase of property and equipment.............    (8,620)   (2,524)   (1,051)
 Purchase of short-term and long-term
  investments...................................  (164,063)  (34,855)   (3,906)
 Purchase of other assets.......................    (4,501)      --        --
 Proceeds from maturities and sale of short-term
  investments...................................   131,889    14,154     9,000
 Proceeds from sale of other assets.............       128       --        --
 Acquisition of businesses, net of cash acquired
  and purchased research and development........    (1,788)      406       --
                                                 ---------  --------  --------
   Net cash provided by (used in) investing
    activities..................................   (46,955)  (22,819)    4,043
                                                 ---------  --------  --------
Cash flows from financing activities:
 Payment on lines of credit.....................    (1,529)   (2,733)   (1,754)
 Proceeds from lines of credit..................       --        --      5,662
 Issuance of notes receivable ..................      (650)      --        --
 Proceeds from issuances of common and preferred
  stock, net....................................   146,634    54,284     3,763
 Other..........................................       197       --        --
                                                 ---------  --------  --------
   Net cash provided by financing activities....   144,652    51,551     7,671
                                                 ---------  --------  --------
   Net increase (decrease) in cash and cash
    equivalents.................................    33,902     8,953      (943)
Cash and cash equivalents, beginning of year....    13,405     4,452     5,395
                                                 ---------  --------  --------
Cash and cash equivalents, end of year.......... $  47,307  $ 13,405  $  4,452
                                                 =========  ========  ========
Supplemental disclosure of cash flow
 information:
 Interest paid during the year.................. $   1,036  $    --   $     68
                                                 =========  ========  ========
 Income taxes paid during the year.............. $       1  $      1  $      1
                                                 =========  ========  ========
Noncash financing activities:
 Common stock warrants issued................... $     --   $    --   $    480
                                                 =========  ========  ========
 Common stock issued in connection with
  FreeGate, Xstreamis Public Port and Vintel
  acquisitions.................................. $  41,119  $  4,414  $    --
                                                 =========  ========  ========
 Accretion of preferred stock................... $     --   $    235  $  2,584
                                                 =========  ========  ========
 Conversion of preferred stock to common stock.. $     --   $ 47,802  $    --
                                                 =========  ========  ========
 Unearned compensation related to stock and
  stock option grants........................... $   1,614  $    --   $  1,820
                                                 =========  ========  ========
</TABLE>

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

                                       41
<PAGE>

                               TUT SYSTEMS, INC.

                   NOTES TO 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 which 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.

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

 Principles of consolidation

   These consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.

 Use of estimates

   The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The most significant estimates include valuation of
inventories and accounts receivable, estimation of loss on purchase commitments
and the recoverability of long-lived assets. Actual results could differ from
those estimates. Periodically, the Company reviews all significant investments
and assumptions affecting financial statements and, when necessary, records the
effect of any adjustments.

 Fair value of financial instruments

   The fair value of the Company's cash and cash equivalents, short-term
investments, accounts receivable, accounts payable and lines of credit
approximate their carrying value due to the short maturity or market rate
structure of those instruments. The estimated fair values of short-term
investments are based on quoted market prices for those securities or similar
financial instruments.

 Cash, cash equivalents and investments

   Cash, cash equivalents and short-term investments are stated at cost or
amortized cost, which approximates fair value, and consist of money market
funds, commercial paper, US government agency notes, certificates of deposits
and corporate bonds. The Company includes in cash and cash equivalents all
highly liquid investments which mature within three months of their purchase
date. Noncash and noncash equivalents maturing within twelve months from the
balance sheet date are classified as short-term investments. Management
determines the appropriate classification of debt securities at the time of
purchase and re-evaluates that designation as of each balance sheet date. As of
December 31, 2000, debt securities were classified as held-to-maturity as the
Company intended to, and had the ability to hold these securities to maturity.
Held-to-maturity securities are stated at amortized cost, which approximates
fair market value.

   The Company also has certain other minority investments in nonpublicly
traded companies. These investments are included in other assets on the
Company's balance sheet and generally are carried at cost. The Company monitors
those investments for impairment and makes appropriate reductions in carrying
values when necessary.

                                       42
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


 Inventories

   Inventories are stated at the lower of cost or market. Cost is computed
using standard cost, which approximates actual cost on a first-in, first-out
basis.

 Property and equipment

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

<TABLE>
     <S>                                                              <C>
     Office equipment................................................   5 years
     Computers and software.......................................... 3-7 years
     Test equipment..................................................   5 years
     Leasehold improvements.......................................... 1-7 years
</TABLE>

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

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

 Intangible assets

   Intangible assets are stated at cost less amortization and consist of
goodwill, completed technology and patents, and assembled workforce and are
amortized on a straight line basis over the estimated periods of benefit, which
are as follows:

<TABLE>
     <S>                                                                 <C>
     Goodwill........................................................... 5 years
     Completed technology and patents................................... 5 years
     Assembled workforce................................................ 3 years
</TABLE>

   Goodwill represents the excess of cost over the fair value of the net assets
acquired.

 Accounting for long-lived assets

   The Company evaluates the recoverability of its long-lived assets, goodwill
related to those assets, and enterprise goodwill in accordance with Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121").
SFAS 121 requires recognition of impairment of long-lived assets upon the
occurrence of certain events and in the event that the net book value of such
assets exceeds the future undiscounted cash flows attributable to such assets.

   The Company assesses the impairment of long-lived assets and related
goodwill periodically in accordance with the provisions of SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of. An impairment review is performed whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
considered important which could trigger an impairment review include, but are
not limited to, significant underperformance relative to expected historical

                                       43
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

or projected future operating results, significant changes in the manner of use
of the acquired assets or the strategy for the overall business, significant
negative industry or economic trends, a significant decline in the stock price
for a sustained period, and the market capitalization relative to net book
value.

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

Revenue recognition

 Product revenues

   The Company generally recognizes product revenue when persuasive evidence of
an arrangement exists, delivery has occurred, the fee is fixed or determinable,
and collectibility is probable. Revenue from service obligations included in
product revenues is deferred and generally recognized ratably over the period
of the obligation. The Company also maintains accruals and allowances for all
cooperative marketing and other programs. Estimated sales returns, and warranty
costs based on historical experience by product, are recorded at the time
revenue is recognized.

 License and royalty revenues

   The Company has entered into non-exclusive technology agreements with
various licensees. These agreements provide the licensees the right to use the
Company's proprietary technology to manufacture or have products manufactured
using the proprietary technology and to receive customer support for specified
periods and any changes or improvement to the technology over the term of the
agreement.

   Contract fees for the services provided under these licensing agreements are
generally comprised of license fees and non-refundable, prepaid royalties which
are recognized when the proprietary technology is delivered if there are no
significant vendor obligations. If the licensing agreements contain post-
contract customer support, the Company recognizes the contract fees ratably
over the five year period during which the post-contract customer support is
expected to be provided. This period represents the estimated life of the
technology. The Company begins to recognize revenue under the contract, once it
has delivered the implementation package which contains all information needed
to use the Company's proprietary technology in the licensee's process. The
remaining obligations are primarily to provide the licensee with any changes or
improvements to the technology and technical advice on specifications, testing,
debugging and enhancements.

   The Company recognizes royalties upon notification of sale by its licensees.
The terms of the royalty agreements generally require licensees to give
notification to the Company and to pay royalties within 60 days of the end of
the quarter during which the sales take place.

Accounting for stock based compensation

   The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, and "Accounting for Stock Issued to Employees," Financial Accounting
Standard Board Interpretation No. 44 ("FIN 44") "Accounting for Certain
Transactions Involving Stock Compensation-an Interpretation of APB 25," and
complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-
Based Compensation." Under APB No. 25, compensation

                                       44
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

expense is based on the difference, if any, on the date of the grant, between
the fair value of the Company's stock and the exercise price. The Company
accounts for stock issued to non-employees in accordance with the provisions of
SFAS No. 123 and the EITF Issue No. 96-18, "Accounting for Equity Instruments
that are Issued to other than Employees for Acquiring, or in Conjunction with
Selling Goods or Services."

Advertising expenses

   The Company accounts for advertising costs as expense in the period in which
they are incurred. Advertising expense for the years ended December 31, 2000,
1999 and 1998 was $144, $86 and $127, respectively.

Research and development

   Research and development expenditures are charged to expense as incurred.

Income taxes

   Deferred income taxes result primarily from temporary differences between
financial and tax reporting. Deferred tax assets and liabilities are determined
based on the difference between the financial statement bases and the tax bases
of assets and liabilities using enacted tax rates. A valuation allowance is
established to reduce a deferred tax asset to the amount that is expected more
likely than not to be realized.

Foreign currency translation

   The functional currency for the Company's foreign subsidiary is the relevant
local currency. The translation from foreign currencies to U.S. dollars is
performed for balance sheet accounts using current exchange rates in effect at
the balance sheet date and for revenue and expense accounts using the weighted
average exchange rate during the period. Adjustments resulting from such
translation are reflected in comprehensive loss as a separate component of
stockholders' equity. Gains or losses resulting from foreign currency
transactions are included in the results of operations.

                                       45
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


Net loss per share

   Basic and diluted net loss per share are computed using the weighted average
number of common shares outstanding. Options, warrants and preferred stock 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 attributable to common stockholders
follows:

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                  ----------------------------
                                                    2000      1999      1998
                                                  --------  --------  --------
   <S>                                            <C>       <C>       <C>
   Net loss per share attributable to common
    stockholders, basic and diluted:
   Net loss attributable to common
    stockholders................................  $(74,098) $(11,969) $(16,331)
                                                  ========  ========  ========
   Shares used in computing net loss per share
    attributable to common stockholders, basic
    and diluted.................................    14,866    10,729       269
                                                  ========  ========  ========
   Net loss per share attributable to common
    stockholders, basic and diluted.............  $  (4.98) $  (1.12) $ (60.62)
                                                  ========  ========  ========
   Antidilutive securities including options,
    warrants and preferred stock not included in
    net loss per share attributable to common
    stockholders' calculations..................     2,895     1,442     9,180
                                                  ========  ========  ========
</TABLE>

Comprehensive income (loss)

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

<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                                  ----------------------------
                                                    2000      1999      1998
                                                  --------  --------  --------
   <S>                                            <C>       <C>       <C>
   Net loss...................................... $(74,098) $(11,969) $(16,331)
   Unrealized gains on other assets..............       26       --        --
   Foreign currency translation adjustment.......      (20)      --        --
                                                  --------  --------  --------
   Total comprehensive loss...................... $(74,092) $(11,969) $(16,331)
                                                  ========  ========  ========
</TABLE>

Concentrations

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

                                       46
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


   The Company had significant accounts receivable balances due from three
customers, collectively representing 37% of accounts receivable at December 31,
2000. The Company performs ongoing credit evaluations of its customers and
generally requires no collateral.

   Currently, the Company relies on contract manufacturers and some 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.

   The Company from time to time 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 relative to diversification and maturities that
attempt to maintain safety and liquidity. To date, the Company has not
experienced any significant losses on its cash equivalents or short-term
investments. However, at December 31, 2000, the Company held an investment in
commercial paper issued by Southern California Edison Company. This investment
is included in short-term investments at a carrying value of approximately $9.2
million which matured in January 2001 and is currently in default. The Company
believes that the fair value of this investment has declined since the balance
sheet date, however, the ultimate amount of the decline and the net realizable
value of this investment is not currently practicably determinable.

Recent accounting pronouncements

   In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as
required by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement
No. 133," effective January 1, 2001. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly does not believe that the
adoption of SFAS No. 133 will have a material impact on the financial reporting
and related disclosures of the Company.

   In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements," which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
Management evaluated the guidance in SAB 101 and the current interpretations
and believes that it has complied with the guidance contained therein.

   In March 2000, the Financial Accounting Standards Board issued FIN 44. FIN
44 clarifies the application of Opinion No. 25 for (a) the definition of
employee for the purposes of applying Opinion No. 25, (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan, (c) the
accounting consequences of various modifications to the terms of a previously
fixed stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 was effective July 1,
2000, but certain conclusions covered specific events that occurred after
either December 15, 1998, or January 12, 2000. The adoption of FIN 44 did not
have a material effect on the financial statements.

Reclassifications

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

                                       47
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


NOTE 3--BUSINESS COMBINATIONS:

 Pooling of interests combination

   In June 1999, the Company acquired Public Port, Inc. ("Public Port"), a
company that designed and developed subscriber management systems. Under the
terms of the agreement, the Company issued 169 shares of its common stock for
all of the outstanding stock of Public Port. The transaction was accounted for
as a pooling of interests. The historical results of operations and financial
position of Public Port have not been significant in relation to the Company.
As such, historical results of the Company have not been restated for this
acquisition.

 Purchase combinations

   a) Vintel

   In November 1999, the Company acquired all of the common stock and
outstanding options to purchase common stock of Vintel Communications, Inc.
("Vintel") for a total purchase price of $4,780, which consisted of $500 cash,
116 shares of the Company's common stock, 40 options to purchase shares of the
Company's common stock and related expenses. The acquisition was accounted for
as a purchase and the results of the operations of Vintel have been included in
the consolidated financial statements from the date of acquisition.

   The allocation of the purchase price was based on the estimated fair value
of the net assets at the date of the acquisition of $354, goodwill of $1,446,
assembled workforce of $380, and in-process research and development of $2,600.
The amount allocated to intangibles was determined based on an appraisal
completed by an independent third party using established valuation techniques.
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 costs to develop the purchased in-process technology into a commercially
viable product, estimating the resulting net cash flows from the sale of the
product resulting from the completion of the in-process technology and
discounting the net cash flows back to their present value. Research and
development costs to bring in-process technology from Vintel to technological
feasibility are not expected to have a material impact on the Company's future
results of operations or cash flows.

   b) FreeGate

   On February 14, 2000, the Company acquired FreeGate Corporation ("FreeGate")
for a total of $25,486. The purchase price consisted of 511 shares of the
Company's common stock and approximately 20 options to acquire the Company's
common stock, and acquisition related expenses, consisting primarily of
investment advisory, legal, other professional fees and other assumed
liabilities. This acquisition was accounted for as a purchase and the results
of the operations of FreeGate have been included in the consolidated financial
statements from the date of acquisition.

   The allocation of the purchase price was based on the estimated fair value
of goodwill of $19,786, completed technology and patents of $3,400, assembled
workforce of $1,500, and in-process research and development of $800. The
amount allocated to intangibles was determined based on an appraisal completed
by an independent third party using established valuation techniques. 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

                                       48
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

in-process technology was determined by estimating the costs to develop the
purchased in-process technology into a commercially viable product, estimating
the resulting net cash flows from the sale of the product resulting from the
completion of the in-process technology and discounting the net cash flows back
to their present value. Research and development costs to bring in-process
technology from FreeGate to technological feasibility are not expected to have
a material impact on the Company's future results of operations or cash flows.

   c) Xstreamis

   On May 26, 2000, the Company acquired Xstreamis, plc ("Xstreamis"), a United
Kingdom based holding company, for a total of $19,557. The purchase price
consisted of 439 shares of the Company's common stock and 11 options to acquire
the Company's common stock, $100 in cash and $600 in acquisition related
expenses, consisting primarily of legal and other professional fees. This
acquisition was accounted for as a purchase and the results of the operations
of Xstreamis have been included in the consolidated financial statements from
the date of acquisition. The name of the acquired company was changed to
Xstreamis Limited and subsequently to Tut Systems UK Limited.

   The allocation of the purchase price was based on the estimated fair value
of the goodwill of $11,967, completed technology and patents of $7,180, and
assembled workforce of $410. The amount allocated to intangibles was determined
based on an appraisal completed by an independent third party using established
valuation techniques.

   The following unaudited pro forma consolidated information gives effect to
the acquisitions of Vintel, FreeGate and Xstreamis as if they had occurred on
January 1, 2000 and January 1, 1999, respectively, by consolidating the results
of operations of Vintel, FreeGate and Xstreamis with the results of operations
of the Company for the years ended December 31, 2000 and 1999, respectively.
These pro forma results exclude the nonrecurring write-off of in-process
research and development of $800 related to the FreeGate acquisition and $2,600
related to the Vintel acquisition for the years ended December 31, 2000 and
1999, respectively.

<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                     ------------------------
                                                        2000         1999
                                                     -----------  -----------
                                                           (unaudited)
     <S>                                             <C>          <C>
     Revenue........................................ $    72,082  $    30,153
     Net loss attributable to common stockholders... $   (77,430) $   (34,432)
     Net loss per share attributable to common
      stockholders, basic and diluted............... $     (5.13) $     (2.57)
</TABLE>

   d) OneWorld

   On April 28, 2000, the Company acquired certain assets of OneWorld Systems,
Inc. for $2,408 in cash. The allocation of the purchase price was based on the
fair market value of the assets at the date of acquisition of property and
equipment of $300, and the estimated fair value of goodwill of $1,098 and
assembled workforce of $1,010.

                                       49
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


NOTE 4--BALANCE SHEET COMPONENTS:

<TABLE>
<CAPTION>
                                                                December 31,
                                                               ----------------
                                                                2000     1999
                                                               -------  -------
     <S>                                                       <C>      <C>
     Inventories, net:
       Finished goods......................................... $43,151  $ 6,731
       Raw materials..........................................   6,889    2,088
                                                               -------  -------
                                                                50,040    8,819
       Less: reserves......................................... (13,755)    (418)
                                                               -------  -------
                                                               $36,285  $ 8,401
                                                               =======  =======
     Prepaid expenses and other:
       Receivables from contract manufacturers................ $ 2,448  $ 1,324
       Prepaid expenses.......................................   1,078    2,422
                                                               -------  -------
                                                               $ 3,526  $ 3,746
                                                               =======  =======
     Property and equipment:
       Computers and software................................. $ 6,326  $ 2,661
       Leasehold improvements.................................   4,286      469
       Test equipment.........................................   3,257    1,795
       Office equipment.......................................   1,241      631
                                                               -------  -------
                                                                15,110    5,556
       Less: accumulated depreciation.........................  (4,532)  (2,080)
                                                               -------  -------
                                                               $10,578  $ 3,476
                                                               =======  =======
     Intangibles and other assets:
       Goodwill............................................... $34,298  $ 1,446
       Completed technology and patents.......................  10,580      --
       Assembled workforce....................................   3,300      380
                                                               -------  -------
                                                                48,178    1,826
       Less: accumulated amortization.........................  (7,648)     (53)
                                                               -------  -------
       Net intangibles........................................  40,530    1,773
       Other..................................................   5,931    3,982
                                                               -------  -------
                                                               $46,461  $ 5,755
                                                               =======  =======
     Accrued liabilities:
       Provision for loss on purchase commitments............. $19,042  $   --
       Compensation...........................................   2,571    1,488
       Customer deposit.......................................     --     1,000
       Other..................................................   5,516    1,063
                                                               -------  -------
                                                               $27,129  $ 3,551
                                                               =======  =======
</TABLE>

                                       50
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

NOTE 5--SHORT-TERM INVESTMENTS:

<TABLE>
<CAPTION>
                                                                 December 31,
                                                                ---------------
                                                                 2000    1999
                                                                ------- -------
     <S>                                                        <C>     <C>
     Commercial paper.......................................... $37,564 $   --
     Corporate bonds...........................................  12,637  15,736
     US government agency notes................................   5,106     --
     Certificates of deposits..................................     --    3,095
                                                                ------- -------
                                                                $55,307 $18,831
                                                                ======= =======
</TABLE>

   The cost of short-term investments approximated the fair value at December
31, 2000 and 1999. At December 31, 2000, we held an investment in commercial
paper issued by Southern California Edison Company. This investment is included
in short-term investments at a carrying value of approximately $9.2 million
which matured in January 2001 and is currently in default. The Company believes
that the fair value of this investment has declined since the balance sheet
date, however, the ultimate amount of the decline and the net realizable value
of this investment is not currently practicably determinable.

NOTE 6--LINES OF CREDIT:

   The Company entered into a credit facility for up to $7,500 with a lending
institution in December 1998. The credit facility was composed of two
revolvers: a formula revolver of up to the lesser of $3,000 or 85% of
qualifying accounts receivable and a non-formula revolver up to $4,500. The
credit facility required a minimum monthly interest payment of $10. The term of
the credit facility was eighteen months and was renewable for additional terms
of one year unless 60 days' written notice was given by either party. The loans
under this credit facility were collateralized by substantially all assets of
the Company. This agreement prohibited the payment of dividends. The Company
granted the lending institution a warrant to purchase 55 shares of the
Company's common stock at an exercise price of $14.00 per share on December 21,
1998. The warrant was exercisable for 5 years from the date of issuance and was
valued using the Black-Scholes option pricing model. Amounts outstanding under
lines of credit were $1,529 as of December 31, 1999. This credit facility was
paid off during fiscal year 2000 and, as a result, there was no amount
outstanding under these lines of credit as of December 31, 2000.

   On December 18, 1999, the lending institution completed a cashless exercise
of its warrant to purchase the Company's common stock, resulting in the
issuance of 37 shares of common stock.


                                       51
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

NOTE 7--INCOME TAXES:

   The income tax provision for $1 for each of 2000, 1999 and 1998 relates to
the state minimum franchise tax. The components of net deferred tax assets and
liabilities as of December 31, 2000 and 1999 are as follows:

<TABLE>
<CAPTION>
                                                               December 31,
                                                             ------------------
                                                               2000      1999
                                                             --------  --------
     <S>                                                     <C>       <C>
     Deferred tax assets:
       Net operating loss carryforwards..................... $ 26,124  $ 14,937
       Research and development credit......................    2,557     1,599
       Deferred research and development costs..............    1,269       635
       Deferred revenue.....................................      998     1,152
       Accruals and reserves................................   24,136     1,195
       Investment write-offs................................    1,234       --
       Other................................................      243       378
                                                             --------  --------
         Gross deferred tax assets..........................   56,561    19,896
                                                             --------  --------
     Deferred tax liabilities:
       Acquired intangibles.................................     (905)     (145)
       Deferred compensation................................     (415)      --
                                                             --------  --------
       Gross deferred tax liabilities.......................   (1,320)     (145)
                                                             --------  --------
       Less: valuation allowance............................  (55,241)  (19,751)
                                                             --------  --------
         Net deferred tax assets............................ $    --   $    --
                                                             ========  ========
</TABLE>

   Due to the uncertainty surrounding the realization of the tax attributes in
tax returns, the Company has placed a full valuation allowance against its
otherwise recognizable net deferred tax assets.

   At December 31, 2000, the Company has approximately $73,766 in federal and
$17,991 in state net operating loss, or NOL, carryforwards to reduce future
taxable income. Of these amounts, $28,011 and $12,016 represent federal and
state tax deductions, respectively, from stock option compensation. The tax
benefit from these deductions will be recorded as an adjustment to additional
paid-in capital in the year in which the benefit is realized.

   At December 31, 2000, the Company also has research and experimentation tax
credit carryforwards of approximately $1,424 and $1,133 for federal and state
income tax purposes, respectively. The NOL and credit carryforwards expire in
2007 to 2020.

   NOL and tax credit carryforwards may be subject to annual limitations due to
a change in ownership as defined under the Tax Reform Act of 1986.

NOTE 8--COMMITMENTS AND CONTINGENCIES:

 Lease obligations

   The Company leases office, manufacturing and warehouse space under
noncancelable operating leases that expire through 2002. On March 3, 1998, the
Company extended its existing lease for its former headquarters location for
three years beginning June 1, 1998 to May 31, 2001. In July 2000, the Company
subleased this former headquarters location when the Company moved to its new
headquarters in Pleasanton, California. In connection with the business
combinations in 1999, the Company assumed operating leases which expire in
April and December 2001.

                                       52
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


   In July 2000, the Company relocated its principal administrative and
engineering facilities from Pleasant Hill, California to Pleasanton,
California. The lease for the Pleasanton facility expires 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 $1,800. The
letter of credit is collateralized by restricted funds in the amount of $3,208,
which are included in Intangibles and Other assets. The letter of credit is
reduced annually by $250 provided the Company is not in default under the terms
of the lease agreement.

   Minimum future lease payments under operating leases at December 31, 2000
are as follows:

<TABLE>
     <S>                                                                 <C>
     2001............................................................... $ 2,716
     2002...............................................................   2,243
     2003...............................................................   1,755
     2004...............................................................   1,630
     2005...............................................................   1,684
     Thereafter.........................................................   2,619
                                                                         -------
                                                                         $12,647
                                                                         =======
</TABLE>

   Rent expense for the years ended December 31, 2000, 1999 and 1998 was
$2,165, $369 and $314, respectively.

 Purchase commitments

   At December 31, 2000, the Company had noncancellable commitments to purchase
finished goods inventory totaling $10,693 in aggregate.

 Royalty obligation

   The Company has acquired the rights, title and interests in two patents from
a founder and stockholder of the Company. These two patents give the Company
exclusive control of the Balun technology required in the Company's products.
Under a previous agreement, the Company was required to pay on-going royalties
based on the net sales price of products sold utilizing the patented
technology. In February 1999, the Company paid the founder $2,500 as a lump sum
payment for all its future royalty obligations, which the Company is amortizing
ratably over five years. This period represents the estimated life of the
patented technology. As of December 31, 2000, the balance of this payment
remaining to be amortized was $1,542. Amortization expense for the years ended
December 31, 2000 and 1999 was $500 and $458, respectively.

   For 1998, the royalty fees related to this technology were based on 1% of
net sales and totaled approximately $100.

 Contingencies

   The Company is subject to 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.


                                       53
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

NOTE 9--STOCKHOLDERS' EQUITY

 Stock split

   In September 1998, in connection with the Company's reincorporation from
California to Delaware, the Company effected a four for one reverse split of
its common and preferred stock. All share data and stock option plan
information have been restated to reflect the reverse split and the
reincorporation.

 Preferred stock

   The Company has 5,000 shares of undesignated preferred stock, $0.001 par
value, authorized for issuance. The Board of Directors can issue, in one or
more series, this preferred stock and fix the voting rights, liquidation
preferences, dividend rights, repurchase rights, conversion rights, redemption
rights and terms and certain other rights and preferences with stockholder
action. There was no preferred stock issued and outstanding at December 31,
2000 or 1999.

 Warrants for Series G Mandatorily Redeemable Convertible Preferred Stock

   In connection with the issuance of Series G redeemable convertible preferred
stock ("Series G"), in 1998 the Company issued warrants to purchase 667 shares
of Series G with an exercise price of $10.00 per share. In January 1999, prior
to the public offering, these warrants were exercised, resulting in the
issuance of 667 shares of Series G in exchange for cash proceeds totaling
$6,700. Simultaneously with the closing of the initial public offering, these
Series G redeemable convertible preferred shares were automatically converted
into shares of common stock. There were no warrants issued and outstanding at
December 31, 2000 or 1999.

 Initial Public Offering

   On January 29, 1999, the Company completed its initial public offering of
common stock. The Company issued 2,875 shares at $18.00 per share, obtaining
net proceeds of approximately $46,900, net of underwriting discounts,
commissions and other offering costs. Simultaneously with the closing of the
initial public offering, all issued and outstanding shares of the Company's
convertible preferred stock and redeemable convertible preferred shares were
automatically converted into shares of common stock.

 Secondary Offering

   On March 23, 2000, the Company completed its secondary offering of common
stock. The Company issued 2,500 shares at $60.00 per share, obtaining net
proceeds of approximately $141,700, net of underwriting discounts, commissions
and other offering costs.

NOTE 10--EQUITY BENEFIT PLANS

 Stock option plans

   In November 1993, the Company adopted the 1992 Stock Plan (the "1992 Plan"),
under which the Company may grant both incentive stock options and nonstatutory
stock options to employees, consultants and directors. Options issued under the
1992 Plan can have an exercise price of no less than 85% of the fair market
value, as defined under the 1992 Plan, of the stock at the date of grant. The
1992 Plan, including amendments, allows for the issuance of a maximum of 1,438
shares of the Company's common stock. This number of shares

                                       54
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

of common stock has been reserved for issuance under the 1992 Plan. At December
31, 2000, the Company is no longer granting stock options from the 1992 Plan.
As stock options are terminated or cancelled from the 1992 Plan, the stock
options are being retired and are no longer available for future grant.

   The Company's 1998 Stock Plan (the "1998 Plan") was adopted by the Board of
Directors in July 1998 and was approved by the stockholders in September 1998
and has rights and privileges similar to the 1992 Plan. The 1998 Plan allows
for the issuance of a maximum of 1,000 shares of the Company's common stock
with annual increases starting in 2000, subject to certain limitations. In
January 2000, the 1998 Plan was amended to increase the maximum number of
shares that may be issued to 1,358.

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

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

                                       55
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                   (in thousands, except per share amounts)


   Activity under the 1992, 1998 and 1999 Plans (the "Plans") are summarized
as follows:

<TABLE>
<CAPTION>
                                                             Outstanding Options
                                             ----------------------------------------------------
                                                                                     Weighted
                          Shares                                                     Average
                         Available  Options  Number of       Price        Aggregate  Exercise
                         For Grant Exercised  Shares       Per Share        Price     Price
                         --------- --------- --------- ------------------ ---------  --------
<S>                      <C>       <C>       <C>       <C>                <C>        <C>      <C>
Balance, January 1,
 1998...................     317       208       725   $   0.28 - $  2.00 $    385    $ 0.53
  Options authorized....   1,188       --        --          --        --       --        --
  Options granted.......    (414)      --        414       2.00 -   15.00    2,822      6.82
  Options exercised.....     --        129      (129)      0.36 -    2.40      (63)     0.49
  Options terminated....       5       --         (5)                0.52       (3)     0.52
                          ------     -----     -----                      --------
Balance, December 31,
 1998...................   1,096       337     1,005       0.28 -   15.00    3,141      3.13
  Options authorized....   1,000       --        --          --        --       --        --
  Options granted.......    (849)      --        849       1.85 -   51.38   22,346     26.35
  Options exercised.....     --        268      (268)      0.36 -   15.00     (508)     1.89
  Options terminated....      30       --       (144)      0.48 -   46.63   (1,957)    13.59
  Available options
   retired from 1992
   Plan.................     (10)      --        --          --                 --        --
                          ------     -----     -----                      --------
Balance, December 31,
 1999...................   1,267       605     1,442       0.36 -   51.38   23,022     15.96
  Options authorized....   1,183       --        --          --        --       --        --
  Options granted.......  (2,461)      --      2,461       6.16 -  100.63   98,263     39.92
  Options exercised.....     --        450      (450)      0.36 -   59.59   (4,281)     9.51
  Options terminated....     695       --       (698)      0.48 -   94.50  (25,146)    36.03
  Restricted stock
   issued...............     (46)      --        --          --        --       --        --
  Available options
   retired from 1992
   Plan.................     (51)      --        --          --        --       --        --
                          ------     -----     -----                      --------
Balance, December 31,
 2000...................     587     1,055     2,755     $ 0.36 - $100.63 $ 91,858    $33.34
                          ======     =====     =====                      ========
</TABLE>

   In addition to options granted under the Plans, in March 2000, the Company
granted an option to purchase 75 shares at $51.25 with rights and privileges
similar to the 1998 Plan. In December 2000, the Company granted an option to
purchase 65 shares at $7.44 with rights and privileges similar to the 1998
Plan.

   In addition, during 2000 restricted stock was granted with repurchase
rights which lapse over an eighteen month period. The unearned compensation
associated with restricted stock grants is amortized on a straight line basis
over the eighteen month period. Accordingly, the Company amortized $1,107 for
the year ended December 31, 2000.

   In connection with the grant of options for the purchase of 356 shares of
common stock to employees during the period from December 1997 through June
1998, the Company recorded aggregate deferred compensation of $1,820
representing the difference between the deemed fair value of the common stock
and the option exercise price at the date of grant. In December 2000, the
Company reduced this deferred compensation by $251 to $1,569 before
amortization, reflecting employee terminations through December 2000. This
deferred compensation will be amortized over the vesting period relating to
these options. Accordingly, the Company amortized $438, $455 and $393 for the
years ended December 31, 2000, 1999 and 1998, respectively.

   The Company uses the Black-Scholes option pricing model to value options
granted to consultants. The

                                      56
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

total estimated fair value of these grants during the periods presented was not
significant and was expensed over the applicable vesting periods.

   At December 31, 2000, 1999 and 1998, vested options to purchase 418, 379 and
385 shares of common stock, respectively were unexercised. The weighted average
exercise price of these options was $19.92, $1.96 and $0.65 per share for 2000,
1999 and 1998, respectively.

   The following table summarizes information about stock options outstanding
at December 31, 2000:

<TABLE>
<CAPTION>
                  Options Outstanding                 Options Exercisable
   -----------------------------------------------------------------------
                                  Weighted
                                   Average
                                  Remaining  Weighted             Weighted
                                 Contractual Average              Average
       Range of        Number       Life     Exercise   Number    Exercise
   Exercise Prices   Outstanding   (years)    Price   Exercisable  Price
   ----------------  ----------- ----------- -------- ----------- --------
   <S>               <C>         <C>         <C>      <C>         <C>
   $ 0.36 - $  0.52        97       5.40      $ 0.47       79      $ 0.45
     1.85 -    2.40       138       7.20        2.31       91        2.30
     3.60 -    3.60         8       7.10        3.60        5        3.60
     6.16 -    8.00       166       9.70        7.15        4        8.00
    12.00 -   15.00        82       7.70       14.24       25       14.35
    20.11 -   28.00       826       9.20       25.96      115       24.20
    31.38 -   46.63     1,162       9.20       38.11       59       37.18
    47.88 -   68.25       289       9.40       59.21       40       65.92
    74.94 -  100.63       127       9.70       83.31      --        95.62
                        -----                             ---
                        2,895                             418
                        =====                             ===
</TABLE>

 Employee Stock Purchase Plan

   The Company's 1998 Employee Stock Purchase Plan (the "1998 Purchase Plan")
was adopted by the Board of Directors in July 1998 and was approved by the
stockholders in September 1998. Under the 1998 Purchase Plan, an eligible
employee may purchase shares of common stock from the Company through payroll
deductions of up to 15% of his or her compensation, at a price per share equal
to 85% of the lesser of the fair market value of the Company's common stock as
of the first or last trading day on or after May 1 and November 1 and end on
the last trading day of the period six (6) months later. At December 31, 1998,
the Company has reserved 250 shares of common stock for issuance under the 1998
Purchase Plan. The 1998 Purchase Plan is subject to annual increases, subject
to certain limitations.

 Pro forma stock-based compensation

   The Company is required under Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), to disclose
pro forma information regarding option grants made to its employees based on
specified valuation techniques that produce estimated compensation charges. The
following information concerning the Company's stock option plans and employee
stock purchase plan is provided in accordance with SFAS 123. The Company
accounts for its stock option plans and employee stock purchase plan in
accordance with APB No. 25 and related Interpretations. Had compensation
expense for the stock option plans and the employee stock purchase plan been
determined based on the fair value at the grant date for awards granted in
2000, 1999 and 1998, consistent with the provisions of SFAS 123, the pro forma
net loss would have been reported as follows:


                                       57
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                  Year Ended December 31,
                                                 ----------------------------
                                                   2000      1999      1998
                                                 --------  --------  --------
   <S>                                           <C>       <C>       <C>
   Net loss attributable to common
    stockholders--as reported................... $(74,098) $(11,969) $(16,331)
   Net loss attributable to common
    stockholders--pro forma.....................  (87,618)  (13,602)  (16,496)
   Net loss per share attributable to common
    stockholders--as reported...................    (4.98)    (1.12)   (60.62)
   Net loss per share attributable to common
    stockholders--pro forma.....................    (5.89)    (1.27)   (61.24)
</TABLE>

   The Black-Scholes option pricing model was developed for use in estimating
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option pricing models require the input of highly
subjective assumptions including the expected stock price volatility. The
Company uses projected volatility rates which are based upon historical
volatility rates trended into future years. Because the Company's stock options
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimates, in management's opinion, the existing models do not
necessarily provide reliable single measure of the fair value of the Company's
options.

   Prior to the Company's initial public offering, the fair value of each
option grant was estimated using the minimum value method. Volatility and
dividend yields were not factors in the Company's minimum value calculation.
Subsequent to the offering, the fair value of each stock option grant has been
estimated on the date of the grant using the Black-Scholes option pricing
model. The Company has also estimated the fair value of the purchase rights
issued from its employee stock purchase plan, using the Black-Scholes option
pricing model. The Company first issued purchase rights from the 1998 Purchase
Plan in fiscal 1999. The following table outlines the weighted average
assumptions for both the stock options granted and the purchase rights issued:

<TABLE>
<CAPTION>
                                              Stock Option      Employee Stock
                                                  Plans         Purchase Plan
                                             -----------------  ----------------
                                               Year Ended         Year Ended
                                              December 31,       December 31,
                                             -----------------  ----------------
                                             2000   1999  1998  2000   1999
                                             -----  ----  ----  -----  ----
<S>                                          <C>    <C>   <C>   <C>    <C>   <C>
Expected dividend yield.....................   0.0%  0.0% 0.0%    0.0%  0.0%
Risk-free interest rate.....................   6.2%  5.6% 5.4%    5.8%  4.7%
Expected volatility......................... 120.0% 90.0% 0.0%  120.0% 90.0%
Expected life (in years)....................   4.0   4.0  4.0     0.5   0.5
</TABLE>

   Generally, the Company grants options at a price equal to the fair market
value of the Company's stock on the date of the grant. The weighted-average
estimated fair values of stock options granted during fiscal 2000, 1999 and
1998 as calculated using the Black-Scholes option pricing model were $31.51,
$17.74 and $2.13 per share, respectively.

 401(k) Plan

   In April 1995, the Company adopted the Tut Systems' Inc. 401(k) Plan (the
"401(k) Plan") covering all eligible employees. Contributions are limited to
15% of each employee's annual compensation. Contributions to the 401(k) Plan by
the Company are discretionary. The Company did not make any contributions for
the years ended December 31, 2000, 1999 and 1998.


                                       58
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)

NOTE 11--LOSS ON PURCHASE COMMITMENTS AND ABANDONED PRODUCTS

   At December 31, 2000, the Company accrued a provison for loss on purchase
commitments in the amount of $19,042 related to canceled purchase orders. In
addition, the Company recorded a provision for loss on abandoned products of
$8,181 related to the Company's decision to abandon the further development and
sale of certain product lines. This amount excludes $6,287 already recorded as
a provision for excess and obsolete inventory included in the cost of goods
sold related to product.

NOTE 12--SEGMENT INFORMATION:

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

<TABLE>
<CAPTION>
                                                          Years Ended December
                                                                   31,
                                                         -----------------------
                                                          2000    1999    1998
                                                         ------- ------- -------
     <S>                                                 <C>     <C>     <C>
     United States...................................... $42,474 $18,825 $ 8,601
     International:
       Korea............................................  12,791       *      **
       Canada...........................................       *   2,779      **
       All other countries..............................  16,726   6,203   1,954
                                                         ------- ------- -------
                                                         $71,991 $27,807 $10,555
                                                         ======= ======= =======
</TABLE>
--------
* Revenue attributable to this country was less than 10% of total revenue and
any revenue attributable to this country is included in the "All other
countries" line.

** The Company was able to determine revenue by country in 2000 and 1999. In
prior periods, the Company was only able to determine revenue breakdown between
the United States and all other countries.

   It is impracticable for the Company to compute product revenues by product
type for the years ended December 31, 2000, 1999 and 1998.

   Three customers accounted for 18%, 12% and 11%, respectively, of the
Company's revenue for the year ended December 31, 2000. Two customers accounted
for 12% and 10%, respectively, of the Company's revenue for the year ended
December 31, 1999. One customer accounted for 10% of the Company's revenue for
the year ended December 31, 1998.

NOTE 13--SUBSEQUENT EVENTS (UNAUDITED):

 Completed Acquisition

   On January 11, 2001, the Company acquired ActiveTelco, Inc. ("ActiveTelco")
for approximately $4,850, consisting of an aggregate of 321 shares of the
Company's common stock and 19 options to purchase shares of the Company's
common stock, and acquisition related expenses consisting primarily of legal,
other professional fees, assumed ActiveTelco convertible notes in the amount of
$650 plus accrued interest and other assumed liabilities of approximately
$1,100. This transaction will be treated as a purchase for accounting purposes.
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.

                                       59
<PAGE>

                               TUT SYSTEMS, INC.

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
                    (in thousands, except per share amounts)


   The preliminary allocation of the purchase price was based on the estimated
fair value of goodwill of $3,248, assembled workforce of $442, and in-process
research and development of $1,160. The preliminary amount allocated to
intangibles was determined based on an appraisal using established valuation
techniques. 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 costs to develop the purchased in-process technology into a
commercially viable product, estimating the resulting net cash flows from the
sale of the product resulting from the completion of the in-process technology
and discounting the net cash flows back to their present value. Research and
development costs to bring in-process technology from ActiveTelco to
technological feasibility are not expected to have a material impact on the
Company's future results of operations or cash flows.

Option Exchange Program

   The Company is offering its employees the opportunity to cancel up to
1,711,963 outstanding options in return for new options to purchase shares of
common stock equal to the number of options canceled. The new options will be
issued six months and two days after the cancellation. The exercise price will
be the fair market value on the grant date. Employees who choose to cancel
options will receive credit for past vesting as well as vesting during the
waiting period. In addition, the vesting period for the new options will be
shortened by approximately six months.

                                       60
<PAGE>

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

   There has been no change in our independent accountants during the past two
fiscal years. There have been no disagreements with our independent accountants
on our accounting or financial reporting that would require our independent
accountants to qualify or disclaim their report on our consolidated financial
statements and financial statement schedule, or otherwise require disclosure in
this Annual Report on Form 10-K.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders,
when filed pursuant to Regulation 14A under the Securities and Exchange Act of
1934, as amended (the "Exchange Act"), will be incorporated by reference in
this Annual Report on Form 10-K pursuant to General Instruction G(3) and will
provide the information required in Item 10.

ITEM 11. EXECUTIVE COMPENSATION

   The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders,
when filed pursuant to Regulation 14A under the Securities and Exchange Act,
will be incorporated by reference in this Annual Report on Form 10-K pursuant
to General Instruction G(3) and will provide the information required in Item
11.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders,
when filed pursuant to Regulation 14A under the Securities and Exchange Act,
will be incorporated by reference in this Annual Report on Form 10-K pursuant
to General Instruction G(3) and will provide the information required in Item
12.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   The Company's Proxy Statement for its 2001 Annual Meeting of Stockholders,
when filed pursuant to Regulation 14A under the Securities and Exchange Act,
will be incorporated by reference in this Annual Report on Form 10-K pursuant
to General Instruction G(3) and will provide the information required in Item
13.

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

   (a)

   1. Financial Statements

   The following documents are filed as part of this Annual Report on Form 10-
K:

<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                       <C>
Report of Independent Accountants........................................  37
Consolidated Balance Sheets as of December 31, 2000 and 1999.............  38
Consolidated Statements of Operations for the years ended December 31,
 1998, 1999, and 2000....................................................  39
Consolidated Statements of Stockholders' Equity (Deficit) for the years
 ended December 31, 2000, 1999 and 1998..................................  40
Consolidated Statements of Cash Flows for the years ended December 31,
 2000, 1999 and 1998.....................................................  41
Notes to Consolidated Financial Statements...............................  42
</TABLE>

                                       61
<PAGE>

   2. Financial Statements Schedules

   The following financial statement schedule is filed as part of this Annual
Report on Form 10-K:

     Schedule II--Valuation and Qualifying Accounts and Reserves

   All other schedules have been omitted as they are not required, not
applicable, or the required information is otherwise included.

   3. Exhibits

   The exhibits listed on the accompanying index to exhibits immediately
following the financial statement schedule are filed as part of, or
incorporated by reference into, this Annual Report on Form 10-K.

   (b) Reports on Form 8-K

   We did not file any Reports of Form 8-K during the fourth quarter ended
December 31, 2000.

                                       62
<PAGE>

                                   SIGNATURES

   Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

   Date: April 2, 2001

                                          TUT SYSTEMS, INC.

                                                  /s/ Nelson Caldwell
                                          By: _________________________________
                                                      Nelson Caldwell
                                               Vice President, Finance, Chief
                                              Financial Officer and Secretary

                               POWER OF ATTORNEY

   KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Salvatore D'Auria and Nelson Caldwell, and each
of them, jointly and severally, his true and lawful attorneys-in-fact, each
with full power of substitution and resubstitution, for him in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he or she might or could do if
personally present, hereby ratifying and confirming all that each said
attorney-in-fact and agent, or his or her substitute or substitutes or any of
them, may lawfully do or cause to be done by virtue hereof.

   Pursuant to the requirements of the Securities Act of 1934, this Annual
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
      /s/ Salvatore D'Auria            President, Chief Executive   April 2 , 2001
______________________________________ Officer and Chairman of
          Salvatore D'Auria            the Board (Chief Executive
                                       Officer)

       /s/ Nelson Caldwell             Vice President, Finance,      April 2, 2001
______________________________________ Chief Financial Officer
           Nelson Caldwell             and Secretary (Chief
                                       Financial and Accounting
                                       Officer)

       /s/ Saul Rosenzweig             Director                      April 2, 2001
______________________________________
           Saul Rosenzweig

         /s/ Neal Douglas              Director                      April 2, 2001
______________________________________
             Neal Douglas
</TABLE>

                                       63
<PAGE>

<TABLE>
<CAPTION>
              Signature                          Title                   Date
              ---------                          -----                   ----

<S>                                    <C>                        <C>
    /s/ Clifford H. Higgerson          Director                      April 2, 2001
______________________________________
        Clifford H. Higgerson

         /s/ David Spreng              Director                      April 2, 2001
______________________________________
             David Spreng

     /s/ George M. Middlemas           Director                      April 2, 2001
______________________________________
         George M. Middlemas

        /s/ Roger H. Moore             Director                      April 2, 2001
______________________________________
            Roger H. Moore
</TABLE>


                                       64
<PAGE>

                               TUT SYSTEMS, INC.

          SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

<TABLE>
<CAPTION>
                                                Addition
                                   Balance at (reductions)             Balance
                                   Beginning  to Costs and            at End of
                                   of Period    Expenses   Write-offs  Period
                                   ---------- ------------ ---------- ---------
<S>                                <C>        <C>          <C>        <C>
Allowance for doubtful accounts:
  Year ended December 31, 1998...   $    29     $   104     $   (18)   $   115
  Year ended December 31, 1999...       115         235         (15)       335
  Year ended December 31, 2000...       335      22,546      (1,714)    21,167
Valuation allowance for deferred
 tax assets:
  Year ended December 31, 1998...     8,981       5,290         --      14,271
  Year ended December 31, 1999...    14,271       5,480         --      19,751
  Year ended December 31, 2000...    19,751      35,490         --      55,241
Allowance for excess and obsolete
 inventory and abandoned product:
  Year ended December 31, 1998...         7         203         (95)       115
  Year ended December 31, 1999...       115         340         (37)       418
  Year ended December 31, 2000...       418      14,468      (1,131)    13,755
</TABLE>

                                       65
<PAGE>

                               INDEX TO EXHIBITS

<TABLE>
<CAPTION>
 Exhibit
 Number                                Description
 -------                               -----------
 <C>     <S>
   2.1   Agreement and Plan of Reorganization dated as of October 15, 1999, by
         and among the Company, Vintel Acquisition Corp., and Vintel
         Communications, Inc.(4)

   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.(3)

   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.(5)

   2.4   Asset Purchase Agreement by and between the Company and OneWorld
         Systems, Inc. dated as of February 3, 2000.(6)

   2.5   Amendment No. 1 to Asset Purchase Agreement by and between the Company
         and OneWorld Systems, Inc. dated as of February 17, 2000.(6)

   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.(8)

   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.(10)

   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)

  10.1   1992 Stock Plan, as amended, and form of Stock Option Agreement
         thereunder.(1)

  10.2   1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase
         Agreement thereunder.(1)

  10.3   1998 Employee Stock Purchase Plan, as amended.(2)

  10.4   1998 Stock Plan Inland Revenue Approved Rules for UK Employees.(6)

  10.5   American Capital Marketing, Inc. 401(k) Plan.(1)

  10.6   Fourth Amended and Restated Shareholders' Rights Agreement, dated
         December 16, 1997, between the Company and certain stockholders.(1)

  10.7   Lease by and between Pleasant Hill Industrial Park Associates, a
         California Limited Partnership, and the Company dated April 4, 1995,
         as amended.(1)

  10.8   Office Building Lease between Petula Associates, Ltd., an Iowa
         corporation, and Principal Mutual Life Insurance Co., an Iowa
         corporation, doing business as RC Creekside Phase VI and the Company
         dated April 25, 1997.(1)

  10.9   Licensing and Cooperative Marketing Agreement between Microsoft
         Corporation and the Company dated August 27, 1997, as modified and
         restated on July 30, 1998.(1)

  10.10  Form of Indemnification Agreement entered into between the Company and
         each director and officer.(1)

  10.11  Employment Agreement by and between the Company, FreeGate Corporation
         and Sandy Benett dated as of November 17, 1999.(6)

  10.12  Non-competition Agreement by and between the Company, FreeGate
         Corporation and Sandy Benett dated as of November 17, 1999.(6)

  10.13  Agreement and General Release between the Company and And Yet, Inc.
         dated July 31, 1998.(1)

  10.14  Software License Agreement between RouterWare, Inc. and the Company
         dated December 16, 1997.(1)
</TABLE>


                                       66
<PAGE>

<TABLE>
<CAPTION>
 Exhibit
 Number                                Description
 -------                               -----------
 <C>     <S>
  10.15  Home Phoneline Promoters Agreement by and between the Company and IBM
         Corporation, Hewlett-Packard Company, Compaq Computer Corporation,
         Advanced Micro Devices, Inc., Intel Corporation, Epigram, Inc., AT&T
         Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor
         Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998.(1)

  10.16  Master Agreement between the Company and Compaq Computer Corporation
         dated April 21, 1998 including supplements thereto.(1)

  10.17  Loan Agreement, General Security Agreement, and Collateral Assignment
         and Patent Mortgage and Security Agreement with Imperial Bank, each
         dated August 16, 1997.(1)

  10.18  Loan and Security Agreement, Streamlined Facility Agreement, Revolving
         Credit Note, Patent and Trademark Security Agreement, Security
         Agreement in Copyrighted Works and Stock Subscription Warrant between
         the Company and TransAmerica Business Credit Corporation, each dated
         December 18, 1998.(1)

  10.19  Extension Agreement among the Company, And Yet, Inc. and Marty Graham
         dated December 21, 1998.(1)

  10.20  Registration Rights Agreement, dated as of May 26, 2000, by and
         between the Company and Xstreamis Plc stockholders listed therein.(7)

  10.21  Commercial Office Lease between Las Positas LLC and the Company, dated
         March 8, 2000.(7)

  10.22  Executive Retention and Change of Control Plan.(9)

  10.23  Non-Executive Retention and Change of Control Plan and Summary Plan
         Description.(9)

  10.24  Non-Qualified Stock Option Agreement issued to Mark Carpenter on March
         3, 2000.(9)

  11.1   Calculation of earnings per share (contained in Note 2 of Notes to
         Consolidated Financial Statements).

  21.1   List of Subsidiaries of the Company.

  23.1   Consent of Independent Accountants.

  24.1   Power of Attorney (See page 63).
</TABLE>
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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.
(2) Incorporated by reference to our Quarterly Report on Form 10-Q for the
    quarter ended March 31, 1999.
(3) Incorporated by reference to our Quarterly Report on Form 10-Q for the
    quarter ended June 30, 1999.
(4) Incorporated by reference to our Quarterly Report on Form 10-Q for the
    quarter ended September 30, 1999.
(5) Incorporated by reference to our Current Report on Form 8-K dated February
    14, 2000.
(6) Incorporated by reference to our Annual Report on Form 10-K for the year
    ended December 31, 1999.
(7) Incorporated by reference to our Registration Statement on Form S-1 (File
    No. 333-31446) as declared effective by the Securities and Exchange
    Commission on March 23, 2000.
(8) Incorporated by reference to our Current Report on Form 8-K dated May 26,
    2000 as filed June 9, 2000.
(9) Incorporated by reference to our Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2000.
(10) Incorporated by reference to our Current Report on Form 8-K dated January
     18, 2001.

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