UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K10-K/A
(Mark One)AMENDMENT NO. 1 TO FORM 10-K)
ý | Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, | |||
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period fromto | |||
Commission File Number: 000-25291
TUT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware | 94-2958543 | |
(State or other jurisdiction
| (I.R.S. Employer
|
|
| |
(address of principal executive offices) | (zip code) |
Registrant’sRegistrant's telephone number, including area code: (925) 460-3900
(503) 594-1400
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 xý No o¨
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’sregistrant'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. o¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý¨ No xo
The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $29,311,461$78,767,255 as of March 27,June 30, 2003 based on the closing price of the common stock as reported on The Nasdaq National Market for March 27,June 30, 2003. There were 19,805,041shares20,276,454 shares of the Registrant’sRegistrant's common stock issued and outstanding on March 27, 2003.
January 26, 2004.
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, 2002.2003.
AMENDMENT NO. 1 TO THE
ANNUAL REPORT ON FORM 10-K
10-K/A
TABLE OF CONTENTS
| ITEM NO. | Page | ||||
|---|---|---|---|---|---|
| PART I | |||||
1. | BUSINESS | 3 | |||
2. | PROPERTIES | 13 | |||
3. | LEGAL PROCEEDINGS | 13 | |||
4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | 15 | |||
PART II | |||||
5. | MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS | 16 | |||
6. | SELECTED CONSOLIDATED FINANCIAL DATA | 17 | |||
7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 18 | |||
7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 40 | |||
8. | CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 42 | |||
9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 75 | |||
PART III | |||||
9A. | CONTROLS AND PROCEDURES | 76 | |||
10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT | 76 | |||
11. | EXECUTIVE COMPENSATION | 77 | |||
12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT | 77 | |||
13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS | 77 | |||
14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES | 77 | |||
PART IV | |||||
15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K | 78 | |||
SIGNATURES | 79 | ||||
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Page | ||||
ITEM NO. | ||||
PART I | ||||
1. | 1 | |||
2. | 16 | |||
3. | 16 | |||
4. | 17 | |||
PART II | ||||
5. | MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS | 17 | ||
6. | 18 | |||
7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 19 | ||
7A. | 48 | |||
8. | 49 | |||
9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 78 | ||
PART III | ||||
10. | 79 | |||
11. | 79 | |||
12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT | 79 | ||
13. | 79 | |||
14. | 79 | |||
PART IV | ||||
15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K | 80 | ||
81 | ||||
84 | ||||
IMPORTANT NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Amendment No. 1 to the Annual Report on Form 10-K10-K/A contains “forward-looking statements”"forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include, but are not limited to, statements about (1)may generally be identified by the developmentuse of our Astria™ VSS system and the system’s ability to distribute content, provide video service management, multi-tier Internet protocol (IP) multicasting and digital subscriber line access multiplexer (DSLAM) aggregation capabilities, (2) our expectation that residential and commercial demand for broadband services will continue to increase, (3) our assumption that incumbent local exchange providers’ and international post, telephone and telegraph companies’ intend (and are able) to offer bundled services, (4) our expectation that the video trunking market will expand, (5) our ability to incorporate technologies from our Astria product line into our video trunking products, (6) our ability to expand and further specialize our video trunking products, (7) Astria CP’s ability to encode and transcode content into MPEG-4 and Windows Media, thereby providing service providers with more competitive offerings for their end-users, (8) our expectation that our Expresso™ product line will continue to be deployed for high-speed Internet access (HSIA)-based multi-tenant unit (MTU) applications, (9) our expectation that our IntelliPOP 5000 system will be deployed for high-speed data and video applications in commercial environments, (10) our Signature-Switch™ technology’s ability to provide an attractive solution to our customers, (11) our ability to maintain and grow our video-based independent operating company (IOC) business, (12) our ability to partner with third parties in order to expand our presence into new markets, (13) our expectation that small and medium-sized IOCs in the U.S. will remain our near-term market for Astria products, (14) our belief that our products can serve a substantial market for digital video and high-speed data access products outside of the U.S., (15) our expectation that we will continue to make significant investments into our research and development activities, (16) our expectation that we will release our Astria VSS system in the second quarter of 2003, (17) our expectation that the Astria VSS system will be a more cost-effective solution for service providers than such providers’ present alternatives and (18) 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,” “will”as "expect," "anticipate," "believe," "intend," "plan," "will," or the negative of these terms or similar expressions are generally intended to identify forward-looking statements. Because"shall." We have based these forward-looking statements involveon our current expectations and projections about future events. Such forward-looking statements are subject to various risks and uncertainties there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-lookingprojected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. These forward-looking statements reflect current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions. As a result, actual results may differ materially from the forward-looking statements contained herein. Such risks and uncertainties include those set forth in Part II, Item 7— “Management’sunder "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations—Additional Risk FactorsOperations." The forward-looking statements contained in this annual report include statements about the following: (1) our belief that Could Affect our Operating Results and the Market Pricevideo products will provide most of our Stock”growth opportunities for the foreseeable future, (2) our belief that the number of telco video subscribers will grow significantly between 2003 and those identified2007, (3) our intention to expand our relationship with value-added distributors and partners in Europe and Asia, (4) our intention to expand and further specialize our video trunking products for surveillance and broadcast TV backhaul applications, (5) our anticipation that we will introduce products to support new technologies, (6) our expectation that small to medium size IOCs in the introductionU.S. will remain our primary near term customers for Astria products, (7) our belief that our cash and cash equivalents as of December 31, 2003 are sufficient to Part II, Item 7. In particular, see “Additional Risk Factorsfund our operating activities and capital expenditure for the next twelve months, (8) our expectation that Could Affectworking capital will begin to increase in future periods, (9) our Operating Resultsexpectation that we will seek additional equity funding in the first quarter of 2004 and (10) our expectation that customers outside of the Market PriceUnited States will represent a significant and growing portion of our Stock—We have a history of lossesrevenue.
The cautionary statements contained under the caption "Risk Factors" and expectother similar statements contained elsewhere in this prospectus, including the documents that are incorporated by reference, identify important factors with respect to continue to incur losses in the future,” “—Our operating results may fluctuate significantly, whichsuch forward-looking statements, including certain risks and uncertainties that could cause our stock price to decline,” and “—We are and continue to be affectedactual results, performance or achievements expressed or implied by poor general economic conditionssuch forward-looking statements.
Although we believe that have resultedthe expectations reflected in significantly reduced sales levels and, if such adverse economic conditions continue or worsen, our business, operating results and financial condition will continue to be negatively impacted.” All subsequent written and oral forward-looking statements attributableare based upon reasonable assumptions, no assurance can be given that such expectations will be attained or that any deviations will not be material. We disclaim any obligation or undertaking to usdisseminate any updates or persons actingrevision to any forward-looking statement contained herein or reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on our behalf are expressly qualified in their entirety by this paragraph.which any such statement is based.
Overview
Our principal executive offices are located at 5200 Franklin Drive, Suite 100, 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. Our financial information is set forth in Item
8 to this annual report, which is incorporated herein by reference. A discussion of factors potentially affecting our operations is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock,” in Item 7, which is incorporated herein by reference.
We design, develop, and sell digital video content processing systems optimizedthat enable telephony-based service providers to deliver broadcast quality digital video signals over their networks. We also offer digital video processing systems that enable private enterprise and government entities to transport video signals over satellite, fiber, radio, or copper networks for surveillance, distance learning, and TV production applications. We also offer broadband transport and service management products that enable the provisioning of public broadcast digital TV services across telephone companyhigh speed Internet access and cable company facilities, digital video trunking systems for applications across TV broadcast, government and education facilities, andother broadband data transmission systems for applicationservices over existing copper networks within hotels and private campus or building facilities.
Historically, we derived most of our sales were derived from our broadband data transmission systems.transport and service management products. In order to expand upon our broadband product and market strategies,November 2002, we entered into an agreement to acquireacquired VideoTele.com Inc. (VTC)or VTC, from Tektronix, Inc. (Tektronix). On November 7, 2002, we completed the acquisition of VTC for approximately $7,154,888, consisting of an aggregate of 3,283,597 shares of our common stock valued at $3,611,957, acquisition related expenses consisting primarily of legal and other professional fees of $320,000, a note payable to Tektronix in the amount of $3,222,931 and assumed other liabilities of approximately $1,776,000. This transaction was treated as a purchase for accounting purposes. VTC offers digital head-end (DHE) solutions enabling home entertainment delivery via the broadband Internet. With this acquisition of VTC, we extendedextend our product offerings to include digital video content processing systems. As a result, our revenue increased from $9.4 million in 2002 to $32.2 million in 2003. Video-based products now represent a majority of our
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sales and video trunking systems. Among the benefits that we are seeking from the acquisition are to:
The acquisition of VTC has resulted in a significant change in the structure, organization and priorities of Tut, including: (1) changes in our organizational structure and employee staffing; (2) establishment of significant operations in Lake Oswego, Oregon, at the prior headquarters location of VTC; (3) the designation of Douglas Shafer, the former President and Chief Executive Officer of VTC, as Vice President, Finance and Administration, Chief Financial Officer and Secretary of Tut Systems; (4) an expansionwill provide most of our salesgrowth opportunities for the foreseeable future. Our net loss in 2003 was $5.5 million compared with a net loss of $41.6 million in 2002.
Industry Background and marketing efforts to include VTC products;Dynamics
Growing Demand for Bundled Voice, Data, and (5) a reprioritizationVideo Services
Historically, traditional telephone companies have been the sole providers of our research and development budget to include the research and development of products acquired by us in our acquisition of VTC.
Based on over 20 years of video expertise, our content processing systems combine advanced video compression technology and coding techniques to transform a variety of video content from multiple sources into a complete service package of standard MPEG (Moving Picture Experts Group) video streams for delivery over fiber, copper, or coaxial cable networks. Our high-performance, cost-effective systems are based on the MPEG-1 and MPEG-2 standards. We are developing software programs that can upgrade these productsvoice services to the new MPEG-4 standard that will provide lower encoding rates and more advanced interactivity than previous MPEG standards provided. Our systems support a variety of standard Internet and other protocols that allow high-quality digital video content to be transmitted over a wide variety of public telephone, public cable and private broadband networks. To facilitate interoperability with the existing base of fiber and DSL (digital subscriber line) systems, we have developed a video services switch that supports asynchronous transfer mode (ATM) or Internet protocol (IP) format conversion and video replication.
Our video trunking systems take advantage of our advanced content processing technology for private network applications such as broadcast video backhaul, video surveillance, and video conferencing in which digital video signals are “trunked,” or transmitted, over long distance networks. Our broadband data transmission
systems combine advanced IP service differentiation and management technology with both proprietary and standards based copper line transmission technologies into complete IP system packages for high-speed Internet access (HSIA) and other data services within venues such as hotels, apartment complexes, and campus networks.
Our target customers for our content processing systems are telephony-based incumbent local exchange companies (ILECs), such as the former Regional Bell Operating Companies (RBOCs), IOCs, and international Post, Telephone, and Telegraph (PTT) companies that aim to deliver advanced video services over their existing copper or coaxial cable infrastructures. Including sales by VTC prior to our acquisition of VTC, over 30 content processing systems have been sold and deployed since 1999 serving over 50 IOCsresidential market in the United States. TargetOver the past several years, cable television operators, with competition from satellite television providers beginning in the 1990s, have become the primary providers of multi-channel broadcast TV services. More recently, traditional telephone companies and cable operators have become direct competitors for the growing market for high-speed Internet access. In addition, many large cable system operators have begun to offer local and long distance telephone service to their customers for ouras part of a bundle of services, including voice, data, and video trunking systems include TV broadcasters, government agencies, and educational institutions. Target customers for our broadband data systems are regional competitive carriers and systems integrators, ILECs, and private educational and commercial entities.
Our products are typically used to convert video or data signals to an appropriate format for delivery over existing fiber and copper facilities. Our AstriaTM content processor is typically used by carriers at a digital TV head-end location to process upwards of 200 or more TV channels into a consistent, reliable, constant-bit-rate MPEG-2 format for subsequent delivery over any broadband access network to residential subscribers. Our Astria VSS system now under development is intended to receive encoded content from fiber backbone networks and distribute it to local DSL access multiplexers (DSLAMs) or to fiber-to-the-home (FTTH) networks. Our M2 video trunking product line uses the same video compression technology that is used withinnetwork on the Astria product line, but M2 productssame bill. Thus, telcos are packaged in a smaller form factor for private video backhaul applications. Our IntelliPOP broadband data platform, powered by our proprietary Signature Switch technology, provides for advanced qualitynow at risk of service (QoS) management across multiple digitizedlosing traditional voice video, and data applications while providing scalabilitylines to support from tens to thousands of residential or commercial subscribers per system. Our Subscriber Management System (SMS) and Expresso product lines provide for plug and play installation, subscriber authentication, web portal redirection, IP address management and other features required by increasingly sophisticated hotel and apartment multi-tenant unit (MTU) applications. Our XL product line enables Ethernet networks to be extended over distances of up to 20,000 feet over ordinary telephone wire.
Industry Background
Continued Growth in Residential and Commercial Demand for Broadband Services
In recent years, there has been a dramatic increase in demand by businesses and consumers for high-speed data access to the Internetboth cable operators offering bundled services and to private corporate networks. This demand is being driven by the growth in the numberwireless telephone vendors that compete on mobility and price.
As a result of users whothese competitive threats, large telcos are accessing networksbeginning to use their broadband DSL infrastructure to offer broadcast TV services and better compete for a variety of applications, including communications via the Internet and corporate intranets, electronic commerce, and telecommuting. As an example of the growth in high-speed access, research carried out by London-based industry analyst Point Topic estimates that the worldwide installed base of DSL lines almost doubled in 2002, from 18.8 million to 36.3 million lines.
In addition to an increasing demand for broadband data services, there has been substantial consumer demand for advanced digital-based television services that until recently could only be delivered over broadband fiber, coaxial cable, or satellite facilities. As an example of growth in demand for advanced television services, satellite-delivered digital television to U.S. households has risen dramatically over the last seven years from under 1 million subscribers to over 19 million subscribers at the end of 2002.
Worldwide Telecommunications Deregulation and New Technology Spawns Competition for Bundled Services
An open regulatory framework for telecommunication (telecom) services and advances in broadband technology have led to cable television companiescustomer with a bundled offering voice services and HSIA services to their traditional base of cable TV subscribers. By bundling multiple voice, video, and data services into a single service package, cable-based multi-system operators (MSOs) reduce their infrastructure, marketing and sales cost per revenue dollar and increase their customer retention rate while increasing revenue from these customers in absolute terms. MSOs’ success in gaining
new telephone customers at the expense of the ILECs has been dramatic, with subscription rates in certain United States regions exceeding 25% of local residential telephone subscribers. The success of the MSOs is creating increasing pressure on the ILECs to offer similar bundled packages of voice, data, and video services. With continuing advances in DSL video compression technologies, a competitive service package, including digital broadcast video, can be delivered overIn the ILECs’ embedded base ofmeantime, many small independent operating telephone lines. If the ILECs do not respond to these MSO offerings with similarly competitive offerings, they may be left with an underutilizedcompanies, or IOCs, and expensive network as their voice and data customers migrate to competitive offerings.
Smaller rural IOCs in the United Statesinternational carriers are already achieving success with bundled voice/data/installing or planning to install digital video offerings by providingheadends to offer broadcast TV service using MPEG-2 over asynchronoustheir DSL (ADSL) and very high-speed DSL (VDSL). With higher-speed ADSL-2 standards nowfiber infrastructures. According to a report released by InStat/MDR in place and lower bit rate MPEG-4 compression technologies being introducedApril 2003, the number of telco video subscribers worldwide will increase from 572,000 at the end of 2003 to over 19.0 million by the market, it will soon be possible to deliver three channelsend of video plus HSIA service plus normal telephone service over a single telephone line. These technological advancements, plus the competitive threat from the MSOs, could lead the larger ILEC carriers and PTTs into also offering bundled services.
2007.
Characteristics of the MarketTechnical Challenges for Digital TV Head-ends among Telecommunication CompaniesDelivering Broadcast Quality Video over Telco Networks
DigitalTo deliver broadcast quality video, a non-satellite-based service provider must install a digital TV head-ends (DHEs) are deployed in metropolitan areasheadend to a) receive both national and local broadcast TV channels via satellitesignals and local TV channels via off-air antennas and b) to properly process these signals for carriagedelivery over fiber, coaxial, and/cable, or copper networkcopper-based DSL facilities. The total DHE market tendslimited bandwidth capacity of telco DSL facilities when compared with the high bandwidth capacity of cable facilities means that telco digital headends require greater video processing performance to reduce the bandwidth required for successful transmission. For example, while video headends deployed by cable operators have been able to simply pass high-bit-rate, satellite-fed TV signals directly to their cable networks without further video compression, telcos are required to compress the widely varying bit rate of source TV signals to a low constant-bit-rate for transmission over their DSL networks. Telcos also utilize a mix of different transport networks and protocols that often require video signals to be fragmented into two sub-markets: a head-end marketconverted from one network or protocol to another type of network or protocol.
Technical Advancements Are Increasing the Available Market for cable-based MSOs using statistical multiplexingTelcos to Deliver Video
The bandwidth and quadrature amplitude modulation (QAM) over hybrid fiber coax (HFC) networks, and a head-end market for telecommunication companies (telcos) using constant bit rate (CBR) multiplexing and IP or ATM protocols over fiber and copper networks. There are rural telcos that use both cable and copper networks for their TV services and these telcos might use a combination of head-end products.
For the telco head-end market, a basic head-end requirement is to provide high quality digital encoding of local analog TV signals and digital “turnaround” of satellite TV signals. Digital turnaround content processing takes variable bit rate signals as input and “turns them around” into constant bit rate IP or ATM streams for subsequent delivery over ADSL or VDSL access networks. Since mostdistance limitations of the TVcopper-based "last mile" constrain both the number of video channels in any service bundle are national in scope, certain telco head-end customers are deploying a major head-end in one location, placing these national channelsthat may be delivered simultaneously over a regional or statewide fiber network,DSL system and then using remote “mini” head-ends deployed throughout the state to add local channels to the lineup as appropriate in individual towns or cities.
For telcos using ADSL for video service delivery, a key DHE requirement is for low bit rate encoding and digital turnaround to maximize the available market. In other words, today’s ADSL systems can deliver service speedsnumber of up to 8 Mbps, but only for customers that are within 6,000reachable from a telco central office. Emerging advancements in video compression technology will soon enable high quality video streams to 8,000 feetbe transported at bit rates below 2.0 Mbps in contrast to bit rates as high as 9.0 Mbps currently used in existing satellite and cable facilities today. These emerging compression advancements also introduce the possibility of delivering high-definition television over bandwidth constrained DSL lines for the DSLAM or digital loop carrier (DLC)first time. Additionally, there are DSL advancements emerging that is providingexpand the ADSL service. A serviceavailable downstream bandwidth thereby supporting higher DSL bit rates over longer distances. The combination of these advancements will enable telcos to reach a higher percentage of their customers with a larger number of video channels.
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While DSL technology will continue to dominate telco broadband networks for the foreseeable future, telephone companies are beginning to construct fiber networks to their customers' homes. Though fiber-to-the-home will eliminate bandwidth limitations on delivering higher speed of 8 Mbps is enough to provide 2 TV channels at 3.5 Mbps each plus a 1 Mbps HSIA channel. If thedata services and high-quality video encoding rate could be dropped to 2 Mbps, then 5 Mbps of ADSL speed would be sufficient and customers as far as 11,000 to 13,000 feet from the DSLAM/DLC could receive service. Thus, the lower bit rate signals available throughofferings, telephone companies deploying fiber-to-the-home will require advanced video encoding techniques will greatly expand the market reach of an ADSL-based video service.
processing to convert signals between multiple protocols used in their networks.
The Market for Enterprise and Government Video Trunking Market CharacteristicsSystems
ThePrivate enterprises and government entities also use digital video trunking market is characterized byprocessing systems to distribute video for applications ranging from corporate training, video and film production, video surveillance, and distance education. In these applications, the need to deliver a small number of private or public video signals over a private broadband network or privately leased facility. The particular video source to be encoded may be a signal from a local TV station that needs to be brought back to a regional or statewide DHEdigital TV headend that is 100 miles away. The video sourceaway, it may be a signal received from an outdoor surveillance camera that needs to reach a decoder or personal computer (PC) for viewing hundreds of miles away, or the video sourceit may be a signal from a university seminar that needs to feed 15multiple remote classroom sites.
The video trunking This market is also characterized by tradeoffs between the cost of long-distance broadband facilities and the cost of low-bit-rate encodersvideo encoding systems to reduce the need for broadband bandwidth. AsWe believe that this market will also expand as advanced video encoding techniques find their way into products and lower the needbandwidth requirements for bandwidth, this market will also expand.
transmitting video signals.
Private Broadband Network Market CharacteristicsOur Solutions
Our suite of products is focused on enabling the delivery of broadcast quality video over traditional telco networks. We leverage VTC's previous 20 years of experience as part of Tektronix to develop video-based products that meet the special video processing requirements of telcos. Unlike standard cable headends, our Astria digital video headend solution converts the high and varying bit rate signal received as input from a satellite or terrestrial source into a lower constant-bit-rate video stream for subsequent delivery over a telco's DSL or fiber-to-the-home access network. Our high-performance, cost-effective systems are based on the MPEG-1 and MPEG-2 standards developed by the Motion Pictures Expert Group. We are developing upgrades to the Astria family of products (for introduction in the second half of 2004) to support the emerging MPEG-4 and Microsoft Windows Media 9 compression technologies that will provide lower encoding rates and more advanced interactivity than the current MPEG standards. We believe that the lower encoding rates of these new technologies will extend the reach of video services and enable high-definition TV to be delivered over bandwidth-constrained copper networks. Customers for our Astria video content processing systems include independent operating companies in North America, such as Oxford Networks, and international incumbent carriers, such as PCCW in Hong Kong.
The market Our M2 video processing systems use software and hardware components from our digital TV headend systems packaged in a smaller form factor to encode video signals for transmission over private or government networks. Our M2 products are used for applications such as studio-to-transmitter transport, video surveillance, and distance education. We sell our M2 video processing systems to TV broadcasters, government agencies, and educational institutions.
We also offer broadband transport and service management products that enable the provisioning of high speed Internet access and other broadband data services over existing copper networks within hotels and private campus facilities. Customers for our broadband data systems is characterized byinclude system integrators, competitive carriers for the need to transport high-speed data signals acrosshospitality industry and private buildings or campus locations in which the only available transmission facility is composed of ordinary telephone wires. Applications within this market include the need to connect hotel guests to HSIA service over the hotel’s telephone wires, the need to connect video surveillance cameras, back office PCs,educational and ticket machines found across a railroad station to a backbone network, and the need to connect two local area networks (LANs) across a business campus without having to run new wires or cables.commercial entities.
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Strategy
Our objective is to be the leading provider of video content processing solutions for the delivery of broadcast and on-demand video services to residential customers over telephony networks. Key elements of our business strategy are as follows:
TheMaintain Market Leadership in North American Telco Market for Digital TV Headends
We believe that our installed base of digital video headend systems represents over 50% of the North American headend market for video over DSL services. Our strategy is to maintain this leadership position with continued enhancements to the Astria product line as more and larger telephone companies in North America begin to introduce bundled voice, data and video services. Our development efforts are focused on introducing new compression technologies such as MPEG-4 and Windows Media 9 that will be available as an upgrade option to our installed base. These compression technologies will enable our telco customers to address a larger percentage of their geographic market and deliver advanced video services such as high-definition TV.
Expand Sales Efforts to International Markets
While we continue to grow our North American customer base, we are strengthening our direct sales force to focus on major European service providers that see a need for a bundled voice, data and video offering. In Asia, we are developing relationships with our value-added distributors and partners to focus on key opportunities to market and sell our Astria products. Many of the larger European and Asian service providers represent an opportunity to sell multiple digital TV headends.
Accelerate Market Adoption of Video Over Telco Networks
To encourage service providers to more rapidly accept the business case for video over telco networks, we are working simultaneously on several initiatives to:
Partner with Leading Industry Vendors to Provide End-to-End Solutions
To deliver a complete end-to-end video solution, we are partnering with leading industry vendors that provide key system elements such as broadband access systems, network switches and routers, customer premises set-top boxes, video-on-demand systems and service management software that, together with our Astria content processor products, provide a complete video solution. As a result, we have focused our business development and strategic marketing efforts on working with such partners to facilitate a cost-effective, ready-to-deploy, high-performance solution based on customers' architecture and business requirements. Our strategy with these partners is to design, develop and market end-to-end systems solutions that will allow any form of video content (including broadcast TV,
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video-on-demand and streaming media from the Internet) to be carried over any telephony network to any TV, personal computer, or mobile end-user device.
Leverage Our Digital TV Headend Expertise in Additional Markets
We will continue to incorporate software and hardware components developed for our broadband data products include end usersdigital TV headend systems into our M2 video processing systems to meet the growing need for advanced surveillance and broadcast applications. Additionally, we will continue to partner with other industry vendors on applications for new potential customers, such as universitieslarge corporations and commercial enterprises, regional system integrators who often bundleeducational institutions. We intend to expand and further specialize our products with othervideo products for a complete turnkey solution,surveillance and regional competitive carriers who usebroadcast TV backhaul applications, and we will seek new distribution channels for our productsM2 product line.
Selectively Pursue Acquisitions to offer HSIA services to hotel guests and/or apartment tenants.
The Tut Systems Solution SetExpand Our Markets and Product Offerings
In addition to our internal research and development efforts, we continually evaluate acquisitions of companies and technologies that could extend our product offerings, technology expertise, industry knowledge and global customer base. Since 2000, we have completed four acquisitions, including the acquisition of VideoTele.com in November 2002. The products and technologies that we acquired through these acquisitions have facilitated our entry into new markets, expanded our product line in existing markets, and added additional technical expertise to develop new products for evolving markets in the future. Going forward, we anticipate our acquisition efforts will be focused on targets that will extend our existing video-based products and markets.
Our Products
We design, develop and sell video content processing systems optimized for the provisioning of public broadcastand broadband transport and service management products. Our digital TV services across telephone company and cable company facilities, video trunkingheadend system enables telephony-based service providers to transport broadcast quality digital video applicationssignals across TV broadcast,their networks and our digital video transmission systems optimize the delivery of video signals across enterprise, government and education facilities,networks. Our broadband transport and service management products enable the transmission of broadband data transmission systems for application over existing hotels and private campus or building facilities.networks.
Video Processing Systems
We use our technical strengths, skills, and experience in video-based applications to develop highly reliable, high performance systems for processing and converting either analog video or pre-encoded digital video signals into the proper format for transmission over fiber, coaxial cable, or copper facilities. The format of the output signals from our systems varies according to application and can be either MPEG-1 and MPEG-2 format in either IP, ATM, IP-over-ATM, or digital video broadcasting asynchronous serial interface (DVB-ASI) protocols over copper, fiber or coaxial interfaces. Our video systems are designedprocessing products must interoperate with other products from third parties to international standards to facilitate interoperation with companion systems and software from third-party vendors to formenable a complete end-to-end broadcast TV system. To ensure proper interoperation for our customers, we offer a system forintegration service whereby we purchase, assemble, configure and test key components together before delivering the integrated system to the customer. For some customers, we provide systems integration services to our customers to ensure that the entire video system, includingTypical third-party components include satellite receivers, antennas set-top boxes, and operational software, works seamlessly together.
Our broadband data products provide our customers with reliable, high-performance, cost-effective broadband transportdecoders, network switches and with enhanced capabilities such as subscriberrouters, radio frequency modulation units, and service management bandwidth management, plug-and-play installation, portal redirection, IP address management, service authorization and network address translation. Our products are designed with the specific requirements of the target market in mind and provide the following benefits to our customers:software.
Video Content Processing Systems
Astria Content Processor (CP)CP (Content Processor)
Our Astria CP is a digital video processing platform typically used by carriers at a digital TV headend location to convert hundreds of TV channels into low, constant-bit-rate video formats for delivery over any broadband access network. It is a third-generation, chassis-based platform that has been purposefullywe have specifically designed for the digital TV marketplace. The Astria CP uses our patent-pending QualViewTMQualView™ software applications to deliver high quality video when converting satellite-based variable bit rate video and audio signals to groomed CBRlow, constant-bit-rate content for delivery over accesstelco networks. ThisThese QualView digital turnaround (DTA) application, coupled with Astria-based MPEG encodingapplications can separate the desired TV channels from a mix of over 200 channels received from various satellites, lower the bit rate of the desired channels, and convert the video signals to the
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appropriate network protocol processing, offers service providers a robust platform that adapts all digital head-end videointerface and audio content for distribution over a variety of access networks.
protocol. The Astria CP platformalso supports encoder modules that convert uncompressed video signals to compressed constant-bit-rate video streams.
Each Astria CP can process up to 200 video and audio channels, per chassis, depending on the type of processing required. The platform integratesAstria CP works with IP, ATM, IP over ATM,various telephone company copper, fiber, or DVB-ASIcable networks providing ultimate flexibility when designing a commercial video delivery system. The Astria CP ismay be populated with a mix of video encoders and flexible Quad Stream Processor (QSP)processor modules, that canwhich in turn may be configured and reconfigured with a simple QualView software download to enable a variety of video processing functions. For example, onUp to 12 system modules may be configured within a digital turnaround application one QSP can be utilized to de-multiplex a multi program transport stream (MPTS) from a satellite. The de-multiplexed channel or single program transport stream (SPTS) can then be routed to another QSP for bit rate reduction that is required for transport over a DSL access network. Each Astria QSP module contains 4 separately configurable QSPs and each Astria CP chassis supports up to 11 modules for a total possible QSP count of 44 per chassis.
In many cases, the Astria CP enables DHE systems to be deployed without the need to decode the received digital satellite signals to analog baseband signals. This ability reduces the amount of equipment required in the head end, as well as the likelihood of inducing noise into the video and audio streams. In addition, bit rate reduction can be done while maintaining video quality using Qualview applications running on the QSPs. These applications contain sophisticated algorithms that are specifically designed to make intelligent use of the uplink encoding decisions that were imposed on the original content before it was transmitted over the satellite link.
Today the Astria CP outputsprocesses video content in standard MPEG-1 or MPEG-2 formats. We are developing softwareupgrades to allowthe Astria CPfamily of products to encode and transcode content intosupport the emerging MPEG-4 and Windows Media formats. Transcoding9 encoding technologies. These new technologies will provide lower encoding rates and more advanced interactivity than MPEG standards previously provided. We anticipate first commercial availability of these capabilities in the second half of 2004. These capabilities will enable MPEG-2 input streams that may be received from a satellite link to be transcoded into either MPEG-4 or Windows Media formats. This will enable head-ends to deliver MPEG-2 ans MPEG-4 signals simultaneously to subscriber set top boxes. This capability will enable head-end providersour customers to reach the next stage in bit rate reduction without having to hardware upgrade their complete head-end,headend, thus preserving the customer’scustomer's original investment. In the future itThis will also allowenable video streams to be easily viewed from the large base of PCspersonal computers running MPEG-4 Windows Media or MPEG-4 players. It will also enable service providers to take advantage of the content bundling features in MPEG-4 to insert local and/or personalized content directly into particular video streams.
AstriaRemote RCP (Remote Content Processor (RCP)Processor)
For service providers delivering digital TV over regional or statewide backbone networks, our Astria RCP provides an affordable way to distribute video signals sourced from a single digital head-end.
TV headend. The Astria RCP typically accepts pre-processed MPEG-2 videoTV channels from a centralized Astria CP via ATM or Etherneta fiber networks (rings or point-to-point links)backbone network and performs appropriate network and protocol conversion for delivery of the video streams over a variety of telco access platforms, including ADSL, VDSL, cablenetworks. The Astria RCP can also be used to encode and compress local TV (CATV) and FTTH.channels. This flexibility allows service providers to place Astria RCPs at the edge of a fiber optic transport network andto deliver aggregated and localized content enabling customization of a channel line-up to a specific region or community. The ability to add/add or drop channels into the line-up at the edge of the transport network allows service providers to incorporate local programming, advertising, and emergency alert system (EAS) content. This createscapability enables a completeservice provider to offer a customized mix of channels and content that is relevant to local subscribers.
The Astria Video Services Switch (VSS)
Our Astria VSS that is under development is intended to provide video service management, multi-tier IP multicasting, and DSLAM aggregation capabilities to support cost-effective delivery of advanced video servicesRCP comes in two versions, a common format across a variety of embedded and emerging access networks. VSS will simultaneously deliver over 200 broadcast video channels, 100 video-on-demand (VOD) channels, and high-speed Internet access to upwards of 2,000 subscribers per system node, making it potentially one of the industry’s most powerful and robust video delivery systems. The VSS product line is12-slot version based on industry standard fiber interfaces that usethe same chassis as the Astria CP and a service provider’s embedded network infrastructure of ATM-based DSLAMs and DLCs while providing a path6-slot version. In contrast to new IP-based DSLAMs, DLCs, FTTH systems.the Astria CP, the RCP does not process the high, variable-bit-rate signals received from satellites.
AveonTMAveon™ Element Management System
Our Aveon Element Management System enables the service provider to configure and monitor Astria CP and RCP systems across wide area networks. The ability to use Aveon to create a single network view of the system gives service providers a simple to use yet powerful tool for controlling all aspects of operating a video network from a single management location.
M2 Video Processing Systems for Enterprise and Government Applications
Video Trunking SystemsOur M2 video processing system leverages the software components and hardware modules used within the Astria CP, but M2 products are packaged in a smaller form factor for private enterprise and government markets.
Our M2-T300 product line incorporates a flexible architectureM2-400 system was introduced in the second quarter of 2003 and is our premier digital video system for delivering mission critical, high-quality video in real-time for private network applications. Each M2-400 chassis is designed to supporthold multiple input or output video channels. It is based on a 5-slot, 7-inch high chassis with a variety of encoding, decodingencoders, decoders and network options available. A number of encoding options are available ranging from MPEG-1 at 400 kbpsinterfaces. The M2-400 system supports up to MPEG-2 4:2:2 @ML at 40 Mbps. Network options include DVB/ASI for6 system modules in contrast to the Astria CP that supports up to 12 system modules. The M2-400 works across satellite, operations, ATM options for terrestrial switched applications,radio, or DS-3/E-3 for point-to-point applications.fiber networks. An embedded web server controls and manages the M2 product line via an intuitive web-based graphical user interface, enabling
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administration of the product from any location on an IPthe network.
Our M2-400 product line now under development, and scheduled to be available in the second quarter of 2003, is intended to supercede our M2-T300 products. It is intended to be our premier video trunking system for delivering mission critical, high-quality MPEG video in real-time for private network applications. The M2-400 system will be the latest in a long line of video trunking products that began with the devices first used to transport video over long distances via fiber optics from the 1980 Winter Olympics in Lake Placid, New York to broadcast studios located in New York City. As with the M2-T300, each M2-400 chassis is designed to hold multiple encoders, decoders and network interfaces. Whereas the M2-T300 product line only supported DVB/ASI and ATM interfaces, the M2-400 is also being designed to support a 100/1000 Base-T Ethemet network interface. The web-based management of the M2-T300 is being extended to the M2-400 and the M2-400 is also designed to integrate withsupported by third-party scheduling software for video conferencing and distance learning applications.
Our M2-10x system was also introduced in 2003 for video applications that only require a single encoder or decoder per end-point. For example, one of our digital TV headend customers uses the M2-10E at a remote location to encode local events on site for addition to their basic lineup of broadcast TV channels. This capability helps them differentiate their service offering from the national network-based offerings of the satellite television vendors.
Private Broadband Data SystemsTransport and Service Management Products
ForPrior to our entry into the video processing business in November 2002, our primary focus was on the sale of our broadband transport and service management products. The market for these systems is characterized by the need to transport high-speed video or data applicationssignals across private buildings or campus locations, where the only available transmission facility is composed of copper telephone wires. We have been a participant in this market since the introduction of our first XL Ethernet extension product in 1992. Applications within this market include: i) connecting hotel guests to broadband Internet services over the hotel's telephone wires, ii) connecting video surveillance cameras, back office PC's, and railroad station ticket machines to a backbone network, and iii) connecting two local area networks, our IntelliPOP 5000 product line offersor LANs, across a compact, easy-to-deploy stackable VDSL system that can grow from 12 portsbusiness campus without having to over one hundred ports per system. Up to 26 Mbps of transport capacity can be provided over ordinary telephone lines at distances up to 3,500 feet.run new wires or cables.
For HSIA MTU applications, ourOur Expresso line of products usinguses proprietary HomeRun or LongRun transmission technology provideto provides a low-cost, plug and play Ethernet solutionseasy to install solution that can deliver HSIAbroadband Internet access to multiple nodes over a single pair of copper wire simultaneously being used for telephone service.broadband Internet applications across multi-tenant complexes such as hotels, apartments and private campus facilities. We recently added Ethernet over very high speed DSL line cards to our existing Expresso chassis. This higher speed application enables our customers to deliver broadcast TV, video-on-demand service, and Internet service throughout a multi-tenant complex.
Our XL line of Ethernet extension products is often used by individual enterprises to extend their Ethernetdata networks over distances that can notcannot be accommodated by standard Ethernet wiring. Various XL products operate over distances of up to 20,000 feet, and at bit rates up to 10 Mbps, all over a single pair of ordinary telephone wires. In certain situations, these XL products are used in combination with our M2 products to support the encoding of local content to feed digital video headends.
Our Expresso and XL transport products are augmented by our Expresso SMSsubscriber management system, which authenticates users, manages bandwidth and IP addresses, and processes credit card or password information for billing purposes. SMSSubscriber management systems are typically found in hotels that offer HSIAbroadband Internet service to guests, in campus housing complexes to manage HSIAbroadband Internet access, and in wireless “hot spots”Wi-Fi "hot spots" such as hotel lobbies and Internet cafes.
Overall System Level Design Criteria
Our various systems and product lines are designed to incorporate technical standards developed by worldwide organizations, including International Telecommunications Union, Institute of Electrical and Electronic Engineers, American National Standards Institute, or ANSI, European Telecommunications Standards Institute, or ETSI, and the Full-Service VDSL (FS-VDSL) Committee. Important capabilities supported by these
standards include ATM QoS, MPEG encoding, Internet Group Management Protocol (IGMP), Dynamic Host Configuration Protocol (DHCP), Network Address Translation (NAT), and IP protocol stack/encapsulation over ATM. To build upon these standards and to further enhance our products’ service capabilities, we use proprietary rate control techniques and other bandwidth management techniques to allow service providers to efficiently create and deploy new service packages for additional revenue opportunities.
Our Signature SwitchTM technology in particular manages bandwidth all the way to and from the end-user appliance or application. The added flexibility afforded by the Signature Switch technology can allow instantaneous creation and manipulation of bandwidth guarantees so that consumers can purchase bandwidth on demand for their critical applications. Most importantly, we believe that Signature Switch technology can be extended to support a variety of wholesale and retail business models by enabling a “wholesale” service provider to partition subscribers, and particular applications and devices with a subscriber’s premises, among multiple “retail” service providers in a secure and guaranteed manner. We are currently investigating several opportunities for embedding Signature Switch into new products for service providers.
Strategy
Our objective is to be the dominant provider of advanced video-based content processing solutions for the delivery of broadcast and on-demand video services to residential customers over telephony networks. Key elements of our business strategy are as follows:
Continue Our Market Leadership in Digital TV Head-end Markets
Today, Tut Systems enjoys over a seventy-five percent market share in the market for digital TV head-ends among telephone companies in the United States. Over 30 Astria systems have been deployed as of December 31, 2002 serving over 50 IOCs. Our strategy is to maintain this leadership position with continued enhancements to the Astria product line as larger telephone companies, both domestic and international, begin to introduce bundled voice/data/video services. The Astria product line is designed to support the standards, feature requirements, and business objectives of the FS-VDSL Committee of major ILECs and PTTs. It is also designed to take rapid advantage of new technologies emerging such as MPEG-4 video compression.
To deliver a complete end-to-end video solution, we are partnering with leading industry vendors that provide key system elements such as broadband access systems, set-top boxes, VOD systems and service software that, together with our Astria content processor products, provide a complete video solution. Therefore, our business development and strategic marketing efforts will focus on working with such partners to facilitate a cost-effective, ready-to-deploy, high-performance solution based on FS-VDSL architecture and business requirements. Our strategy with these partners is to allow any video content (e.g., broadcast TV, video- on-demand, streaming media from the Internet) to be carried over any network (IP or ATM, fiber, coax, or copper) to any device (e.g., TV, PC, personal digital assistant).
Grow Our Market Position in Video Trunking Markets
Our M2 product line of video trunking products has achieved success among US and Chinese government organizations for video surveillance and for video conferencing and broadcast applications. We intend to incorporate technologies developed for our Astria product line into our video trunking products for continued success among our current customers. We intend to partner with other industry vendors for applications among new potential customers, such as large corporations and educational institutions. We intend to expand and further specialize our video trunking products to the surveillance and broadcast TV backhaul applications and we will seek new distribution channels for the M2 product line.
Continue Penetration of Private Broadband Markets with Expresso and IntelliPOP5000 Products
We believe that our Expresso product line will continue to be deployed for HSIA-based MTU applications and that our IntelliPOP 5000 system will be deployed for high-speed data and video applications in commercial
environments. Our MTU marketing efforts stress that the Signature Switch technology embedded in the IntelliPOP 5000 offers a high performance VDSL system for commercial applications in terms of delivering guaranteed QoS bandwidth per user, per device, and/or per application. Our Expresso SMS subscriber management system is being marketed to and deployed in hotel fixed-line applications and in 802.11b wireless “hot spot” applications.
Continue to Develop Advanced Service Capabilities of our Products and Systems
A combination of business needs and regulatory requirements compels many large, incumbent carriers to support both a wholesale and retail service model across multiple voice, video and data services. We believe that we can facilitate such a business model through our Signature Switch technology. As our Signature Switch technology evolves and becomes embedded in products for ILEC applications, it may provide a more flexible and effective alternative to monolithic, first-generation, transport-only broadband access systems. By enabling the key functions of service selection and service management to be distributed closer to the edge of a service provider’s network, Signature Switch can provide the service provider with greater control over the number and type of broadband services that can be delivered on both a wholesale and retail basis.
Expand Sales Efforts to focus on Large Incumbent Service Providers
We will continue to maintain and grow our video-based IOC business directly and our data-based MTU business through competitive service providers, integrators and distributors worldwide. Additionally, we are strengthening our direct sales force to focus on major domestic and international ILECs who see a need for full-service broadband deployment. Our primary focus is on the largest service providers in North America and Europe. We will use and add distributors, agents, and partners internationally as needed to penetrate specific countries or markets.
Core Technologies and Products
We continue to build upon our core competencies in video compression and IP-based data systems to deliver high quality digital broadcast and interactive video systems to support our expanded focus on the markets for residential bundled video and data services. Our products enable the delivery of broadcast video, video-on-demand, video conferencing and high-speed Internet data services as a bundled service offering over existing copper telephone lines or FTTH networks.
Video Content Processing Systems
Astria CP
The Astria CP is based on a highly-reliable, carrier-grade 16-slot chassis that supports a variety of interface and processing modules necessary to enable a complete digital head-end. All modules are software configurable to support multiple applications. The control CPU and power supply are available in redundant configurations for the highest reliability applications. Power supplies are available in AC or DC configurations. Software licenses are available to enable the various forms of de-multiplexing, encoding, decoding, rate shaping, and rate converting that are covered by either our patents and/or third-party patents.
The Astria CP supports a variety of interfaces that enable service providers to both leverage their existing network infrastructure and migrate to newer infrastructures. Encoder input interfaces may be analog or digital. Digital interfaces may be MPEG over asynchronous serial interface (ASI), digital head-end extended interface (DHEI), ATM, or IP protocols. Output streams may be directed over IP, ATM, IP or ATM, or DVB-ASI networks. The CP also supports a variety of coding and processing techniques, including direct encoding of analog streams, rate converting of digital streams from variable bit rate to CBR, rate shaping high bit rate streams to lower bit rates, and protocol conversion between ATM and IP formats. The wide variety of options available with Astria lowers the total cost of operations to a service provider in that a single platform can be used to support the many different applications that a typical service provider needs, and this platform can be upgraded to support new applications, such as MPEG-4, in the future.
Astria RCP
The Astria RCP is similar to the CP in form but is intended for remote, not head-end deployments. Service providers can deploy a centralized Astria CP feeding multiple Astria RCPs over a fiber ring network. The RCP can encode local analog video channels and convert ATM backbone traffic to local IP traffic, or vice versa, but it is not designed to process digital satellite-fed signals.
Astria VSS
Our Astria VSS system is under development and scheduled for release in the second quarter of 2003. It is a carrier-class, network equipment building specification-level 3 (NEBS-3) chassis with 4 input slots and 10 output slots for network interface modules. The network modules that will be available upon first release include a quad optical carrier - level 3 (OC-3c) module and an OC-12c module with a gigabit ethernet (GbE) module scheduled for later release. Redundant control modules will be available and all modules are planned to be hot swappable for maximum reliability and uptime. The Astria VSS is purposely designed to support the distribution of broadcast video signals, and it is expected to be significantly more cost-effective for the service provider than the present alternative of using high-end, general-purpose IP routers or ATM switches for broadcast video distribution.
Our VSS system is designed to remove the complexity of networking for service providers and allows service providers to mix and match IP and ATM equipment from different vendors into a consistent, cost-effective service platform. For example, Astria VSS is designed take MPEG video streams off of an ATM-based fiber ring and simultaneously distribute these signals to an embedded base of ATM DSLAMs, new Ethernet DLCs, and IP-based passive optical networks (PONs) all while interfacing to a local IP-based VOD server.
In addition to simply distributing video streams across multiple access infrastructures, the VSS may provide enhanced value through support of IGMP multicasting. This may allow the present version of “dumb” DSLAMs to support broadcast TV by effectively doing all of the required TV channel changing behind the DSLAM. Thus older DSLAMs do not need to be upgraded to support advanced services. The VSS can also aggregate all of the high-speed Internet traffic to/from the DSLAM and thereby reduce the overall network cost of backbone facilities.
Video Trunking Systems
The M2-400 currently under development is designed to be our premier product in the video trunking product line. The M2-400 design is based on a small, modular chassis capable of supporting multiple MPEG-2 encoders, decoders, and/or satellite interfaces. Its key features will include low latency of encoded streams, support for tele-text and closed captioning, software provisioning of bit rate, MPEG format, and video resolution, and a software upgrade path to MPEG-4. Any combination of up to 10 encoders and/or 20 decoders can be deployed within a single 7” high chassis. Both AC and DC power options will be available. Compressed streams may be outputted in ATM or IP over ATM formats over DS-3 or OC-3 links or in IP format over 10, 100, or 1000 Mbps Ethernet links.
Private Broadband Data Systems
IntelliPOP 5000
The IntelliPOP 5000 system includes the IntelliPOP 5212 12-port Service Gateway, IntelliPOP 5224 24-port Service Gateway, IntelliPOP 5102 Service Access Unit and the 5112 Service Adapter. A comprehensive Tut Management System (TMS) allows full utilization of the Signature Switch based service management aspects of IntelliPOP. The IntelliPOP 5212 Service Gateway is a compact, stackable service platform based on VDSL technology 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 VDSL-based line-side ports, each of which can deliver up to 15 Mbps of symmetric bandwidth to an IntelliPOP 5102 customer premises unit. The IntelliPOP 5102 Service Access Unit includes two standard Ethernet ports for interfacing with a variety of end-user devices and/or networks.
Expresso System Products
Our Expresso MDU products are designed for incumbent carriers and other service providers to offer high-speed advanced data services to large numbers of end users over private copper network infrastructures. The Expresso MDU platform has been designed for deployment in residential locations, such as in the basement wiring room of an apartment building or hotel. Expresso MDU is AC-powered and, when integrated with our HomeRun™ or LongRun™ technology, provides owners of private copper networks with an easily deployable and scalable means to distribute high-speed data access to tenants over the copper telephone wires found in MTUs.
HomeRun creates a cost-effective Ethernet local area network, or LAN, over the random topology of home telephone wires, without disturbing existing telephone service. With HomeRun, multiple devices can share peripherals and/or a single high-speed Internet access connection on a 1 Mbps Ethernet LAN. HomeRun is designed to operate at distances up to 500 feet.
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. LongRun is intended to operate at distances up to 2,500 feet.
An Expresso MDU system consists of a compact, modular central-site shelf with a simple network management protocol (SNMP) management card, and optional multiplexing cards, and up to 17 symmetric DSL (SDSL), HomeRun or LongRun line cards. 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 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.
Our Expresso SMS 2000 and companion Expresso OCS (operations center software) system provide plug-and-play functionality, subscriber management, network address translation, credit card billing, and other functions for the MTU market. The Expresso SMS 2000 system runs on a Red Hat Linux operating system, is typically located on the premises of an MTU complex and supports up to 800 simultaneous user sessions per unit. The centralized Expresso OCS system is a software package that runs on a standard personal computer 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 databases most often used by competitive local exchange carriers (CLECs) and Internet service providers.
XL Products
We utilize proprietary 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. In the XL 4000 product, we also 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. 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.
Customers and Markets
We develop, market and focusOur target customers for our sales efforts to service providers forAstria video content processing systems are telephony-based incumbent local exchange companies, independent operating telephone companies and international post, telephone and telegraph companies that aim to service providersdeliver advanced video services over their existing copper, fiber or coaxial cable infrastructures. Target customers for our M2 video processing systems include TV broadcasters, government agencies, and educational institutions. Target customers for our broadband data systems integrators for video trunking systems and toare system integrators, competitive carriers for the hospitality industry, and private broadband systems.educational and commercial entities.
Service Providers
Over 50 independent operating companies, or IOCs, in the United States now use our Astria products to deliver digital TV over xDSLDSL and other broadband networks. Our customers include a cross-section of small, medium and large telecommunications companies in the United States and Europe. VTC’sWe installed our first commercially deployed
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commercial digital head-end wasTV headend at Chibardun Telephone Cooperative in Dallas, Wisconsin in 2000. Since that time, we have deployed our digital TV headend solution to IOCs that range in size from 5,000 to over 90,000 access lines.
Our international sales to service providers have been concentrated among three large carriers. In 2002, Telenor AS, Norway’sNorway's largest telecommunications provider with more than 1.8 million customers, launched digital TV services over its ADSL and VDSL networksnetwork using an Astria CP. In 2003, PCCW, which acquired the former Hong Kong Telephone Company in 2000, launched service to its customers from an Astria headend and signed up more than 150,000 customers to its Broadband TV service in the first two months after launch. Additionally in 2003, our broadband transport and service management products were deployed by Telefonos de Mexico, S.A., or TelMex, to offer a national "hot spot" wireless Internet in Mexico's major public facilities such as airports, hotel lobbies, restaurants and hospitals.
We expect the small to medium size IOCsindependent telephone operating companies in the United States to remain the primary near-term market for Astria products as theproducts. The larger ILECsNorth American and PTTsInternational carriers continue to investigateexplore and test the marketmarkets and technologies for DSL-based video services.
Distributors and System Integrators
We market our private broadband data systemstransport and service management products to domestic and international system integrators who in turn market and sell our products to educational and government institutions, to small to large commercial enterprises, and to regional competitive service providers and national carriers. Our systemsdistributors and system integrators range from smallinclude local companies toresellers, large volume distributors such as Ingram Micro to country-specific integrators such as Rikei in Japan,Inc., and to international integrators such as Enterasys and Siemens AG in Europe.
Marketing, Sales and Customer Support
Marketing
We seek to increase demand for our products and to expand both the demand and visibility of the company and our products in the market. In addition to customer-specific sales efforts, our marketing activities includemarkets we serve through attendance at major industry tradeshows and conferences, the distribution of sales and product literature, operation of a Company web site, 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, semiconductorand manufacturers of various products, including radio, fiber, or video equipment, manufacturers, set-top box manufacturers,boxes and others.
Sales
WeIn North America, we sell our products primarily to service providers and through multiple sales channels, in the United States, including a select group of regional value added resellers, system integrators and distributors, data networking catalogs and directly to service providers.distributors. Internationally, we sell and market our products through sales agents, systems integrators and distributors. In 1999, we opened a sales office inWe have regional account managers throughout the United Kingdom,States and with the acquisition of VideoTele.com, we now have a sales presenceoffices in China.Beijing, China, Hong Kong, and Oxford, England. For the year ended December 31, 2002,2003, we derived approximately 43%18.4% of our revenue from customers outside of the United States. We believe that our products can serve athe substantial emerging market for digital video and 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. Our Systems Application Engineers,systems application engineers, located in each of our sales regions, support pre-sales and post-sales activities. Customers can also access technical information and receive technical support via our web site.
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Our systems integration group in Cary, Illinois integrates our solution with third-party equipment and then tests, delivers and installs complete headend systems for our customers that require an end-to-end solution.
Research and Development
Our research and development efforts are focused on enhancing our existing products and developing new products through our emphasis on early stage system engineering. As a result of our acquisition of VTC and the large market opportunity that it offers, most of our research and development efforts relate to our video content processing technologies. 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, such as the FS-VDSL CommitteeBroadband World Forum and MPEG-4 Industry Forum. Key elements of our research and development strategyefforts include:
Intellectual Property
As a result of our
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acquisition of VTC, Tektronix has agreed not to assert against us or any of our affiliates or customers any of its patents that are based on applications filed prior to November 7, 2002 or that are based on inventions conceived or reduced to practice prior to that date where the assertion relates to our products for generating, processing or delivering video, audio or data for the education, entertainment, conferencing or security markets. We leverage readily available technology and standard components by adding proprietary software enhancements to gain competitive advantage, increase performance and lower cost. In addition, we have curtailed developments directly related to VDSL-line technologies while initiating new development efforts related to video compression technologies.
Expenditures for research and development in fiscal 2002 were $12,337,000, compared to $15,044,000 in fiscal 2001 and $17,149,000 in fiscal 2000. We anticipate that we will continue to have significant research and development expendituressubstantial trade secrets in the future to provide a continuing flowarea of innovative, high-quality products to enhance our competitive position.
processing and managing video streams.
Manufacturing
We do not manufacture any of our own products. We rely on contract manufacturers and third-party OEMs to manufacture, assemble, test and package our products. We require International Organization for Standardization (ISO) 9002 registration for theseour contract manufacturers as a condition of qualification. We monitor each contractor’scontractor's manufacturing process performance through audits, testing and inspections. Each contractor’scontractor's quality is also rigorously assessed 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 a substantial portion of the raw materials and components used in our products through contract manufacturers. We forecast our product requirements to maintain sufficient product inventory to ensure that we can meet the required delivery times demanded by our customers. Our future success will depend in significant part on our ability to obtain manufacturingmanufactured products on time, at low costs and in sufficient quantities to meet demand.
Competition
Within our traditionalThe market for private broadband products, intense price competition in certain areas of the Asia-Pacific has decreased our market opportunity significantly in these areas. Our sales declines in the North American market for privatevideo and broadband data systems have less to do with competitionis intensely competitive, and more to do with the deteriorating economics of the CLECwe expect that this market which has reduced customer demand from this segment of the market. To maintain a competitive position in our traditional market, we have focused our product efforts on cost reduction, feature enhancements for particular vertical markets, and working with large, established systems integrators in Europe.
The service provider market for video systems, represented by the incumbent carriers, is characterized by small IOCs that tend to readily adopt new technologies and enter new markets, and the larger incumbents, such as the RBOCs and PTTs, that take longer to make decisions and deploy new technology and services. Both markets are equally competitive with many of the competitive factors influencing procurement decisions external to the technology and outside of our control, such as:
In order towill continue to bebecome more competitive in service provider markets, we believe that our company must continue to adhere to the following principles:
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 ourOur immediate competitors for digital TV markets will increase in the future.
Many of our competitors are primarily small private companies that are focused on a more narrow product line than ours and thereby may be able to devote substantially more targeted resources to developing, marketing and marketingselling new products than we can. In addition,targeting larger telco customers, we expect to compete with larger public companies, including Harmonic, Motorola and Tandberg Television. These competitors have achieved success in providing TV headend components for cable multiple system operators and satellite TV providers. Although their products have been designed specifically to meet the needs of cable networks, we expect these competitors to market some of their products for use in TV over DSL applications. We attribute our success in this market to the quality, cost-effectiveness, and unique capabilities of our Astria video content processing system.
Our competition in the market for surveillance, distance education, and broadcast applications primarily comes from small private companies and public companies such as Optibase and Tandberg that together offer a wide array of products with special features and functions. A few of these companies may become targetsalso compete with us in the digital TV headend market. Our competitive success in this market has depended upon having the right form factor and set of features required for acquisition bya specific application, our long established distribution channels, and our ability to quickly modify an existing product to support the required features.
Our broadband transport and service management products business tends to compete against public network equipment providers, such as Paradyne Corporation, and private and foreign companies. To maintain our competitive position in the private broadband market, we have focused our product development efforts on cost reduction and feature enhancement. Our expertise in particular vertical markets such as the hospitality industry, and our relationships with system integrators in those markets
12
allow us to compete more effectively against larger companies,competitors. We believe that we are among the market leaders for broadband systems in which case we would face competitors that would have substantially greater name recognition and technical, financial and marketing resources than we do. Suchthe United States hospitality industry.
All of our competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products than we can. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures that we face will not harm our business, financial condition, results of operations or cash flows.
business.
BacklogEmployees
As a result of our November 2002 acquisition of VTC,December 31, 2003, we acquired businessemployed 102 people, including 16 in manufacturing operations and product lines with which we historically have little management,customer support, 33 in sales and operational experience. In addition, as with purchase orders for our legacy products, all open purchase orders for VTC products are cancelable by the customers at any time until deliverymarketing, 36 in research and development and 17 in general and administrative.
During each of the product to and acceptance of the product by the customer. Therefore, whilepast three years we currently have backlog ofreduced our products, we do not believe that product backlog provides a meaningful indicator of future sales trends and is not material to an understanding of our overall business.
Proprietary Rights
Our success and ability to compete depends in part upon on 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 45 United States patents and have 25 United States patent applications pending. Furthermore,work force as a result of a significant slowing in industry spending and the resulting adverse impact on our acquisitionresults of VTC, we have gained access to all pertinent video-based patents held by Tektronix as of the date of acquisition. 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 we take 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 such 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 December 31, 2002, we employed 122 people, including:
operations. None of our employees are represented by a labor unionunion. We consider our relations with our employees to be good and we have experienced no work stoppages to date.
Geographic Information
A summary of domestic Competition for skilled personnel in our industry remains strong and international financial data is set forthour future depends, in Note 12part on our ability to attract and retain a skilled workforce and key personnel. We cannot assure you that we will be successful in retaining key personnel or that we will be able to attract and retain skilled workers in the Consolidated Financial Statements in Item 8, which is incorporated herein by reference. A discussion of factors potentially affecting our domestic and foreign operations is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock,” in Item 7, which is incorporated herein by reference.
future.
Available Information
Our Annual Report on Form 10-K, as amended, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.tutsystems.com when such reports are available on the Securities and Exchange Commission website. The contents of our website are not incorporated into this Form 10-K/A.
OurAs a result of our November 2002 acquisition of VTC, our executive and principal administrative and engineering facility totaling approximately 22,450 square feet is located in Lake Oswego, Oregon. In addition, we entered intoWe also have a lease agreement in December 2002 for our principal executive facility, totaling approximately 17,000 square feet, which is located in Pleasanton, California. The lease for the Lake Oswego facility expires in July 2005, and the lease for the Pleasanton facility expires in December 2003. We vacated facilitiesSeptember 2004. In addition, we have a product staging and warehouse facility totaling approximately 7,500 square feet in Bridgewater Township New JerseyCary, Illinois. The lease for this facility expires in July 2002 and moved from our Pleasanton facility located at 5964 West Las Positas Blvd., Pleasanton, California in December 2002. The costs for terminating these facilities leases were included as part of our restructuring costs recorded in the third and fourth quarters of 2002, respectively.2004. We have twoone minor facilitiesfacility in the United Kingdom that areis leased month-to-month. Selling, marketing, operational and research and development activities are conducted at all of our facilities. We 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.
Whalen v. Tut Systems, Inc. et al
On October 30, 2001, we and certain of our current and former officers and directors were named as defendants inWhalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from our January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged
13
actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and alleges claims against certain of our current and former officers and directors under Sections 15 and 20(a) of the Securities Act. The complaint also names as defendants the underwriters for our initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public offerings and secondary offerings conducted in 1999 and 2000. Therefore, for pretrial purposes, theWhalen action is being coordinated with the approximately 300 other suits before United States District Court Judge Shira Scheindlin of the Southern District of New York under the matterIn Re Initial Public Offering Securities Litigation. The individual defendants in theWhalen action, namely, Nelson Caldwell, Salvatore D'Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, approving the parties' October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying our motion to dismiss.
In June and July 2003, nearly all of the issuers named as defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the "issuer-defendants"), including our Company, approved a tentative settlement proposal that is reflected in a memorandum of understanding. Our Board of Directors approved the memorandum of understanding in June 2003 on certain conditions, including the number of issuers participating in the settlement. The memorandum of understanding is not a legally binding agreement. Further, any final settlement agreement would be subject to a number of conditions, most of which would be outside of our control, including approval by the Court. The underwriter-defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the "underwriter-defendants"), including the underwriters named in theWhalen suit, are not parties to the memorandum of understanding.
The memorandum of understanding provides that, in exchange for a release of claims against the settling issuer-defendants, the insurers of all of the settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the underwriter-defendants. The ultimate amount, if any, that may be paid on our behalf will therefore depend on the final terms of the settlement agreement, including the number of issuer-defendants that ultimately approve the final settlement agreement, and the amounts, if any, recovered by the plaintiffs from the underwriter-defendants and other non-settling defendants. In the event that all or substantially all of the issuer-defendants approve the final settlement agreement, the amount that we would be required to pay to the plaintiffs could range from zero to approximately $3.5 million, depending on plaintiffs' recovery from the underwriter-defendants and from other non-settling parties. If the plaintiffs recover at least $1 billion from the underwriter-defendants, we would have no liability for settlement payments under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, we believe that our insurance will likely cover some or all of our share of any payments towards satisfying plaintiffs' $1 billion recovery deficit. Management estimates that its range of loss relative to this matter is zero to $3.5 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount we will ultimately be required to pay, if any, as of December 31, 2003, we have not accrued a liability for this matter.
In re Tut Systems, Inc. Securities Litigation, Civil Action No. C-01-2659-JCS (the "Securities Litigation Action").
Beginning July 12, 2001, sixnine putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against Tut Systems, Inc.us and certain of itsour current and former officers and directors. The complaints were filed on behalf of a purported class of peopleinvestors who purchased the Company’sour stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that the Companywe and certain of itsour current and former officers and directors
14
made false and misleading statements about itsour business during the putative class period. Specifically, the complaints allege violations of SectionsSection 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have beenwere consolidated under the nameIn re Tut Systems, Inc. Securities Litigation Civil Action, Master File No. C-01-2659-JCSC-01-2659-CW (the “Securities"Securities Litigation Action”Action"). Lead plaintiffs and lead counsel for plaintiffs have beenwere appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the courtCourt granted in part and denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants filed a motionMotion to dismiss portionsDismiss the amended complaint, and on August 6, 2003 the Court granted in part that Motion. On September 24, 2003, defendants answered the remaining allegations of the amended complaint. Defendants reached a settlement of the Securities Litigation Action in December 2003. Subject to preliminary and final approval by the Court, our insurance carriers agreed to pay $10 million, on our behalf, to settle the suit. The settlement includes a release of all defendants. The Company has recorded a liability in its financial statements for the proposed amount of the settlement. In addition, because the insurance carriers agreed to pay the entire $10 million settlement amount and, therefore, recovery from the insurance carriers was probable, a receivable was also recorded for the same amount. Accordingly, there is no impact to the statement of operations because the amounts of the settlement and the insurance recovery fully offset each other. The insurance carriers paid the settlement amount to plaintiffs' escrow agent in January 2004. The Court has not ruledpreliminarily approved the settlement on that motion.February 24, 2004. The Company believessettlement amount will be paid out of escrow if and when the allegations against it are without merit and intendsCourt finally approves the settlement. A hearing before the Court to defendconsider final approval of the action vigorously. An unfavorable resolutionterms of this litigation could have a material adverse effect onsettlement is currently scheduled for May 14, 2004. Because the Company’s business, results of operations, financial condition, or cashflows.settlement is subject to Court approval, there is no guarantee the settlement will become final.
Lefkowitz v. D'Auria, et al
In On March 19, 2003, Chesky Lefkowitz, a shareholderone of the Company,our stockholders, filed a derivative complaint entitledLefkowitz v. D’Auria,D'Auria, et al., No. RG03087467, in the Superior Court of the State of California, County of Alameda, against certain of the Company’sour current and former officers and directors. The complaint alleges causes of action for breach of fiduciary duty, gross negligence, breach of contract, unjust enrichment, and improper insider stock trading based on the same factual allegations contained in the Securities Litigation Action. The complaint seeks unspecified damages against the individual defendants on our behalf, of the Company, equitable relief, and attorneys’attorneys' fees. There has not been a responseOn May 21, 2003, we and the individual defendants filed separate demurrers to the complaint, discovery has not commenced,complaint. We and no trial date has been established.
On August 3, 2001,the individual defendants reached a complaint,Arrow Electronics, Inc. v. Tut Systems, Inc., Case No. CV 800433, was filed in the Superior Courtsettlement of the Statederivative action in December 2003. The settlement involves our adoption of California forcertain corporate governance measures and payment of attorneys' fees and expenses to the County of Santa Clara against the Company. The complaint was filed by one of the Company’s suppliers and alleges causes of action for breach of contract and for money on common counts. The complaint sought damagesderivative plaintiff's counsel in the amount of $10,469,000. The Company settled$722,000 and an incentive award to the derivative plaintiff in the amount of $3,000. We have recorded a liability in our financial statements for the proposed amount of the settlement. In addition, because the insurance carrier involved in this case on December 20, 2002suit agreed to pay the entire $725,000 settlement amount and, therefore, recovery from the insurance carrier was probable, a receivable was also recorded for the same amount. Accordingly, there is no impact to the statement of operations because the amounts of the settlement and the related costs have been recorded ininsurance recovery fully offset each other. The settlement was approved by the consolidated financial statements.Court on January 12, 2004, and, shortly thereafter, the insurance carrier paid the settlement amount to the derivative plaintiff's counsel. The settlement includes a release of our company and the individual defendants.
On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants inWhalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from the Company’s January 29, 1999 initial public offering and its March
23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended (the “1933 Act”) and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the underwriters for the Company’s initial public offering and secondary offering. The Court has denied the Company’s motion to dismiss and the case will now proceed to discovery. The Company believes the allegations against itWe are without merit and intends to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on the Company’s business, results of operations, financial condition, or cashflows.
The Company is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. The Company’sOur management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’sour consolidated financial position, results of operations, or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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”"TUTS" since our initial public offering in January 1999. The following table sets forth, for the periods indicated, the low and high closing sales prices per share of the common stock by quarter for 20012002 and 2002,2003, as reported on theThe Nasdaq National Market.
| | High | Low | |||||
|---|---|---|---|---|---|---|---|
| 2002 | |||||||
| First Quarter | $ | 2.44 | $ | 1.27 | |||
| Second Quarter | 1.90 | 1.43 | |||||
| Third Quarter | 1.49 | 0.67 | |||||
| Fourth Quarter | 1.75 | 0.49 | |||||
2003 | |||||||
| First Quarter | 1.60 | 1.23 | |||||
| Second Quarter | 4.65 | 1.45 | |||||
| Third Quarter | 5.96 | 2.94 | |||||
| Fourth Quarter | $ | 6.66 | $ | 4.47 | |||
Low | High | |||||
2001: | ||||||
First Quarter | $ | 2.94 | $ | 8.13 | ||
Second Quarter |
| 1.49 |
| 3.30 | ||
Third Quarter |
| 0.61 |
| 1.68 | ||
Fourth Quarter |
| 0.61 |
| 2.40 | ||
2002: | ||||||
First Quarter |
| 1.27 |
| 2.44 | ||
Second Quarter |
| 1.43 |
| 1.90 | ||
Third Quarter |
| 0.67 |
| 1.68 | ||
Fourth Quarter | $ | 0.49 | $ | 1.75 | ||
On March 27, 2003,April 5, 2004, the last reported sale price of our common stock on the Nasdaq National Market was $1.48$4.35 per share. As of March 27, 2003,January 26, 2004, there were 19,805,04120,276,454 shares of our common stock outstanding and approximately 314294 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.
16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended December 31, | ||||||||||||||||||||
2002 | 2001 | 2000 | 1999 | 1998 | ||||||||||||||||
(in thousands, except per share data) | ||||||||||||||||||||
(unaudited) | ||||||||||||||||||||
Statement of Operations Data: | ||||||||||||||||||||
Total revenues | $ | 9,371 |
| $ | 13,748 |
| $ | 71,991 |
| $ | 27,807 |
| $ | 10,555 |
| |||||
Total cost of goods sold |
| 13,909 | (1) |
| 40,489 | (2) |
| 69,983 | (3) |
| 15,459 |
|
| 5,809 |
| |||||
Gross (loss) margin |
| (4,538 | ) |
| (26,741 | ) |
| 2,008 |
|
| 12,348 |
|
| 4,746 |
| |||||
Operating expenses: | ||||||||||||||||||||
Sales and marketing |
| 8,695 |
|
| 12,413 |
|
| 19,945 |
|
| 10,523 |
|
| 8,462 |
| |||||
Research and development |
| 12,337 |
|
| 15,044 |
|
| 17,149 |
|
| 7,618 |
|
| 6,200 |
| |||||
General and administrative |
| 5,060 |
|
| 10,148 |
|
| 34,487 | (4) |
| 4,884 |
|
| 4,040 |
| |||||
Restructuring costs |
| 9,147 |
|
| 2,311 |
|
| — |
|
| — |
|
| — |
| |||||
In-process research and development |
| 562 |
|
| 1,160 |
|
| 800 |
|
| 2,600 |
|
| — |
| |||||
Impairment of intangibles and goodwill |
| — |
|
| 32,551 |
|
| — |
|
| — |
|
| — |
| |||||
Amortization of intangibles and goodwill |
| 1,304 |
|
| 8,085 |
|
| 7,623 |
|
| 52 |
|
| — |
| |||||
Total operating expenses |
| 37,105 |
|
| 81,712 |
|
| 80,004 |
|
| 25,677 |
|
| 18,702 |
| |||||
Loss from operations |
| (41,643 | ) |
| (108,453 | ) |
| (77,996 | ) |
| (13,329 | ) |
| (13,956 | ) | |||||
Impairment of certain equity investments |
| (592 | ) |
| — |
|
| (3,100 | ) |
| — |
|
| — |
| |||||
Interest and other income, net |
| 610 |
|
| 4,127 |
|
| 6,998 |
|
| 1,595 |
|
| 209 |
| |||||
Net loss |
| (41,625 | ) |
| (104,326 | ) |
| (74,098 | ) |
| (11,734 | ) |
| (13,747 | ) | |||||
Dividend accretion on preferred stock |
| — |
|
| — |
|
| — |
|
| (235 | ) |
| (2,584 | ) | |||||
Net loss attributable to common stockholders | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | $ | (11,969 | ) | $ | (16,331 | ) | |||||
Net loss per share attributable to common stockholders, basic and diluted | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | $ | (1.12 | ) | $ | (60.71 | ) | |||||
Shares used in computing net loss per share attributable to common stockholders, basic and diluted |
| 16,957 |
|
| 16,326 |
|
| 14,866 |
|
| 10,729 |
|
| 269 |
| |||||
(1) Includes reserves for excess and obsolete inventory of $7,125 and the write-off of the remaining unamortized royalty balance related to the Balun technology of $542. (2) Includes reserves for excess and obsolete inventory of $34,237. (3) Includes provision for loss on purchase commitments and abondoned products of $27,223. (4) Includes provision for doubtful accounts of $22,546.
| ||||||||||||||||||||
December 31, | ||||||||||||||||||||
2002 | 2001 | 2000 | 1999 | 1998 | ||||||||||||||||
(in thousands) | ||||||||||||||||||||
(unaudited) | ||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
Cash, cash equivalents and short-term investments | $ | 25,571 |
| $ | 49,367 |
| $ | 102,614 |
| $ | 32,236 |
| $ | 4,452 |
| |||||
Working capital |
| 24,396 |
|
| 51,484 |
|
| 110,920 |
|
| 44,416 |
|
| 7,173 |
| |||||
Total assets |
| 40,589 |
|
| 78,992 |
|
| 205,588 |
|
| 65,356 |
|
| 15,257 |
| |||||
Redeemable convertible preferred stock and warrants |
| — |
|
| — |
|
| — |
|
| — |
|
| 45,995 |
| |||||
Long-term debt |
| 3,262 |
|
| — |
|
| — |
|
| — |
|
| 4,262 |
| |||||
Accumulated deficit |
| (276,536 | ) |
| (234,911 | ) |
| (130,585 | ) |
| (56,487 | ) |
| (44,434 | ) | |||||
Total stockholders’ equity (deficit) |
| 28,231 |
|
| 66,096 |
|
| 166,173 |
|
| 51,522 |
|
| (41,839 | ) | |||||
The section entitled “Management’sfollowing table presents our selected consolidated financial data for, and as of the end of, each of the periods indicated. The selected consolidated financial data for, and as of the end of, the fiscal years ended December 31, 1999, 2000, 2001, 2002 and 2003 are derived from our audited consolidated financial statements. The selected consolidated financial data are not necessarily indicative of the results that may be expected for any future period. The selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations”Operations" and our consolidated financial statements and notes included elsewhere in this prospectus.
| | Fiscal Year Ended December 31, | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 1999 | 2000 | 2001 | 2002(5) | 2003(5) | |||||||||||||
| | (in thousands, except per share data) | |||||||||||||||||
| Statement of Operations Data: | ||||||||||||||||||
| Total revenues | $ | 27,807 | $ | 71,991 | $ | 13,748 | $ | 9,371 | $ | 32,192 | ||||||||
| Cost of goods sold | 15,459 | 69,983 | (3) | 40,489 | (2) | 13,909 | (1) | 15,646 | ||||||||||
| Gross profit (loss) | 12,348 | 2,008 | (26,741 | ) | (4,538 | ) | 16,546 | |||||||||||
| Operating expenses | ||||||||||||||||||
| Sales and marketing | 10,523 | 19,945 | 12,413 | 8,695 | 7,479 | |||||||||||||
| Research and development | 7,618 | 17,149 | 15,044 | 12,337 | 7,909 | |||||||||||||
| General and administrative | 4,884 | 34,487 | (4) | 10,148 | 5,060 | 4,476 | ||||||||||||
| Restructuring costs | — | — | 2,311 | 9,147 | 292 | |||||||||||||
| In-process research and development | 2,600 | 800 | 1,160 | 562 | — | |||||||||||||
| Impairment of intangible assets | — | — | 32,551 | — | 128 | |||||||||||||
| Amortization of intangible assets | 52 | 7,623 | 8,085 | 1,304 | 1,809 | |||||||||||||
| Total operating expenses | 25,677 | 80,004 | 81,712 | 37,105 | 22,093 | |||||||||||||
| Loss from operations | (13,329 | ) | (77,996 | ) | (108,453 | ) | (41,643 | ) | (5,547 | ) | ||||||||
| Impairment of certain equity investments | — | (3,100 | ) | — | (592 | ) | — | |||||||||||
| Interest and other income, net | 1,595 | 6,998 | 4,127 | 610 | 30 | |||||||||||||
| Net loss | (11,734 | ) | (74,098 | ) | (104,326 | ) | (41,625 | ) | (5,517 | ) | ||||||||
| Dividend accretion on preferred stock | (235 | ) | — | — | — | — | ||||||||||||
| Net loss attributable to common stockholders | $ | (11,969 | ) | $ | (74,098 | ) | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | |||
| Net loss per common share attributable to common stockholders, basic and diluted | $ | (1.12 | ) | $ | (4.98 | ) | $ | (6.39 | ) | $ | (2.45 | ) | $ | (0.28 | ) | |||
| Shares used in computing net loss per share attributable to common stockholders, basic and diluted | 10,729 | 14,866 | 16,326 | 16,957 | 19,996 | |||||||||||||
| | December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 1999 | 2000 | 2001 | 2002 | 2003 (Restated)(6) | ||||||||||
| | (in thousands, except per share data) | ||||||||||||||
| Consolidated Balance Sheet Data: | |||||||||||||||
| Cash and cash equivalents | $ | 32,236 | $ | 102,614 | $ | 49,367 | $ | 25,571 | $ | 14,370 | |||||
| Working capital | 44,416 | 110,920 | 51,484 | 24,396 | 21,815 | ||||||||||
| Total assets | 65,356 | 205,588 | 78,992 | 39,729 | 42,771 | ||||||||||
| Long-term debt | — | — | — | 3,262 | 3,523 | ||||||||||
| Total stockholders' equity | 51,522 | 166,173 | 66,096 | 28,231 | 23,655 | ||||||||||
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" set forth below contains “forward-looking statements”"forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include, but not limited to, statements about (1) our ability to generate income in the digital TV head-end, video trucking and private broadband network markets, (2) our ability to generate income through increases in sales volume and reductions in our manufacturing costs, (3) our expectation that international sales will continue to account for a significant portion of our revenue, (4) our expectation that we will derive material benefits from sales of product lines that we acquired in our acquisitions of third parties, (5) our expectation that we will be able to introduce new products and product enhancements that our customers demand, (6) our expectation that our suppliers and manufacturers would be able to meet such demand from our customers in a timely manner, (7) our expectation that our foreign sales will continue to be denominated primarily in U.S. dollars, (8) our expectation that our research and development activities will continue to represent a significant percentage of our overall fixed operating expenses during 2003, (9) our expectation of how in-process research and development will impact our future results of operations or cash flows, (10) our expectation that our amortization of intangibles will increase in 2003, (11) our anticipation that, in future periods, our working capital expenditures will decrease, (12) our expectation 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, (13) our expectation that our cash flows from operations will increase in 2003, (14) our expectations about future license revenue, (15) our expectation that we will not incur restructuring costs in 2003, (16) our revenue sources, our cash flow and cash position, our expense trends, products and standards development, and our plans, objectives, expectations and intentions and other statements contained herein that are not historical facts. When used herein, the words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “seeks,” “should,” “will”"anticipates," "believes," "continue," "could," "estimates," "expects," "intends," "may," "plans," "seeks," "should," "will" or the negative of these terms or similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. These forward-looking statements reflect current views of our management with respect to future events and are subject to these and other risks, uncertainties and assumptions. As a result, actual results may differ materially from the forward-looking statements contained herein. Such risks and uncertainties include those set forth below in “Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock.” In particular, see “Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock—We have a history of losses and expect to continue to incur losses in the future,” “—Our operating results may fluctuate significantly, which could cause our stock price to decline,” and “—We are and continue to be affected by poor general economic conditions that have resulted in significantly reduced sales levels and, if such adverse economic conditions continue or worsen, our business, operating results and financial condition will continue to be negatively impacted.” All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph.
Overview
Our Business
We design, develop, and sell digital video processing systems that enable telephony-based service providers to deliver broadcast quality digital video signals across their networks. We refer to these systems as digital TV headends or video content processing systems. We also offer digital video processing systems optimizedthat enable private enterprise and government entities to transport video signals across satellite, fiber, radio, or copper facilities for surveillance, distance learning, and TV production applications.
We also offer broadband transport and service management products that enable the provisioning of public broadcast digital TV services across telephone companyhigh speed Internet access and cable company facilities, digital video trunking systems for applications across TV broadcast, government and education facilities, andother broadband data transmission systems for applicationservices over existing copper networks within hotels and private campus or building facilities.
Our History
Historically, Prior to November 2002, most of our sales were derived from our broadband data transmission systems.transport and service management products. In 2000 and 2001, we acquired three companies (FreeGate Corporation, Xstreamis Limited and ActiveTelco, Inc.) and the assets from two other companies (OneWorld Systems, Inc. and ViaGate Technologies, Inc.) in order to expand our sales of broadband transport and service management products. However, the significant downturn in the world economy in general, and the telecommunications market in particular, beginning in late 2000 had a severe and sustained adverse effect on our business, financial condition and results of operations. Our sales of broadband transport and service management products decreased substantially beginning in 2001, which required us to take a number of restructuring efforts and incur significant impairment and other charges in order to realign our cost structure in light of the economic environment. For the period January 1, 2001 through December 31, 2002, we incurred an aggregate of $32.6 million in intangible asset impairment charges and $11.5 million in restructuring charges. In 2003, sales from our broadband transport and service management products stabilized, as we began to experience an improvement in sales of broadband transport and service management products to the hospitality industry.
With our November 2002 acquisition of Video Tele.com (VTC), formerly aTektronix's subsidiary of Tektronix, Inc.,VTC, we extended our product offerings to includeadd video content processing systems for digital TV headends and for the transmission of video trunking systems.signals over private and government networks. The acquisition of VTC has resulted in a significant changechanges in the structure, organization and priorities of Tut,our business, including: (1) changes in our
organizational structure and employee staffing; (2) establishmentrelocation of our administrative offices, executive offices (as of January 2004) and a significant
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portion of our operations infrom Pleasanton, California to Lake Oswego, Oregon, at the prior headquarters location of VTC; (3) the designation of Douglas Shafer, the former President and Chief Executive Officer of VTC, as Vice President, Finance and Administration, Chief Financial Officer and Secretary of Tut Systems; (4) an expansion of our sales and marketing efforts to include VTC products; and (5)(4) a reprioritization of Tut Systems’our research and development budgetefforts to include the research and development offocus on products that we acquired by Tut in itsour acquisition of VTC.
During 2001 and 2002, we reduced the sales prices of some of our products to remain competitive and to reduce our high levels of inventory. Although we have historically been able to offset most price declines with reductions in our manufacturing costs, there can be no assurance that we will be able to offset further price declines with additional cost reductions. Also, market developments, including the write down of significant amounts of inventory by competitors and products resold as a result of bankruptcies within the industry, have put increased pressure on the sales prices of our existing inventories. In addition, some of our licensees may sell products based on our technology to our competitors or potential competitors.
Sales to customers outside of the United States accounted for approximately 43.0%, 56.3% and 41.0% of revenue for the years ended December 31, 2002, 2001 and 2000, respectively. On average, we expect international sales to represent less than 50% of our revenue. However, actual results, both geographically and in absolute dollars, may vary from quarter to quarter depending on the timing of orders placed by customers. To date, all international sales have been primarily denominated in U.S. dollars.
We expect to continue to evaluate product line expansion and new product opportunities, engage in research, development and engineering activities and focus on cost-effective design of our products. Accordingly, we will continue to make significant expenditures on research and development activities as a percentage of overall operating expenses.
In February 2000, we acquired FreeGate Corporation (FreeGate) for approximately $25.5 million, consisting of 510,931 shares of our common stock, 19,707 options to acquire shares of our common stock, and acquisition related expenses consisting primarily of investment advisory, legal and other professional service fees and other assumed liabilities. This transaction was treated as a purchase for accounting purposes. FreeGate was located in Sunnyvale, California. FreeGate designed, developed and marketed Internet server appliances combining the functions of IP routing, firewall security, network address translation, secure remote access via 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 for accounting purposes. The acquired assets consisted of $1.0 million for acquired workforce, $1.1 million for goodwill and $0.3 million for property and equipment.
In May 2000, we acquired Xstreamis Limited (Xstreamis), formerly Xstreamis, PLC, for $19.6 million, consisting of 439,137 shares of our common stock, 10,863 options to acquire shares of our common stock, $0.1 million in cash and $0.6 million in acquisition related expenses consisting primarily of legal and other professional fees. This transaction was treated as a purchase for accounting purposes. Xstreamis was located in the United Kingdom. Xstreamis provided policy-driven traffic management for high-performance, multimedia networking solutions including routing, switching and bridging functions.
In January 2001, we acquired ActiveTelco, Inc. (ActiveTelco) for approximately $4.9 million, consisting of an aggregate of 321,343 shares of our common stock and 18,657 options to purchase shares of our common stock and acquisition related expenses consisting primarily of legal and other professional fees, assumed ActiveTelco convertible notes in the amount of $0.7 million plus accrued interest and other assumed liabilities of approximately $1.1 million. This transaction was treated as a purchase for accounting purposes. ActiveTelco was located in Fremont, California. ActiveTelco provided an Internet telephony platform that enabled Internet and telecommunications service providers to
integrate and deliver Web-based telephony applications such as unified messaging, long-distance service, voicemail and fax delivery, call forwarding, call conferencing and callback services.
In September 2001, we acquired certain assets, including some intellectual property rights, from ViaGate Technologies, Inc. (ViaGate) for approximately $0.6 million in cash. This transaction was treated as a purchase of assets for accounting purposes. The acquired patents and technology of ViaGate provide a highly scalable, carrier-class, full service gateway built on standards-based asynchronous transfer mode, or ATM, IP and VDSL technology.
In November 2002, we acquired VideoTele.com, Inc. (VTC) from Tektronix, Inc. (Tektronix) for approximately $7.2 million, consisting of an aggregate of 3.3 million shares of our common stock valued at $3.6 million, acquisition related expenses consisting primarily of legal and other professional fees of $0.3 million, a note payable to Tektronix in the amount of $3.2 million and other assumed liabilities of approximately $1.8 million. This transaction was treated as a purchase for accounting purposes. VTC offers Digital Head-end solutions enabling home entertainment delivery via the broadband Internet.
In connection with With our acquisition of VTC, sales of video processing systems now represent a majority of our total revenues and will provide most of our growth opportunities in the foreseeable future.
We earn revenue primarily by selling video content processing systems both directly and through resellers to telecommunications service providers. We also earn revenue by selling video transmission systems to TV broadcasters, government agencies and educational institutions, and by selling broadband transport and service management products directly and through distributors to the hospitality industry and to owners of private multi-tenant campus facilities.
Prior to our acquisition of VTC, international sales represented 56.3% and 43.0% of our total sales in 2001 and 2002, respectively. Since our acquisition of VTC, international sales have represented a smaller percentage of our overall business relative to prior years, though international sales are still a material portion of our total sales. In 2003, international sales represented 18.4% of our total sales.
Material Trends and Uncertainties
We pay close attention to and monitor various trends and uncertainties emerging in the markets we serve. There is a growing demand by independent operating telephone companies to offer video services to their customer base. According to a report released by InStat/MDR in April 2003, the number of telco video subscribers worldwide will increase from 572,000 at the end of 2003 to over 19.0 million by the end of 2007. While this growing market presents opportunities to serve a larger customer base, we are contractually obligatedalso seeing the emergence of intense competition as more companies compete to use our commercially reasonable effortssell digital TV headend products. We expect this market space will continue to register on a Form S-3 pursuantbecome more competitive in the future. As we begin to Rule 415(a)(1)(i) under the Securities Act of 1933, as amended, on a continuous or delayed offering the 3.3 million shares of common stock issued to Tektronix no later than May 30, 2003 in order that Tektronix may sell such shares on or after December 1, 2003.
Whiletarget larger telco customers, we expect to derive benefits from sales of product linescompete with larger public companies, including Harmonic, Motorola and Tandberg Television. Our immediate competitors in the digital TV headend markets are primarily small private companies that are designed, developedfocused on a more narrow product line than ours and marketed as a result of these acquisitions, there can be no assurance that we willthereby may be able to completedevote substantially more targeted resources to developing, marketing and selling new products than we are able to. In addition, these companies may become targets for acquisition by larger companies, in which case we would face competitors with substantially greater name recognition, and technical, financial and marketing resources than we have.
The emergence of new technologies to serve the developmentdigital TV headend market means that we must continue to invest in these new technologies to maintain our market position. The bandwidth and commercial deploymentdistance limitations of certainthe copper based "last mile" constrain both the number of video channels that may be delivered simultaneously over a DSL network and the number of customers that are reachable from a telco central office. Emerging advancements in video compression technology will soon enable high quality video streams to be transported at lower bit rates than currently deployed. These emerging compression advancements also introduce the possibility of delivering high-definition television over bandwidth constrained asymmetric DSL, or ADSL, lines for the first time. Additionally, there are DSL advancements emerging that expand the available downstream bandwidth thereby supporting higher DSL bit rates over longer distances. The combination of these products.technology advancements will enable telcos to reach a higher percentage of their customers with a larger number of video channels. While DSL technology will continue to dominate telco broadband networks for the foreseeable future, telephone companies are beginning to construct fiber networks to their customers' homes. Though fiber-to-the-home will eliminate bandwidth limitations on delivering higher speed data services and high-quality video offerings, telephone companies deploying fiber-to-the-home will require advanced video processing to convert signals between multiple protocols used in their networks.
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Internal Controls and Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2003. This evaluation included various steps that our Chief Executive Officer and Chief Financial Officer undertook in an effort to ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized and reported within the time periods specified by the SEC. This evaluation also included consideration of our internal controls and procedures for the preparation of our financial statements.
In January 2001,connection with the completion of its audit of our financial statements for the year ended December 31, 2003, PricewaterhouseCoopers LLP, the Company's independent auditors, advised management and the audit committee of the Board of Directors that it had identified deficiencies in our internal controls and processes relating to inventory management and reporting that it considers to be material weaknesses, as defined by Statement on Auditing Standards No. 60, "Communication of Internal Control Related Matters Noted in an Audit." PricewaterhouseCoopers LLP identified the following two material weaknesses in our internal controls and processes:
While these material weaknesses had an immaterial effect on our reported results, they may nevertheless constitute deficiencies in our disclosure controls. In light of these material weaknesses and the requirements enacted by the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC, our Chief Executive Officer and Chief Financial Officer concluded, as of December 31, 2003, that our disclosure controls and procedures needed improvement and were not adequately effective. Management believes that there are no material inaccuracies, or omissions of material facts necessary to make the statements not misleading in light of the circumstances under which they were made, in this Form S-3.
The audit committee is taking an active role in responding to the deficiencies identified by PricewaterhouseCoopers LLP, including overseeing management's implementation of corrective measures. In this regard, we decidedare in the process of implementing the following measures:
Management believes its new controls and procedures will address the conditions identified by PricewaterhouseCoopers LLP as material weaknesses. We plan to abandon futurecontinue to monitor the effectiveness of our internal controls and procedures on an ongoing basis and will take further action as appropriate.
Definitions for Discussion of Results of Operations
Our discussion of our results of operations focuses on the following items from our income statement: Total revenues consists of product sales, and license and royalty fees. Product revenue consists of sales of the existing OneGate product that we acquired in the FreeGate acquisition. In April 2001, asour video processing systems, which includes both digital TV headend and video transmission systems. Product revenue also consists of revenue from our broadband transport and
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service management products. License and royalty fees consist of non-refundable license fees and royalties received by us for products sold by our licensees. Since our acquisition of VTC, a large part of our quarterly revenue has been associated with the sale of digital TV headends. Furthermore, each individual headend sale has represented a significant portion of our revenue for each quarter. If we were to sell even one less system than our forecasted number of headend sales per quarter, our quarterly revenue would be materially impacted. As we did not enter into any new license or royalty agreements during 2001, 2002 or 2003, we expect that our license and royalty revenue will decrease in the foreseeable future. Cost of goods sold, or COGS, consists of costs related to raw materials, contract manufacturing, personnel, overhead, test and quality assurance for products, and the cost reduction efforts, we decided not to pursue further incorporation of licensed technology included in our products. Raw materials, contract manufacturing and licensed technology are the related OneGateprincipal elements of COGS and other intellectual property acquired from FreeGate intovary directly with product sales. Sales and marketing expense consists primarily of selling and marketing personnel costs, including sales commissions, travel, trade shows, promotions and outside services. Research and development expense consists primarily of personnel and facilities costs, contract consultants, outside testing services, and equipment and supplies associated with enhancing existing products and developing new products. General and administrative expense consists primarily of personnel costs for administrative officers and support personnel, professional services and insurance expenses. Amortization of intangible assets consists primarily of expenses associated with the designamortization of future products. As a result, we took a write down of $2.7 million for abandonment of the related completed technology and patents inrelated to prior years' acquisitions.
Restatement
Subsequent to issuance of the first quarterDecember 31, 2003 consolidated financial statements, management determined that it should have reflected a liability of 2001. During our impairment review$10 million for the third quarter of 2001, we evaluated the present value of future expected cash flows to determine the fair value of our long-lived assets. This evaluation resulted in a write down of $29.9 million of goodwill and other intangible assets. The underlying factors contributingIn re: Tut Systems Inc. Securities Litigation matter (see Note 9 to the decline in expected future cash flows include a continued decline inconsolidated financial statements) and $725,000 for the telecommunications industry andLefkowitz v. D'Auria matter (see Note 9 to the indefinite postponement of capital expenditures, especially within the hospitality industry. Asconsolidated financial statements) as of December 31, 2002, our net intangible assets remaining2003. In addition, the consolidated financial statements should have reflected a receivable from the Company's insurance carriers of $10,725,000. Consequently, the Company has restated its December 31, 2003 balance sheet to be amortized were $5.4 million, related toreflect these matters. These adjustments had no effect on the acquisitionsconsolidated statements of operations, the ViaGate assets, Xstreamis and VideoTele.com.
In fiscal 2001, we reduced our total workforce by approximately 50% to control overall operating expenses in response to recent declines and expected slower growth in our sales, and we also closed severalconsolidated statements of our satellite offices. In fiscal 2001 we incurred restructuring chargesstockholders' equity or the consolidated statements of $2.3 million related to these restructuring activities. In fiscal 2002, we further reduced our total workforce by an aggregate of approximately 53% in a continued effort to control operating expenses in response to protracted declines in our sales volumes. We incurred restructuring charges of $9.1 million in fiscal 2002, primarily related to the termination of facilities leases and abandonment of related leasehold improvements, property and equipment.
cash flows.
Results of Operations
Years Ended December 31, 2001, 2002 and 2003.
Our acquisition of VTC has had a significant impact on every aspect of our financial statements since November 2002. This impact is reflected in the following discussion of our operating results for fiscal year 2003 relative to 2002 and years prior to 2002. This should be considered when evaluating our period-to-period comparisons of 2003 relative to years prior to 2003.
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The following table sets forth items from our statements of operations as a percentage of total revenues for the periods indicated:
Year Ended December 31, | |||||||||
2002 | 2001 | 2000 | |||||||
Total revenues | 100.0 | % | 100.0 | % | 100.0 | % | |||
Total cost of goods sold | 148.4 |
| 294.5 |
| 97.2 |
| |||
Gross (loss) margin | (48.4 | ) | (194.5 | ) | 2.8 |
| |||
Operating expenses: | |||||||||
Sales and marketing | 92.8 |
| 90.3 |
| 27.7 |
| |||
Research and development | 131.7 |
| 109.4 |
| 23.8 |
| |||
General and administrative | 54.0 |
| 73.8 |
| 47.9 |
| |||
Restructuring costs | 97.6 |
| 16.8 |
| — |
| |||
In-process research and development | 6.0 |
| 8.5 |
| 1.1 |
| |||
Impairment of intangibles and goodwill | — |
| 236.8 |
| — |
| |||
Amortization of intangibles and goodwill | 13.9 |
| 58.8 |
| 10.6 |
| |||
Total operating expenses | 396.0 |
| 594.4 |
| 111.1 |
| |||
Loss from operations | (444.4 | ) | (788.9 | ) | (108.3 | ) | |||
Impairment of certain equity investments | (6.2 | ) | — |
| (4.3 | ) | |||
Interest and other income (expense), net | 6.5 |
| 30.1 |
| 9.7 |
| |||
Net loss | (444.2 | )% | (758.8 | )% | (102.9 | )% | |||
| | Year Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | ||||||
| Total revenues | 100.0 | % | 100.0 | % | 100.0 | % | |||
| Cost of goods sold | 294.5 | 148.4 | 48.6 | ||||||
| Gross profit (loss) | (194.5 | ) | (48.4 | ) | 51.4 | ||||
| Operating expenses: | |||||||||
| Sales and marketing | 90.3 | 92.8 | 23.2 | ||||||
| Research and development | 109.4 | 131.7 | 24.6 | ||||||
| General and administrative | 73.8 | 54.0 | 13.9 | ||||||
| Restructuring costs | 16.8 | 97.6 | 0.9 | ||||||
| In-process research and development | 8.4 | 6.0 | — | ||||||
| Impairment of intangible assets | 236.8 | — | 0.4 | ||||||
| Amortization of intangible assets | 58.8 | 13.9 | 5.6 | ||||||
| Total operating expenses | 594.4 | 396.0 | 68.6 | ||||||
| Loss from operations | (788.9 | ) | (444.4 | ) | (17.2 | ) | |||
| Impairment of certain equity investments | — | (6.3 | ) | — | |||||
| Interest and other income, net | 30.1 | 6.5 | 0.1 | ||||||
| Net loss | (758.8 | )% | (444.2 | )% | (17.1 | )% | |||
Years Ended Total Revenues. For the year ended December 31, 2002, 2001 and 2000
Revenue. We generate revenue primarily2003, our total revenues increased by 243.5% to $32.2 million from the sale of hardware products, including third-party products, professional services, through the licensing of our HomeRun technology and from the sale of software products. Following our acquisition of VTC in November 2002, we also generated $1.1 million in revenues from turnkey solutions, which are comprised of the sale of digital head-end and video trunking equipment. Our total revenue decreased to $9.4 million for the year ended December 31, 20022002. During this same period, our product revenue increased by 266.7% to $31.5 million from $13.7$8.6 million for the year ended December 31, 20012002. This $22.9 million increase in product revenue was due solely to the sale of our video processing systems. Fiscal year 2003 was the first full year that included revenue from our VTC acquisition in November 2002. During 2003, we experienced a growing demand for our video processing systems from independent operating telephone companies as they in turn experienced increasing demand for video services in the markets they serve. Product revenue from the sale of our broadband transport and service management products changed by less than 0.5% from $72.02002 to 2003. For the year ended December 31, 2003, our license and royalty revenue decreased by 9.0% to $0.7 million from $0.8 million for the year ended December 31, 2000. Using2002. We expect sales related to VTC products to continue to increase in 2004 and sales relating to our broadband transport and service management products to also increase in 2004, but a lower rate of increase.
For the year ended December 31, 2002, our product revenue decreased by 33.3% to $8.6 million from $12.9 million for the year ended December 31, 2001. This year-over-year comparison, the decrease of $4.3 million in 2002 compared to 2001 of $4.4 million, or 31.8%,product revenue was primarily due to decreased sales of our Expresso MDU products. The market for ourbroadband transport and service management products was significantly weaker in 2002 than it was in 2001 because our customers continued to delay or forego capital expenditures for products such as ours. The decrease in 2001 compared to 2000 of $58.2$5.4 million, or 80.9%, was also primarily due to a significant decrease inpartially offset by sales of our Expresso MDU products. During the fourth quartervideo processing systems of 2000, our revenue growth slowed substantially due to (i) several key customers who, in the latter part of the fourth quarter of 2000, experienced a rapid deterioration in their ability to obtain additional capital and, as a result, severely curtailed or halted their purchases of our product, and (ii) reduced sales volume in the Korean market. The fourth quarter of 2000 revenue declines 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. These developments were not unique to us and have continued in conjunction with a general and protracted downturn in the telecommunications market throughout 2001 and 2002, affecting our ability to generate comparatively similar levels of sales. In certain instances, these developments made collection of receivables less certain and required us to defer revenue until cash was collected. During the third quarter of 2001, our revenue growth further slowed due to an increase in the number of customers and potential customers, particularly within the hospitality industry, that indefinitely postponed capital expenditures after the events surrounding September 11, 2001 and in reaction to continued weak demand from their own end customers.
License and royalty revenue decreased to $0.8 million for$1.1 million. For the year ended December 31, 2002, our license and royalty revenue decreased by 10.5% to $0.8 million from $0.9 million for the year ended December 31, 2001 and2001.
Cost of Goods Sold. For the year ended December 31, 2003, our cost of goods sold increased by 12.5% to $15.6 million from $2.0$13.9 million for the year ended December 31, 2000. The
slight decrease in 2002 compared to 2001 of $0.1 million, or 10.5%, and the decrease in 2001 compared to 2000 of $1.1 million, or 56.1%, were primarily due to decreases in royalty payments on license agreements. We did not enter into any new license or royalty agreements during 2002 or 2001. We entered into one new license and royalty agreement during 2000.
Cost of Goods Sold/Gross (Loss) Margin
2002. Cost of goods sold consists of raw materials, contract manufacturing, personnel costs, testincreased by $1.7 million between 2002 and quality assurance for products, and the cost of licensed technology included in the products. Our cost of goods sold decreased to $13.9 million in 2002, from $40.5 million for 2001 and from $70.0 million in 2000. The decrease in 2002 compared to 2001 of $26.6 million, or 65.6%, was2003, primarily due to the lower provision for excess and obsolete inventory in 2002costs associated with increased product sales, particularly from sales related to video processing systems of $7.1$11.3 million, compared to $34.2 million in 2001, decreased sales of our Expresso MDU products and lower fixed manufacturing costs due to cost reductions resulting from our restructuring efforts. The decrease in 2001 compared to 2000 of $29.5 million, or 42.1%, was primarily due to decreased sales of our Expresso MDU products. The provision for excess and obsolete inventory in 2001 of $34.2 million was comparable to the provision for loss on purchase commitments and abandoned products of $27.2 million in 2000.
Gross margin as a percentage of revenue, improved to (48.4)% of revenue for the year ended December 31, 2002 from (194.5)% of revenue for the year ended December 31, 2001, and decreased from 2.8% of revenue for the year ended December 31, 2000. The improvement in 2002 compared to 2001 of 146.1% was due primarily to the decrease in the provision for excess and obsolete inventory in 2002 when compared to 2001, lower fixed manufacturing costs due to cost reductions resulting from our restructuring effortspartially offset by overall sales volume decreasesthe effects of changes in 2002 and sales price reductions on some of our Expresso MDU products. The decrease in 2001 compared to 2000 of 197.3% was due primarily to significant sales volume decreases on our Expresso MDU products in 2001 when compared to 2000.
During 2002, we recorded reserves for excess and obsolete inventory totaling $7.1inventories of $8.6 million and decreases in costs associated with sales of our broadband transport and service management products of $1.0 million. In 2003, we reduced our reserves for excess and obsolete inventories by $1.5 million
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because we were able to sell certain products for which we had originally set aside reserves in prior years. These reserves were primarily related to the costs of raw materials and finished goods in excess of what we reasonably expected to sell in the foreseeable future based on the continued decline in the telecommunications market and current economic conditions. These changes in reserves are reflected in cost of goods sold. Our gross profit improved in 2003 compared to 2002 due to the increased sales volume relating to VTC products resulting in a gross margin increase of $11.5 million, reduction in cost of goods sold for our broadband transport and service management products of $1.0 million and the effect of changes in our reserves of $8.6 million.
DuringFor the year ended December 31, 2002, our cost of goods sold decreased by 65.6% to $13.9 million from $40.5 million for the year ended December 31, 2001. This $26.6 million decrease in cost of goods sold between 2002 and 2001 we recorded reserveswas primarily due to a smaller provision for excess and obsolete inventory totalingin 2002 of $7.1 million compared with a provision of $34.2 million. $29.9 million in 2001, and decreased cost of thesesales of our broadband transport and service management products of $0.8 million partially offset by increased cost of goods sold of $1.3 million for our video processing systems. The large provision for reserves were primarily related to the costsin 2001 was a result of raw materialsindustry-wide developments during 2000 and finished goods in excess of what we reasonably expected to sell in the foreseeable future. Market developments over the past two years, including2001 that included the write down of significant amounts of inventory by our competitors, the proliferation of lower-priced competitive products resold as a result of competitors' bankruptcies within the industry, continuedand write-offs, a protracted slowdown in the broader telecommunications market and more recently, the indefinite postponement of capital expenditures especially within the hospitality industry, have contributed to substantial uncertainties related to the value of these inventories. During 2001, we also recorded additional reserves of $4.3 million for excess and obsolete inventory as a part ofby our normal business operations and product inventory assessments.
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. This provision covered 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 of 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. During 2001, we reversed $2.9 million of the provision for loss on purchase commitments against cost of goods sold and we paid our suppliers $11.8 million upon receipt of raw material components related to our provision of loss on purchase commitments recorded in the fourth quarter of 2000. At December 31, 2001, these components were included in inventory offset by the provision for $11.8 million. There were no additional provisions recorded in 2001 related to these raw material components. In 2001, cost of goods sold also included approximately $0.5 million for the sale of raw materials previously reserved through the loss on purchase
commitments. During 2002, we reversed $0.7 million of the provision for loss on purchase commitments against cost of goods sold due to a favorable negotiation with one of our former contract manufacturers.
customers.
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 For the year ended December 31, 2003, our sales and marketing expenses decreased by 14.0% to $7.5 million from $8.7 million for the year ended December 31, 2002. The decrease of $1.2 million in sales and marketing expense in 2003 when compared with 2002 was due to a year-over-year decrease of $0.4 million of personnel related costs a $0.3 million decrease in depreciation expense and a $0.5 million decrease in facilities and infrastructure expenses.
For the year ended December 31, 2002, sales and marketing expense decreased by 30.0% to $8.7 million from $12.4 million for the year ended December 31, 2001. The decrease of $3.7 million in sales and marketing expense in 2002 compared with 2001 included a decrease in travel expenses of $0.5 million, a decrease of $2.0 million in personnel related costs, and a $0.4 million decrease in outside services expenses. These cost reductions were made to reduce our expenses in response to our declining revenues. Also contributing to the year-over-year decrease was a $0.4 million reduction in commission expenses resulting from $19.9lower revenue in 2002 when compared with 2001.
Research and Development. For the year ended December 31, 2003, our research and development expense decreased by 35.9% to $7.9 million from $12.3 million for the year ended December 31, 2000.2002. The $4.4 million decrease in our research and development expense for 2003 when compared with 2002 was primarily due to a year-over-year decrease of $1.8 million in personnel related costs, a $1.2 million decrease in project materials costs and a $1.3 million decrease in facilities and infrastructure expenses. We continued to reduce research and development expenses in 2003 to bring them into better alignment with our current revenues. Our capital expenditures for research and development were $0.3 million in 2002 and $1.1 million in 2003. In total, we expect capital expenditures for research and development to decrease in 2004.
For the year ended December 31, 2002, our research and development expense decreased by 18.0% to $12.3 million from $15.0 million for the year ended December 31, 2001. The decrease of $2.7 million in our research and development expense in 2002 when compared towith 2001 of $3.7 million, or 30.0%, was primarily due to workforce reductions related to our restructurings, which resulted in a year-over-year decrease of $2.0 million of personnel related costs, a $0.5 million decrease in travel related expenses and a $0.4 million decrease in consulting expenses. The decrease in 2002 was also due to the year over year $0.4 million decrease in commission expenses resulting from decreased revenues in 2002 when compared to 2001. The decrease in 2001 when compared to 2000 of $7.5 million, or 37.8%, was primarily due to workforce reductions related to our restructurings, which resulted in a year-over-year decrease of $1.0 million of personnel related costs, a $2.9 million decrease in marketing related expenses (trade shows, channel marketing, mailings and public relations), a $0.5 million decrease in travel related expenses, a $0.5 million decrease in supplies and small equipment expense and a $2.0 million decrease in consulting expenses. The decrease in 2001 was also due to the year over year $1.3 million decrease in commission expenses resulting from decreased revenues in 2001 when compared to 2000.
Research and Development. Research and development expense consists primarily of personnel costs related to engineering and technical support, contract consultants, outside testing services, equipment and supplies associated with enhancing existing products and developing new products. Research and development costs are expensed as they are incurred. Our research and development expenses decreased to $12.3 million for the year ended December 31, 2002 from $15.0 million for the year ended December 31, 2001 and from $17.1 million for the year ended December 31, 2000. The decrease in 2002 when compared to 2001 of $2.7 million, or 18.0%, was primarily due to workforce reductions related to our restructurings,restructuring efforts, which resulted in a year-over-year decrease of $2.1 million ofin our personnel related costs, a $0.8 million decrease in consulting expenses, $0.3 million reduction in facilities expenses and a $0.1 million decrease in travel relatedtravel-related expenses. The decrease in 2002 relative to 2001 was also due to the year over year $0.5 million year-over-year decrease in noncashnon-cash compensation expense, comprisedwhich consisted of amortization of deferred compensation and notenotes receivable
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forgiveness in 2002 when compared to 2001.2002. These decreases in 2002 research and development expense relative to 2001 were partially offset by a $0.8 million increase in project materials expenses in 2002 relative to 2001.
General and Administrative. For the year ended December 31, 2003, our general and administrative expense decreased by 11.5% to $4.5 million from $5.1 million for the year ended December 31, 2002. The $0.6 million decrease in our general and administrative expense for 2003 when compared with 2002 included decreases of $0.4 million in personnel expenses, $0.6 million in depreciation expense, $0.7 million in professional services expenses, and $0.6 million in insurance. Partially offsetting these year-over-year expense reductions was the benefit of a $2.3 million bad debt recovery in 2002 that was not repeated in 2003. We recorded as an expense $10.7 million relating to our pending settlement of certain litigation matters. We also recorded an equal and offsetting gain to reflect the fact that, as of December 31, 2003, our insurance carriers had agreed to pay the settlement amounts.
For the year ended December 31, 2002, our general and administrative expense decreased by 50.1% to $5.1 million from $10.1 million for the year ended December 31, 2001. The $5.0 million decrease in 2001our general and administrative expense for 2002 when compared to 2000 of $2.1 million, or 12.3%,with 2001 was primarily due to workforce reductions related to our restructurings, which resulted in a year-over-year decrease of $0.3 million of personnel related costs, a $1.8 million decrease in consulting expenses, a $1.0 million decrease in project materials expenses. The decrease in 2001 was also due to the year over year $0.6 million decrease in noncash compensation expense comprised of amortization of deferred compensation and note receivable forgiveness in 2001 when compared to 2000. These decreases were offset by a $0.6 million increase in depreciation expense and a $1.0 million increase in facilities and infrastructure expenses in 2001 when compared to 2000. The research and development expenses of FreeGate, Xstreamis and ActiveTelco and VTC were consolidated with our expenses for the periods subsequent to the respective February 2000, May 2000, January 2001 and November 2002 acquisitions. Additionally, in 2002, 2001 and 2000, we amortized to research and development $0.1 million, $0.8 million and $2.0 million, respectively, of deferred compensation and notes receivable related to restricted stock granted to certain FreeGate, OneWorld and ActiveTelco employees. As of December 31, 2002, there were no remaining balances related to deferred compensation and notes receivable that were recorded as a reduction of equity in the balance sheet. Research and development expenses decreased in absolute dollars in 2002 and 2001 as a result of our continued focus on cost saving measures. We expect research and development activities to represent a significant percentage of our overall fixed operating expenses during 2003.
General and Administrative. General and administrative expense primarily consists of personnel costs for administrative officers and support personnel, legal, accounting, insurance and consulting fees. Our general and administrative expenses decreased to $5.1 million for the year ended December 31, 2002 from $10.1 million for
the year ended December 31, 2001 and from $34.5 million for the year ended December 31, 2000. The decrease in 2002 when compared to 2001 of $5.1 million, or 50.1%, was primarily due to workforce reductions related to our restructurings,restructuring efforts, which resulted in a year-over-year decrease of $1.3 million of personnel related costs, ain personnel-related costs. The decrease in year-over-year expenses was also due to $1.3 million decrease in consultingprofessional expenses, a $0.9 million decrease in bad debt expense, a $0.8$0.5 million decrease in bad debt recovery and a $0.5 million decrease in depreciation expense. The decrease in 2001 when compared to 2000 of $24.3 million, or 70.6%, was primarily due to the net bad debt recovery of $1.0 million in 2001 compared to bad debt expense of $22.5 million recorded in 2000. The decrease in 2001 was also due to workforce reductions related to our restructurings, which resulted in a year-over-year decrease of $0.5 million of personnel related costs and a decrease in depreciation expense of $0.7 million. These decreases were offset by a $1.0 million increase in insurance costs and a $0.3 million increase in consulting expense in 2001 when compared to 2000.
Restructuring CostsCosts.. We incurred restructuring costs of $0.3 million for the year ended December 31, 2003, $9.1 million for the year ended December 31, 2002 and $2.3 million for the year ended December 31, 2001. We did not incur any restructuring costs in 2000.
In April 2001,August 2003, we announcedimplemented a restructuring program that included a 28% workforce reduction and relocation. This restructuring program resulted in restructuring costs of $0.3 million in the third quarter of 2003. The restructuring costs consisted of $0.2 million in workforce reduction charges related primarily to severance and fringe benefits and $0.1 million in relocation expenses. As a result of this 2003 restructuring, we reduced our workforce by approximately 11.0%.
In August 2002, we implemented a restructuring program that included a workforce reduction, closure of our New Jersey research and development facility, and disposal of certain of our fixed assets. As a result of this restructuring program, we recorded restructuring costs of $0.9 million in the third quarter of 2002. These restructuring costs consisted of $0.5 million in workforce reduction charges relating primarily to severance and fringe benefits and $0.4 million relating to closure of the New Jersey facility. In November 2002, we undertook further restructuring efforts that included an additional workforce reduction, the termination of our Pleasanton, California facility lease and disposal of certain fixed assets. As a result of these November 2002 efforts, we recorded restructuring costs of $8.3 million, comprising severance and employee outplacement expenses of approximately $0.6 million, $2.4 million to terminate our Pleasanton, California lease early, $2.3 million for abandonment of leasehold improvements, $2.4 million for abandonment of fixed assets and $0.5 million to terminate various equipment leases. In aggregate, we reduced our workforce by approximately 53.0% in fiscal 2002.
In April 2001, we implemented a restructuring program that included a 28.0% reduction in our workforce, closure of excess facilities, and the disposition of certain fixed assets. As a result of this restructuring program, we recorded restructuring costs of $2.1 million in the second quarter of 2001. These restructuring costs were comprised of $1.2 million in workforce reduction charges relating primarily to severance and related benefits, $0.8 million relating to closure of excess facilities and $0.1 million in other fixed assets retired as a result of the workforce reductions. In October 2001, we further reduced our total workforce by 11%an additional 11.0%, which resulted in restructuring costs of $0.2 million during the fourth quarter of 2001, comprised offor severance and related benefits.benefits payments.
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In August 2002, we announced a restructuring program which included a workforce reduction, closure of our New Jersey research and development facility, and disposal of certain of our fixed assets. As a result of this restructuring program, we recorded restructuring costs of $0.9 million in the third quarter of 2002. These restructuring costs were comprised of $0.5 million in workforce reduction charges relating primarily to severance and fringe benefits and $0.4 million relating to closure of the New Jersey facility. In November 2002, we announced a restructuring program that included a workforce reduction, the termination of our Pleasanton, California headquarters facility lease and disposal of certain fixed assets. As a result of this restructuring program, we recorded restructuring costs of $8.3 million, comprising severance and outplacement expenses of approximately $0.6 million, costs to terminate the Pleasanton, California facility lease of $2.4 million, $2.3 million for abandonment of leasehold improvements, $2.4 million for abandonment of fixed assets and $0.5 million to terminate various equipment leases. As of December 31, 2002, we had a remaining restructuring accrual of $0.5 million related to costs to terminate various equipment leases and severance payments, which was paid in the first quarter of 2003. The workforce reduction as a result of fiscal 2002 restructurings was approximately 53%. Our workforce reductions in 2002 and 2001 arose from an effort to control overall operating expenses in response to recent declines and expected slower growth in our sales. We do not expect to incur restructuring costs in 2003.
In-Process Research and Development. During the year ended December 31, 2003 we did not incur any expenses related to in-process research and development. Amounts expensed as in-process research and development were $0.6 million in 2002 and $1.2 million in 20012001.
For the year ended December 31, 2002, our in-process research and $0.8development expense of $0.6 million in 2000, and werewas solely related to in-process research and development purchased from VTC ActiveTelco and FreeGate, respectively.
In-Process Research and Development, VTC. Amountsin November 2002. We expensed as in-process research and development were $0.6 million for the year ended December 31, 2002 and were related to in-process research and development purchased from VTC during the fourth quarter of 2002. The purchased in-process technology was expensed upon acquisition because technological feasibility of the technology had not been established and there were no future alternative uses existed. Thefor the technology. We estimated the in-process technology percentage of completion was estimated to be 20%, 40% and 50% for the Astria, M2 and software product lines, respectively. TheWe determined the value of this in-process technology was determined by estimating the cost to develop the purchased in-process technology into a commercially viable product, estimating the net cash flows from the sale of the product after the completion of the in-process technology and discounting the net cash flows back to their present value using a risk-weighted discount rate of
30%. |
In-Process Research and Development, ActiveTelco. Amounts expensed asdevelopment costs to bring in-process research and developmenttechnology from VTC to technological feasibility were $1.2 million forcompleted in 2003.
For the year ended December 31, 2001, the in-process research and weredevelopment expense of $1.2 million was solely related to in-process research and development purchased from ActiveTelco during the first quarter of 2001. TheWe expensed the purchased in-process technology was expensed upon acquisition because technological feasibility of the technology had not been established and there were no future alternative uses existed. Thefor the technology. We estimated the in-process technology percentage of completion was estimated to be 75%. TheWe determined the value of this in-process technology was determined by estimating the cost to develop the purchased in-process technology into a commercially viable product, estimating the net cash flows from the sale of the product after the completion of the in-process technology and discounting the net cash flows back to their present value using a risk-weighted discount rate of 30%. Research and development costs to bring in-process technology from ActiveTelco to technological feasibility aredid not expected to have a material impact on our future results of operations or cash flows.
In-Process Research and Development, FreeGate. Impairment of Intangible Assets. Amounts expensed During the second quarter of 2003, we determined that certain of the technology acquired as in-process research and development were $0.8part of the purchase of the ViaGate assets had become impaired. As a result, we recorded an impairment charge of $0.1 million to write off the book value of the intangible assets associated with this technology. There was no such impairment 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 cost 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%. We abandoned the in-process research and development associated with FreeGate in 2001 and, therefore, will not incur additional costs in this regard.2002.
Impairment of Intangiblesand Goodwill. Based onDuring the impairment review performed during the third quarter ofyear ended December 31, 2001, we recorded a $29.9$32.6 million in impairment charge to write off all of the remaining goodwill and assembled workforce and reduce the book value of our completed technology and patents. The charge was determined based upon estimated discounted future cash flows using a discount rate of 20%. The assumptions supporting future cash flows, including the discount rate, were determined using management’s best estimates. The underlying factors contributing to the decline in expected future cash flows include a continued slowdown in the telecommunications market, and the indefinite postponement of capital expenditures, particularly within the hospitality industry. In the first quarter of 2001,intangible assets. Of this $32.6 million, we recorded a $2.7 million impairment charge in the first quarter of 2001 to write off the completed technology and patents of FreeGate. This resulted from our decision not to pursue further incorporation of the related OneGate product and other intellectual property acquired from FreeGate into the design of future products. TotalIn addition, we recorded a $29.9 million impairment charge in the third quarter of intangibles2001 to write off all of the remaining goodwill and goodwill was $32.6 million forassembled workforce and reduce the year ended December 31, 2001. There were no such impairments for the years ended December 31, 2002 and 2000. Asbook value of December 31, 2002, our net intangible assets remaining to be amortized were $5.4 million, comprised of completed technology and patentspatents. We determined the amount of the charge based on estimated discounted future cash flows using a discount rate of 20%. We used our best estimates to make assumptions about future cash flows (including the discount rate) and considered a number of underlying factors that contributed to the decline in expected future cash flows, including a continued slowdown in the telecommunications market, and the indefinite postponement of capital expenditures, particularly within the hospitality industry.
Amortization of Intangible Assets. Amortization of intangible assets is comprised of intangibles related to the acquisitions of the ViaGate assets, Xstreamis and VTC and contract backlog, customer list, maintenance contract renewals and trademarks related to the acquisition of VTC.
Amortization of Intangibles and Goodwill. Amortization of intangibles and goodwill was comprised of the amortization of intangibles and goodwill related to the purchase acquisitions of Vintel in 1999, FreeGate, OneWorld assets and Xstreamis in 2000, ActiveTelco and ViaGate assets in 2001, and VTC in 2002. TheseThe remaining intangible assets consistedsubject to amortization from these acquisitions consist primarily of assembled workforce, completed technology and patents, and goodwill, and each are/were amortized over their estimated useful livespatents. For the year ended December 31, 2003, amortization of three, five and five years, respectively. Amortization of intangibles and goodwill decreasedintangible assets increased by 38.5% to $1.8 million from $1.3 million for the year ended December 31, 2002. The $0.5 million increase in 2003 when
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compared with 2002 was primarily the result of a full year of the additional amortization associated with the intangible assets arising from our VTC acquisition in November 2002.
For the year ended December 31, 2002, amortization of intangible assets decreased by 83.9% to $1.3 million from $8.1 million for the year ended December 31, 2001 and from $7.6 million for the year ended December 31, 2000.2001. The decrease of $6.8 million in 2002 when compared towith 2001 of $6.8 million was a result of our recording of an impairment of intangibles and goodwillintangible assets totaling $32.6 million in 2001. The increase in 2001 when compared to 2000 of $0.5 million related to the additional amortization of intangibles and goodwill arising from the acquisitions during those years. We
expect an increase in amortization of intangibles in 2003 duethat relates to our acquisition of VTCacquisitions in November 2002.1999 and 2000. As of December 31, 2002,2003, intangible assets totaling $5.4$3.5 million that relate to our acquisitions in 2000 and 2002, remain to be amortized.
Impairment of Certain Equity Investments. Impairment of certain equity investments consisted of the recognition of expense related to the write offwrite-off of $3.1 million invested in three privately-held companies during the year ended December 31, 2000 and $0.6 million invested in one privately-held company during the year ended December 31, 2002. The value of these investmentsour investment was impaired due to uncertainty associated with the on-going viability of each of these businessesthis business in the current network infrastructure industry. There was no such impairment of our equity investments for the year ended December 31, 2001.2003.
Interest and Other Income, Net. Interest and other income, net consistedconsists primarily of interest income onand expense and foreign currency exchange gains and losses. For the year ended December 31, 2003, our cash, investments and notes receivable balances. Our interest and other income, net decreased to $0.0 million from $0.6 million for the year ended December 31, 2002. The decrease in 2003 of $0.6 million compared with 2002 was primarily the result of lower interest rates on lower average cash balances and increased interest expense associated with the $3.2 million note issued in connection with our purchase of VTC in November 2002.
For the year ended December 31, 2002, our interest and other income, net decreased by 85.2% to $0.6 million from $4.1 million for the year ended December 31, 2001. The decrease of $3.5 million in 2002 compared with 2001 was primarily the result of lower interest rates on lower average cash balances.
Liquidity and $7.0Capital Resources
Cash and cash equivalents totaled $14.4 million at December 31, 2003, compared with cash and cash equivalents of $25.6 million at December 31, 2002, reflecting a net reduction in cash and cash equivalents of $11.2 million.
Cash used in operating activities was $10.9 million for the year ended December 31, 2000.2003, compared with $24.3 million for the year ended December 31, 2002. The decreasereduced cash used in 2002 compared to 2001 of $3.5 million, or 85.2%,operating activities was primarily due to a significantly lower interest rates onnet loss in 2003 compared with 2002, that was partially offset by lower average cash balances. The decreasenon-cash charges for depreciation, no charge for abandonment of fixed assets, and a smaller provision for excess and obsolete inventory and abandoned products in 20012003, compared to 2000 of $2.9 million, or 41.0%,with the same period in 2002. Partially offsetting the reduced net loss was also primarilyan increase in accounts receivable, due to lower interest rates on lower average cash and investment balances. The decrease was offset by a gainthe recognition of more revenue earned in 2001 on a settlement with one of our suppliers of $1.0 million.
Liquidity and Capital Resources
Historically, our principal source of liquidity has been through equity funding. From our inception through January 1999, we financed our operations primarily through the sale of preferred equity securities for an aggregate of $46.2 million net of offering costs. In January 1999, we completed our initial public offering and issued 2,875,000 shares of our common stock at a per share 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 resultlast month of the exercisefourth quarter 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 per share price of $60.00, and we received approximately $141.7 million2003 compared with the same period in 2002. Included in the cash net of underwriting discounts, commissions and other offering costs. Inused in operating activities for the future, we cannot be certain that similar equity funding will be available to us. If we are unable to obtain additional equity financing on terms acceptable to us. If we are unable to obtain additional equity financing on terms acceptable to us, our business, operating results and financial condition could be negatively impacted.
Cash and cash equivalents totaled $25.6 million atyear ended December 31, 2002 were two payments in an aggregate amount of $3.7 million to Arrow Electronics, Inc. in connection with the settlement of a decrease of $23.8 million or 48.2% from cash, cash equivalents and short-term investments of $49.4 million at December 31, 2001.dispute regarding the Company's purchase commitments to Arrow.
Additions to property and equipment were $1.2 million in 2003, compared with $0.4 million in 2002, primarily reflecting an increased investment in research and development assets. In 2004 we expect capital expenditures to be comparable to 2003. We expect these capital expenditures to be funded from operations.
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The net decrease in cash and cash equivalents of $20.8 million during the year ended December 31, 2002 resulted primarily from our use of $24.3 million for operating activities and the purchase of property and equipment of $0.4 million. The net decrease in cash and cash equivalents from these uses was offset by $3.1 million in proceeds from the maturities in short-term investments, the issuance of common stock related to the exercise of stock options and purchases made pursuant to the employee stock purchase plan of $0.1 million and $0.8 million related to the acquisition of VTC.
The net decrease in cash and cash equivalentsfollowing table sets forth our contractual obligations as of $1.0 million during the year ended December 31, 2001 resulted primarily from2003:
| | Payments due by period | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Contractual obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||
| Long-Term Debt Obligations | $ | 3,523 | $ | — | $ | — | $ | 3,523 | $ | — | |||||
| Operating Lease Obligations | 1,221 | 955 | 266 | — | — | ||||||||||
| Purchase Obligations | 1,009 | 1,009 | — | — | — | ||||||||||
| Other Long-Term Liabilities | 44 | — | 44 | — | — | ||||||||||
| Total | $ | 5,797 | $ | 1,964 | $ | 310 | $ | 3,523 | $ | — | |||||
We do not have any off balance sheet arrangements.
As part of our use of $51.2 million for operating activities, the purchase of property and equipment of $1.2 million, the purchase of other assets of $1.2 million, which includes the acquisition of certain ViaGate assetsVTC from Tektronix in November 2002, we issued a note payable to Tektronix for $0.6$3.2 million, with repayment in sixty months, or by November 2007. The interest rate on this note is 8% and acquisition costs related to ActiveTelco of $0.2 million. The net decrease in cash and cash equivalents from these uses was offset by $52.4 million in proceeds fromis compounded annually. Through January 31, 2006, the maturities in short-term investments, net of purchases of investments, the issuance of common stock relatedaccrued interest is added to the exerciseprincipal balance of stock optionsthe note. Thereafter, we will pay accrued interest on this note commencing on January 31, 2006 and purchases made pursuant toon each April 30, July 31 and October 31 thereafter until the employee stock purchase plan of $0.2 million and other proceeds from financing activities of $0.1 million.
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 the exercise of stock options and purchases made pursuant to the employee stock purchase plan 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 of investments, of $36.6 million, the repayment 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.
In future periods, we generally anticipate a decrease in working capital expenditures on a period-to-period basis primarily as a result of completing a substantial portion of payments for purchase commitments for inventory and decreases in our operational costs due to our workforce reductions.
We have entered into certain contractual obligations and other purchase commitments that could result in cash outflows. At December 31, 2002, the remaining accrual for purchase commitments of raw material components was $3.7 million, whichprincipal balance is to be paid in two equal installments infull. Principal and accrued interest on the first and second quarters of 2003. The first installment was paid in January 2003.
Our future minimum lease payments under operating leasesnote payable is $3.5 million at December 31, 20022003.
In connection with the settlement of certain legal matters in December 2003, we have recorded a liability and a receivable, each in the amount of $10.7 million, in our December 31, 2003 balance sheet. This amount will be paid by our insurance carriers, and accordingly, such liability is not reflected in the above table. The settlement amount will be reversed from our balance sheet during 2004, until such time as the settlements are as follows:formally approved by the respective courts.
Year | (in millions) | ||
2003 | $ | 1.2 | |
2004 |
| 0.8 | |
2005 |
| 0.2 | |
Thereafter |
| — | |
$ | 2.1 | ||
We have incurred substantial losses and negative cash flows from operations since inception. For the year ended December 31, 2002,2003, we incurred a net loss of $41.6$5.5 million, negative cash flows from operationsoperating activities of $24.3$10.9 million, and have an accumulated deficit of $276.5$282.1 million. Management believes
We believe that the cash and cash equivalents as of December 31, 20022003 are sufficient to fund itsour operating activities and capital expenditure needs for the next twelve months. Management expectsIn future periods, we generally anticipate that our working capital will begin to increase as a result of several factors, including our expectation that our revenue will continue to increase on a period-to-period basis, we have completed payments for past inventory purchase commitments and that our prior restructurings and expense reduction efforts will result in operational expenditures that are more in line with our expected revenue. We expect the amount of cash used to fund our operations to decrease in 2003.2004. However, toin the extent our business continues to be affected by poorevent that general economic conditions impacting the telecommunications industry,worsen, we will continue tomay require additional cash to fund our operations. We willplan to seek additional equity funding for operations from alternative debtin the first quarter of 2004 to provide working capital, fund potential acquisitions and equity sources, if necessary, to maintain reasonable operating levels.potentially redeem the VTC acquisition indebtedness. We cannot assure that such funding efforts will be successful. Failure to generate positive cash flow in the future could have a material adverse effect on our ability to achieve our intended business objectives.
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Option Exchange Program
On May 14, 2001, we made an offer to exchange all stock options outstanding under our 1992 Stock Plan, 1998 Stock Plan and the 1999 Nonstatutory Stock Option Plan to purchase shares of our common stock held by eligible employees for new stock options that were to be granted under our 1998 Stock Plan or our 1999 Nonstatutory Stock Option Plan, upon the terms and subject to the conditions set forth in the Offer to Exchange. An “eligible employee” refers to all employees of Tut Systems, Inc. and its U.S. subsidiaries who were employees at the time the new stock options were granted, other than all executive officers, vice-presidents, members of the Board of Directors and employees receiving Workers’ Adjustment and Retraining Notification Act pay, all of whom were not eligible to participate in the offer. The number of shares of common stock subject to the new stock options is equal to the number of shares of common stock subject to the unexercised stock options tendered by such eligible employees and accepted for exchange and cancelled. The new stock options were issued on December 13, 2001, a date that was at least six months and two days later than the date of
cancellation. This stock option exchange program required the filing of a tender offer statement. Employees receiving such an offer were requested to read our Form 10-Q for the quarter ended March 31, 2001, a related offering memorandum and other pertinent information before making a decision with respect to the offer. Accounting and other regulatory concerns prevented or limited our ability to issue additional stock options to these employees during the period between cancellation and reissuance.
The offer expired on June 8, 2001. Pursuant to the offer, we accepted, for cancellation, stock options to purchase approximately 1,056,948 shares of our common stock at a weighted average exercise price of $35.99. Subject to the terms and conditions of the offer, on December 13, 2001, we granted new stock options to purchase a total of 850,757 shares of our common stock at an exercise price of $2.15 to those employees who were employed by us at that time who had tendered stock options in response to the offer that were accepted for exchange and cancelled. There was no compensation charge associated with the offer.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenuesrevenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We have identified the policies below as critical to our business operations and the understanding of our results of operations.
Revenue recognitionrecognition.
We generate revenue primarily from the sale of hardware products, including third-party products, through professional services, the licensing of our HomeRun technology, and through the sale of our software products. We sell products through direct sales channels and through distributors.
Product revenues Generally, product revenue is generated from the sale of video processing systems and components and the sale of broadband transport and service management products. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyer's specifications.
Product revenue is generated primarily from the sale of complete end-to-end video processing systems generally referred to as turnkey solutions. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services and post contract support. Sales of turnkey solutions are classified as product revenue in the statement of operations.
Product revenue is also generated from the sale of video processing component products and the sale of broadband transport and service management products. We sell these products through our own direct sales channels and also through distributors.
Our revenue recognition policies for turnkey solutions are in accordance with SOP 97-2,Software Revenue Recognition, as amended, which is the authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP 97-2 requires that revenue recognized from software arrangements be allocated to each element of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or other elements. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by SOP 98-4,Deferral of the Effective Date of a Provision of SOP 97-2 and was amended again in December 1998 by SOP 98-9,Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments deferred and then clarified, respectively, the specification of what was considered vendor specific objective evidence of fair value for the various elements in a multiple element arrangement.
In the case of software arrangements that require significant production, modification or customization of software, which encompasses all of our turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts.We recognize productrevenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the PCS element of the multi-element arrangement, for which we have established
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vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally recognized using the percentage-of-completion method, as stipulated by SOP 81-1. The percentage-of-completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are generally considered to be incidental to the arrangement in its entirety because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.
For direct sales of video processing systems component products not included as part of turnkey solutions and the direct sale of broadband transport and service management products, we recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable.reasonably assured.
Significant management judgments and estimates must be made in connection with the measurement of revenue in a given period. We follow specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, we assess a number of factors, including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, we may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. Revenue from service obligations included in product revenues is deferred and recognized ratably over the periodIn order to recognize revenue, we must also make a judgment regarding collectibility of the obligation.arrangement fee. Management's judgment of collectibility is applied on a customer-by-customer basis pursuant to our credit review policy. We sell to customers for which there is a history of successful collection and to new customers for which such history may not exist. New customers are subject to a credit review process, which evaluates the customers' financial position and ability to pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are only increased after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility is not probable based upon our credit review process, no credit is extended and revenue is recognized on a cash-collected basis.
We also maintain accruals and allowances for all cooperative marketing and other programs.programs, as necessary. Estimated sales returns and warranty costs are based on historical experience and are recorded at the time revenue is recognized.recognized, as necessary. Our products generally carry a one year warranty from the date of purchase.
Turnkey solution revenues
Revenue from turnkey solution sales is generally recognized using the percentage of completion method. Under the percentage of completion method, revenue recognized reflects the portion of the anticipated contract revenue that has To date, warranty costs have been earned, equalinsignificant to the ratio of labor costs expended to date to anticipated final labor costs, based on current estimates of labor costs to complete the project. Generally, the terms of turnkey solution sales provide for billing for products at the time of delivery and for services at the time of substantial completion of the project.overall financial statements taken as a whole.
License and royalty revenues
License and royalty revenue consists of nonrefundable up-front license fees, some of which may offset initial royalty payments, and royalties received by us for products sold by our licensees. 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 received by us for products sold by our licensees. We do not expect that such license and royalty revenue will not constitute a substantial portion of our revenue in future periods.
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Software license and post contract support revenues
Regarding our IntelliPOP product line, we expect that revenue from the sale of software products and maintenance fees may constitute a portion of revenue in future periods. Currently, our software revenue is derived from two separate sources, software license fees and post-contract maintenance and support fees. The software license fee typically grants a perpetual license to the customer. We generally recognize revenue from the sale of the software license when all criteria for revenue recognition have been met similar to our hardware product sales. The revenue for maintenance and support fees is recognized ratably over the term of the separate support contract.
Should changes in conditions cause us to determine that the criteria for revenue recognition are not met for certain future transactions, revenue recognition for any reporting period could be adversely affected.
Inventories Inventories.
Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. We record provisions to write down our inventory and related purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than we estimate, additional inventory provisions may be required.
Allowance for doubtful accountsaccounts.
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make payments. These estimated allowances are periodically reviewed, analyzing the customers’customers' payment history and information regarding the customers’customers' creditworthiness known to us. If the financial condition of any of our customers were to deteriorate, resulting in their inability to make payments, an additional allowance would be required.
Accounting for long-lived assetsassets.
We are required to periodically assess the impairment of long-lived assets and related goodwill periodically.Anassets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends, a significant decline in the stock price for a sustained period, and theour market capitalization relative to net book value.
When our 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 our current business model.
During 2001, we determined that certain intangible long-lived assets were impaired and recorded lossesa loss of $32.5 million accordingly under SFAS No. 121. No such impairment was recorded in 2002. During 2003, we determined that certain intangible long-lived assets were impaired and recorded a loss of $0.1 million under SFAS No. 144. Future events could cause us to conclude that impairment indicators once again exist. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
Legal contingenciescontingencies.
We are currently involved in certain legal proceedings as discussed in Note 9 of our consolidated financial statements. Because of uncertainties related to both the potential amount and range of loss from the pending litigation, management is unable to make a reasonable estimate of the liability that could result if there is an unfavorable outcome toin certain of these legal proceedings. We recorded a liability for theIn re Tut Systems, Inc. Securities Litigation and theLefkowitz matters, as well as an equal and corresponding receivable. We have not recorded a liability for theWhalen matter as a consequence of several uncertainties. As additional information becomes available, we will assess the potential liability related to this pendingthese litigation matters and may revise our estimates accordingly. Revisions of our estimates of such potential liability could materially impact our results of operations, financial condition or cashflows.
Stock-based compensation
Our stock-based employee compensation plans are described more fully in Note 11 to the consolidated financial statements—Equity Benefit Plans. We account for those plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25 and related interpretations. Unearned stock-based employee compensation cost is reflected in net income, as some options granted under those plans had an exercise price less than the fair value of the underlying common stock on the date of grant, which is described more fully in Note 11 to the consolidated financial statements—Equity Benefit Plans.
We amortize stock-based compensation using the straight-line method over the remaining vesting periods of the related options, which is generally four years. Pro forma information regarding net loss and earnings per share is required. This information is required to be determined as if we had accounted for employee stock options under the fair value method of SFAS No. 123, as amended by SFAS No. 148.
The following table illustrates the effect on net loss and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, to stock-based employee compensation:
Year Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Net loss—as reported | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Add: | ||||||||||||
Unearned stock-based employee compensation expense included in reported net loss |
| 17 |
|
| 684 |
|
| 1,545 |
| |||
Deduct | ||||||||||||
Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax effects |
| (14,053 | ) |
| (8,432 | ) |
| (15,065 | ) | |||
Net loss—pro forma | $ | (55,661 | ) | $ | (112,074 | ) | $ | (87,618 | ) | |||
Basic and diluted net loss per share—as reported | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | |||
Basic and diluted net loss per share—pro forma | $ | (3.28 | ) | $ | (6.86 | ) | $ | (5.89 | ) | |||
The fair value of options and shares issued pursuant to the option plans and at the grant date were estimated using the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility rates trended into future years. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options.
The effects of applying pro forma disclosures of net loss and earnings per share are not likely to be representative of the pro forma effects on net loss/income and earnings per share in the future years, as the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.
Recent Accounting Pronouncements
In July 2001, the FASBFinancial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill"Goodwill and Other Intangible Assets,”" which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APBAccounting Principles Board (APB) Opinion No. 17, “Intangible"Intangible Assets.”" It addresses how intangible assets that are acquired individually or with a group of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their acquisition. SFAS
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No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. The adoptionWe adopted the provisions of SFAS No.FAS 142 did not impact our financial statements.on January 1, 2002.
In September 2001, the EITF issued EITF Issue No. 01-09, “Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor’s Products,” which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 “Accounting for ‘Points’ and Certain Other Time- or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future.” The adoption of these Issues did not impact our financial statements.
On October 3, 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” SFAS No. 144 applies to all long-lived assets, including discontinued operations, and consequently amends APB Opinion No. 30, “Reporting the Results of Operations,
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that: (a) can be distinguished from the rest of the entity, and (b) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for all of our financial statements issued in 2002. The adoption of SFAS No. 144 did not impact our financial statements.
In July 2002, the FASB issued SFAS 146, “Accounting"Accounting for Costs Associated with Exit or Disposal Activities.”" SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability"Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),”" where a liability for an exit cost was recognized at the date of an entity’sentity's commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. We do not believe that theThe adoption of this statement willStatement did not have a material impact on our results of operations, financial position or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002 and have been implemented in our financial statements. We are currently assessing what the impact of the remaining guidance would be on our financial statements.
In November 2002, the Emerging Issues Task Force (EITF)EITF reached a consensus on Issue No. 00-21, “Revenue"Revenue Arrangements with Multiple Deliverables.”" EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will applyapplies to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently evaluatingThe adoption of this Issue and itsStatement did not have a material impact on our results of operations, financial statements.position or cash flows.
In December 2002, the FASB issued SFAS No. 148, “Accounting"Accounting for Stock-Based Compensation, Transition and Disclosure.”" SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods beginning after December 15, 2002. The annual disclosure requirements of SFAS No. 148 have been implemented in ourthe Company's financial statements. We are currently evaluatingThe adoption of this standard and itsStatement did not have a material impact on our results of operations, financial statements.position or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.”51, Consolidated Financial Statements," and subsequently revised in December 2003 with the issuance of FIN 4646-R. This interpretation requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46Application of this Interpretation is effective immediatelyrequired in financial statements for all new variable interest entities created or acquiredperiods ending after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after JuneMarch 15, 2003.2004. We do not believe that the adoption of this standardInterpretation will have a material impact on our results of operations, financial position or cash flows.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after September 30, 2003, and for hedging relationships designated after September 30, 2003. The adoption of this Statement did not have a material impact on our results of operations, financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer
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classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after September 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. On November 7, 2003, FASB issued FASB Staff Position No. FAS 150-3 (FSP 150-3), "Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." FSP 150-3 deferred certain aspects of FAS 150. The adoption of FAS 150 and FAS 150-3 did not have a material impact on our results of operations, financial position or cash flows.
On December 17, 2003, the Staff of the SEC issued Staff Accounting Bulletin No. 104 (SAB 104),Revenue Recognition, which supersedes SAB 101,Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC'sRevenue Recognition in Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with SAB 101 that had been codified in SEC Topic 13,Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not materially affect our revenue recognition policies, nor our results of operations, financial position or cash flows.
Additional Risk Factors that Could Affect our Operating Results and the Market Price of our Stock
We have a history of significant losses, and expect to continue to incur losses in the future.we may never achieve profitability.
We have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. We incurred net losses of $41.6 million, $104.3 million and $74.1 million for the years ended December 31, 2002, 2001 and 2000, respectively. As of December 31, 2002,2003, we had an accumulated deficit of $276.5$282.1 million. We expect that we will continue to incur losses into fiscal year 2003.
Wein the near future. Moreover, we may never achieve profitability and, if we do so, we may not be able to maintain profitability. We have spent substantial amounts of money on the development of our Expresso products, HomeRun and LongRun technology, IntelliPOP products and software products. In November 2002, we acquired VideoTele.com and certain products of VideoTele.com that we anticipate will bring us incremental revenue beyond our Expresso, Home Run, Long Run and IntelliPOP products. During fiscal 2001 and 2002, we significantly reduced our workforce in an effort to decrease certain of our operating expenditures, including our sales and marketing, research and development and general and administrative expenditures. However, we may not be able to generate a sufficient level of revenue (even with our newly acquired VideoTele.com products) to offset our current level of expenditures. Additionally, we may be unable to adjust our spending in a timely manner to respond to any unanticipated decline in revenue due to the fact thatMoreover, because our expenditures for sales and marketing, research and development, and general and administrative functions are relatively fixed in the short term. Our ability to achieve and maintain profitability in the future will primarily depend on our ability to do the following:
Our operating results may fluctuate significantly, which could cause our stock price to decline.
A number of factors could cause our quarterly and annual financial results to be worse than expected, which could result in a decline in our stock price. Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future as a result of numerous factors, some of which are outside of our control. These factors include:
We anticipate that average selling prices for our products will continue to decrease in the near future due to increased competitive price pressures in certain geographical regions. In addition, we may also experience substantial period-to-period fluctuations in future operating results and declines in gross margins as a result of the erosion of average selling prices for high-speed data access products and services due to a number of factors, including increased competition and rapid technological change. Decreasing the average selling prices of our products could cause us to experience decreased revenue despite an increase in the number of units sold. We may be unable to sustainadjust our gross margins, even atspending in a timely manner to respond to any unanticipated decline in revenue. If we fail to achieve profitability within the anticipated reduced levels, improve our gross marginstimeframe expected by offering new products or increased product functionality or offset future price declines with proportionate reductions in our cost structure.
As a result of these and other factors, our operating results for future periods may be below the expectations of securities analysts and investors. In that event,or investors, then the market price of our common stock would furtherwill likely decline.
We are and continueEach sale of our headend systems represents a significant portion of our revenue for any given quarter. Our failure to be affected by poor general economic conditions thatmeet our quarterly forecast of sales of headend systems in any given quarter could have resulted in significantly reduced sales levels and, if such adverse economic conditions continue or worsen, our business, operating results and financial condition will continue to be negatively impacted.
The continued poor economic conditions in the world economy, the continued industry-wide downturn in the telecommunications market and recent events in Iraq have materially and adversely affected, and continue to materially and adversely affect, our sales. As a result, we have, and will likely continue to, experience a material adverse impact on our business, operatingfinancial results and financial condition. Comparatively lower sales for eacha given quarter.
Since we acquired VTC in November 2002, a large part of our fiscal years since 2000 have resulted in operating expenses increasing as a percentage ofquarterly revenue for 2002 and 2001 compared to 2000. Although we took actions throughout 2001 and 2002 to create revenue opportunities and reduce operating expenses, including our acquisition of VideoTele.com, a prolonged continuation or worsening of sales trends that we faced in 2001 and 2002 would force us to take additional actions and charges in order to reduce our operating expenses further. If we are unable to reduce operating expenses at a rate and level consistent with anticipated future adverse sales trends or if we continue to incur significant special chargesis associated with such expense reductions that are disproportionate to our sales, our business, operating results and financial condition will be even further negatively impacted.
We depend on a limited numberthe sale of large customers for a substantial portion of our revenue during any given period, and the loss of a key customer or loss or delay of a key order could substantially reduce our revenue in a given period.
We deriveheadend systems. Each sale represents a significant portion of our revenue infor each period from a limitedquarter. We base our operating forecast on our historical sales. Because of the high cost per unit of our headend systems, if we were to sell even one less system than our forecasted number of customers. One customer, Ingram Micro, accounted for 11% ofheadend sales per quarter, such a decrease in sales would have a material and adverse impact on our revenue for the year ended December 31, 2002. Two customers, Kanematsu Computer System Ltd.that quarter, and RIKEI Corporation, respectively accounted for 19%we may fail to meet investor expectations.
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We operate in an intensely competitive marketplace, and 16%, respectively, of our revenue for the year ended December 31, 2001. Three customers, TriGemm InfoComm, Inc., Reflex Communications, Inc. and Darwin Networks Inc., accounted for 18%, 12% and 11%, respectively, of our revenue for the year ended December 31, 2000. Prior to 2002, many of our customers had limited or, in some cases, no access to capital and continue to experience significant financial difficulties, including bankruptcy. In order to meet our revenue targets, we must continue to acquire new customers and increase sales to our existing customers. In addition, our strategy of targeting larger, more established customers may result in longer sales cycles and delayed revenue. Sales to larger accounts could also result in increased competition from larger and more established competitors. If sales to our largest customers decrease materially below current levels or if we are unable to
establish a new base of customers, such decreases or failures would materially and adversely affect our business, results of operations and financial condition.
Wecompetitors have in the past and may in the future acquire companies, technologies or products, and, if we fail to integrate these acquisitions, our business, results of operations and financial condition could be harmed.
In fiscal 2002, 2001 and 2000, we completed four acquisitions. As a part of our business strategy, we expect to make additional acquisitions of, or significant investments in, complementary companies, products or technologies. We may need to overcome significant issues in order to realize any benefits from our past transactions, and any future acquisitions would be accompanied by similar risks. These risks include, but are not limited to:
On November 7, 2002, we completed our acquisition of VTC, a leading provider of video content processing and video trunking, and we are in the process of integrating VTC into our company. We evaluate and enter into other acquisition and alliance transactions on an ongoing basis. The size and scope of the acquisition of VTC relative to our overall size increases both the scope and consequence of ongoing integration risks. We may not successfully address the integration challenges in a timely manner, or at all, and we may not fully realize all of the anticipated benefits or synergies of the VTC acquisition (which are principally associated with restructurings, including workforce reductions, procurement synergies and other operational efficiencies) or of any other transaction to the extent, or in the timeframe, anticipated. Moreover, the timeframe for achieving benefits may depend partially on the actions of employees, suppliers or other third parties.
Even if an acquisition or alliance is successfully integrated, we may not receive the expected benefits of the transaction. Managing acquisitions and alliances requires varying levels of management resources, which may
divert our attention from other business operations. The VTC acquisition also has resulted, and may in the future result, in significant costs and expenses and charges to earnings. These costs and expenses could include those related to severance pay, asset impairment charges, charges from the elimination of duplicative facilities and contracts, in-process research and development charges, inventory adjustments, legal, accounting and financial advisory fees, and required payments to executive officers and key employees under retention plans adopted in connection with the transaction. Also, any prior or future downgrades in our credit rating associated with an acquisition could adversely affect our ability to borrow and result in more restrictive borrowing terms, including increased borrowing costs, more restrictive covenants and the extension of less open credit. This in turn could materially and adversely affect our internal cost of capital estimates and, therefore, our operational decisions. As a result of the foregoing, any completed, pending or future transactions may contribute to financial results that differ from the investment community’s expectations in a given quarter.
If we are not successful in integrating VTC into our operations in a timely manner, our business, operating results and financial condition will be materially and adversely impacted.
We are currently engaged in three securities lawsuits, two of which are class action lawsuits, any of which, if they were to result in an unfavorable resolution, could adversely affect our business, results of operations or financial condition.
Beginning July 12, 2001, six putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against us and certain of our current and former officers and directors. The complaints were filed on behalf of a purported class of people who purchased our stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that we and certain of our current and former officers and directors made false and misleading statements about our business during the putative class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have been consolidated under the nameIn re Tut Systems, Inc. Securities Litigation,Civil Action No. C-01-2659-JCS (the “Securities Litigation Action”). Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the court granted in part and denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants filed a motion to dismiss portions of the amended complaint. The Court has not ruled on that motion. We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, financial condition, or cash flows.
In March 2003, Chesky Lefkowitz, a shareholder of the Company, filed a derivative complaint entitled Lefkowitz v. D’Auria, et al., No. RG03087467, in the Superior Court of the State of California, County of Alameda, against certain of the Company’s current and former officers and directors. The complaint alleges causes of action for breach of fiduciary duty, gross negligence, breach of contract, unjust enrichment and improper insider stock trading, based on the same factual allegations contained in the Securities Litigation Action. The complaint seeks unspecified damages against the individual defendants on behalf of the Company, equitable relief, and attorney’s fees. There has not been a response filed to the compliant, discovery has not commenced, and no trial date has been established.
On October 30, 2001, we and certain of our current and former officers and directors were named as defendants inWhalen v. Tut Systems, Inc. et al.,Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from our January 29, 1999 initial public offering and our March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and former officers and directors under Section 11 of the 1933 Act and under Section 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934,
as amended, and alleges claims against certain of our current and former officers and directors under Sections 15 and 20(a) of the 1933 Act. The complaints also name as defendants the underwriters for our initial public offering and secondary offering. . The Court has denied the Company’s motion to dismiss, and the case will now proceed to discovery. We believe the allegations against us are without merit and intend to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on our business, results of operations, financial condition, or cash flows.
If we do not reduce our inventory, we may be forced to incur additional charges, which would further materially and adversely impact our business, results of operations and financial condition.
In fiscal years 2000 and 2001, we accumulated a substantial inventory of finished goods and components due to poor global economic conditions and the reduction in product demand due to capital funding decreases experienced by several key customers. Since that time, we have written off a significant portion of that inventory because we have been largely unsuccessful in monetizing this inventory by selling our existing finished goods inventory and the component inventory resulting from deliveries on already canceled purchase commitments. We expect that competitors will continue to market and sell inexpensive competitive products in the marketplace, thereby continuing to make it difficult for us to reduce our inventory levels further, which may eventually require that we write off our entire remaining $3,876,000 in inventory. If we are unable to sell a substantial amount of finished goods that we have not yet written off, our expected cash position throughout 2003 will be even further materially and adversely impacted, which will harm our business, results of operations and financial condition.
If our Expresso and IntelliPOP products do not gain broader acceptance in the market, our business, financial condition and results of operations will be further harmed.
We launched our IntelliPOP 5000 product series in the first half of 2001 and have not yet been successful in generating widespread customer interest in this product. Similarly, our sales of Expresso units have been below what we had anticipated. We must devote a substantial amount of human and capital resources in order to broaden commercial acceptance of our Expresso products and to gain commercial acceptance of our IntelliPOP products and expand our offerings of these products in the multi-dwelling unit, or MDU, and the multi-tenant commercial unit, or MCU, markets. However, to date, this commitment of resources to these product lines has not generated the commercial acceptance that we have sought for these products. Historically, the majority of our Expresso products has been sold into the MDU market. Our future success depends on our ability to continue to penetrate this market and to expand our penetration into the MCU market. Our success also depends on our ability to educate existing and potential customers and end-users about the benefits of our Fast Copper and Signature Switch technologies, our LongRun and IntelliPOP products, and about the development of new products to meet changing and expanding demands of service providers, MTU owners and corporate customers, including our new product offerings based on our acquisition of VideoTele.com. The future success of our Expresso and IntelliPOP products will also depend on the ability of our service provider customers to market and sell high-speed data services to end-users. If our IntelliPOP or Expresso products do not achieve broader commercial acceptance within the MDU market, MCU market, or in any other markets we may enter, our business, financial condition and results of operations will be further materially and adversely affected.
The market in which we operate is highly competitive, and we may not be able to compete effectively.
The market for video and broadband data systems is intensely competitive, and we expect that this market will continue to become more competitive in the future. Our immediate competitors include, or are expected to include, Cisco Systems, Inc., Harmonic Inc., Tandberg Television and a number of other public and private companies. Many of these competitors offer or may in the future offer technologies and services that directly compete with some or all of our high-speed access products and related software products. Also, many of these competitors continue to announce significant changes in their business plans and operations, some of which, such as major write downs of inventory, could result in lower priced products flooding the market, which would have a negative impact on our ability to sustain our current pricing and sell our inventory. In addition, the market in
which we compete is characterized by increasing consolidation, and we cannot predict with certainty how industry consolidation will affect us or our competitors.
Our competitors and potential competitors may have substantially greater name recognition and technical, financial and marketingbetter resources than we do, and we can give you no assurancedo.
Our primary competitors in the digital TV headend market are small private companies that we will be ableare focused on a more narrow product line than ours, thereby allowing these competitors 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 targeted resources to developing and marketing new products than we can. In addition,As we begin to target larger telco customers for our HomeRun licensees may sellvideo content processing systems, we expect more competition from large public companies like Harmonic, Inc., Tandberg Television ASA, and Motorola, Inc., all of which have substantially greater financial, technical and other resources than we do. These competitors have achieved success in providing headend components for cable multiple system operators and satellite TV providers and, we expect these competitors to market some of their products based onfor use in TV over DSL applications. For example, in the past, Harmonic provided video content processing systems to SaskTel, a large Canadian telephone service provider. Harmonic also recently announced that it will provide video content processing systems to Video Networks Limited, a video-over-DSL provider in the United Kingdom.
Our competition in the market for video transmission processing products primarily comes from small private companies such as SkyStream Networks and public companies such as Optibase Inc. and Tandberg Television that together offer a wide array of products with special features and functions. Our broadband transport and service management business tends to compete against public, private and foreign network equipment companies.
To the extent that any of these current or potential future competitors enter or expand further into our HomeRunmarkets, develop superior technology and products or offer superior prices or performance features relative to our competitors or potential competitors. This licensing may cause an erosion in the potential market for our Expresso products. We cannot assure you that we will have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete successfully. Thisproducts, such competition could result in price reductions, reduced profit marginslost sales and losssevere downward pressure on our pricing, either of market share, which could harmwould adversely affect our business, financial conditionrevenue and results of operations.
profitability.
Our copper-wire based solutions face severe competition from other technologies, and the commercialCommercial acceptance of any competing solutionstechnological solution that competes with technology based on communication over copper telephone wire could harm our ability to compete and thus materially and adversely impact demand for our business, financial conditionproducts, our revenue and results of operations.growth strategy.
The marketmarkets for video content processing, transmission and high-speed data access productssystems and services isare characterized by several competing communication technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. These competing solutions provide fast access, high reliability and cost-effective solutions for some users. Many of our products are based on the use ofcommunication over copper telephone wire. Because there are physical limits to the speed and distance over which data can be transmitted over copper wire, our products may not be a viable solution for customers requiring service at performance levels beyond the current limits of copper telephone wire. ToOur customer base is concentrated on telephone service providers that have a large investment in copper wire technology. If these customers lose market share to their competitors who use competing technologies that are not as constrained by physical limitations as copper telephone wire, and that are able to provide faster access, greater reliability, increased cost-effectiveness or other advantages, demand for our products will decrease. Moreover, to the extent that telecommunications service providersour customers choose to install fiber optic cable or other transmission media in the last mile,as part of their infrastructure, 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 willmay decline. Commercial acceptance of any one of these competing solutions or any technological advancement or product introduction that provides faster access, greater reliability, increased cost-effectiveness or other advantages over technologies that utilize existing copper telephone wires could decrease the demand for our products and reduce average selling prices and gross margins associated with our products. The occurrence of any one or more of these events couldwould harm demand for our business, financial conditionproducts, which would thereby adversely affect our revenue and resultsgrowth strategy.
If the projected growth in demand for video services from telephone service providers does not materialize or if our customers find alternative methods of operations.delivering video services, future sales of our video content processing systems will suffer.
We manufacture video content processing systems that enable telephone service providers to offer video services to their customers. Our customers, the telephone service providers, face competition from cable companies, satellite service providers and wireless companies. For some users, these
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competing solutions provide fast access, high reliability and cost-effective solutions for delivering data, including video services. Telephone service providers hope to maintain their market share in their core business of voice telephony as well as increase their revenue per customer by offering their customers more services, including video services and high-speed data services. However, if the telephone service providers find alternative ways of maintaining and growing their market share in their core business that do not require that they offer video services, demand for our products will decrease substantially. Moreover, if technological advancements are developed that allow our customers to provide video services without upgrading their current system infrastructure, or that offer our customers a more cost-effective method of delivering video services, sales of our video content processing systems will suffer. Alternatively, even if the telephone service providers choose our video content processing systems, the service providers may not be successful in marketing video services to their customers, in which case our sales would decrease substantially.
Our operating results fluctuate significantly from quarter to quarter, and this may cause the price of our stock to decline.
Over the last 12 quarters, our sales per quarter have fluctuated between $9.2 million and $2.0 million. Over the same periods, our loss from operations as a percentage of revenue has fluctuated between approximately 5.2% and 1,274% of revenue. We anticipate that our sales and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:
The sales cycle for video content processing systems is long and unpredictable, which requires us to incur high sales and marketing expenses with no assurance that a sale will result.
The sales cycle for our headend systems can be as long as 12-18 months. Additionally, with respect to the sale of our products to U.S. and foreign government organizations, we may experience long sales cycles as a result of government procurement processes. As a result, while we continue to incur costs associated with a particular sale prior to payment from the customer, we may not recognize revenue from efforts to sell particular products for extended periods of time.
As a result, our quarter-to-quarter comparisons of our revenue and operating results may not be meaningful and may not provide an accurate indicator of our future performance. Our operating results in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the trading price of our common stock.
If we fail to manageaccurately forecast demand for our operations in light ofproducts, our changing revenue, base, our ability to increase our revenuesprofitability and improve our results of operationsreputation could be harmed.
We rely on contract manufacturers and third-party equipment manufacturers, or OEMs, to manufacture, assemble, test and package our products. We also depend on third-party suppliers for the materials and parts that constitute our products. Our operations have changed significantly duereliance on contract manufacturers, OEMs and third-party suppliers requires us to volatility in our business. Inaccurately forecast the past, we rapidly and significantly expanded our operations. However, in fiscal 2001 and 2002, we reduced our workforce significantly to control overall operating expenses in response to dramatic declines in, and the expectation of continued slowing of, our sales growth. We anticipate that, in the future, expansion in certain areas of our business may be required to expand our customer base and exploit market opportunities. In particular, we expect to face numerous challenges in the implementation of our business strategy to focus on selling our products to the larger, more established customers, such as ILECs and PTTs, in both domestic and international markets.
To exploit the marketdemand for our products we must develop new and enhanced products while implementing and managing effective planning and operating processes. To managecoordinate 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
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efforts 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 portionthose of our revenue, which subjectscontract manufacturers, OEMs and suppliers. We often make significant up-front financial commitments with our businesscontract manufacturers, OEMs and suppliers in order to a number of risks; if we are unable to generate significant international sales, our business, financial conditionprocure the raw materials and results of operations could be materiallybegin manufacturing and adversely affected.
Sales to customers outsideassembly of the United States accounted for approximately 43.0%, 56.3% and 41.0% of revenue for the years ended December 31, 2002 and 2001 and 2000, respectively. There are a number of risks arising from our international business, including, but not limited to:
We expect sales to customers outside of the United States to continue to represent a portion of our revenue. However, we cannot assure you that foreign markets for our products will develop at the rate or to the extent currently anticipated.products. If we fail to generate significant international sales,accurately forecast demand or coordinate our business, financial conditionefforts with our suppliers, OEMs and results of operationscontract manufacturers, we may face supply, manufacturing or testing capacity constraints. These constraints could be materially and adversely affected.
Our ability to attract and retain our personnel has been and may continue to be materially and adversely affected by our low stock price.
Our continued low stock price means that mostresult in delays in the delivery of our outstanding employee stock options are “under water” or priced substantially above the current market price of our common stock. In responseproducts, which could lead to the droploss of existing or potential customers and could thereby result in lost sales and damage to our stock price, on May 14, 2001, we offered our eligible employees the opportunity to tender their existing stock options for cancellation pursuant to a stock option exchange program and have new stock options granted at a date at least six months and two days later than June 8, 2001, the date of cancellation. Accounting and other regulatory concerns prevented or limited our ability to issue additional stock options to these employees during the period between cancellation and the date of the new grant. In the interim, those employees who participated in the stock option exchange offer were granted fewer or, in certain cases, were not granted stock options until December 13, 2001, the date that was six months and two days after the date of such cancellation. Further, employees who did not participate in the stock option exchange offer continue to hold stock options that are priced substantially above the current market price. Since that time, further declines in our stock price have meant that most of these exchanged stock options are themselves “underwater”. Our employees may have felt, and may continue to feel, that they are receiving inadequate compensation. Further, the continued adverse market conditions mean that our stock option offerings and our stock option plans may not offer current and potential future employees sufficient incentive to work for us. If adverse market conditions persist, our stock option offerings and employee stock plans will further diminish our ability to attract and/or retain qualified personnel, which will further materially and adversely impact our business, financial condition, results of operations, or cash flows.
Some of our customers have not been able to meet their financial obligations to us due to changes in the capital markets and these customers’ own precarious financial situations; if more of our customers experience similar financial difficulties, our revenue will decrease further,reputation, which would materially and adversely affect our business.
Due to increased volatility in equity marketsrevenue and tightening of lending in the credit markets, we are exposed to a significant risk that customers will not pay us the amounts that they owe us in order to conserve their capital. This would lead to increases in our outstanding accounts receivable as a percentage of revenue, extended payback periods and increased risk of customer default. For example, during the latter part of the fourth quarter of 2000, several key customers experienced a rapid deterioration in their ability to obtain additional capital to fund their businesses. As a result, these customers declared their inability to make timely payments on their accounts and were unable to demonstrate the ability to pay their existing account balances with us since that time. During fiscal 2001, a significant number of these customers commenced bankruptcy proceedings. As of December 31, 2002, all of these bankruptcies were finalized, and we do not expect that we will collect much, if any, of the amounts owed to us by these customers.
We factor the increased risk of non-payment into our assessment of our customers’ ability to pay, and, in some instances, these considerations will likely result in longer revenue deferrals than we had anticipated at the time that we booked sales to those customers. We also believe that certain of our customers will alter their plans to deploy products to meet the constraints imposed on them by changes in the capital markets. If we are not able to increase sales to other customers, or if our sales are otherwise delayed or revenue written off, our sales will continue to decline, which would further harm our business, operating results and financial condition.
If we inaccurately estimate customer demand, our business, results of operations and financial condition could be harmed.
We plan our expense levels in part based on our expectations about future revenue. These expense levels are relatively fixed in the short-term. However, the number of orders for our products may vary from quarter to quarter. In some circumstances, customers may delay purchasing our current products in favor of next-generation products. In addition, our new products are generally subject to technical evaluations by potential customers that typically last 60 to 90 days. In the case of IntelliPOP, those evaluations may take up to six months. If orders forecasted for a specific customer for a particular quarter are delayed or cancelled, our revenue for that quarter may be less than our forecast. Currently, we have minimal risk of loss associated with long-term customer commitments or penalties for delayed and/or cancelled orders. However, we may be unable to reduce our spending accordingly in the short-term if such a loss occurred, and any such revenue shortfall would have a direct and adverse impact on our results of operations for that quarter.profitability. Further, we outsource the manufacturing of our products based on forecasts of sales. If orders for our products exceed our forecasts, we may have difficulty meeting customers’customers' orders in a timely manner, which could damage our reputation or result in lost sales. Conversely, if our forecasts exceed the orders we actually receive and we are unable to cancel future purchase and manufacturing commitments in a timely manner, our inventory levels would increase. This could expose us to losses related to slow moving and obsolete inventory, which would have a material adverse effect on our business, operating results and financial condition.
profitability.
We depend on contract manufacturersIf we fail to manufacture all of our productsdevelop and rely on them to deliver high-quality products in a timely manner; the failure of these manufacturers to continue to deliver quality products in a timely manner could have a materially adverse effect on our business, results of operations and financial condition.
We do not manufacture our products. We rely on contract manufacturers to assemble, test and package our products. We cannot assure you that these contract manufacturers and suppliers will be able to meet our future requirements for manufactured products, components and subassemblies. In addition, we believe that current market conditions have placed additional financial strain on our contract manufacturers. Any interruption in the operations of one or more of these contract manufacturers would harm our ability to meet our scheduled product
deliveries to customers. We also intend to 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 manufacturersin response to provide us with adequate supplies of high-quality products or the loss of a current contract manufacturer would cause a delay in our ability to fulfill customer orders while we obtain a replacement manufacturer and would harm our business, operating results and financial condition. In addition, we have canceled certain finished goods and component orders, which may harm our relationship with certain contract manufacturers. Moreover, if we do not accurately forecast the actual demand for our products, we may face supply, manufacturing or testing capacity constraints. These constraints could result in delaysrapid technological changes in the delivery of our products or the loss of existing or potential customers, either ofmarkets in which could harm our business, operating results or financial condition.
If our contract manufacturers fail to obtain the raw materials and component products we require in a timely manner, our business could be harmed.compete, we will not remain competitive.
We currently purchase most of our raw materialsThe markets for video content processing, transmission and components used in our products through our contract manufacturers. Components are purchased pursuant to purchase orders based on forecasts, but neither we nor our contract manufacturers have any guaranteed supply arrangements with these suppliers. The availability of many of these components depends in part on our ability to provide our contract manufacturers and their suppliers with accurate forecasts of our future needs. If we or our manufacturers are unable to obtain a sufficient supply of key components from current sources, we could experience difficulties in obtaining alternative sources at reasonable prices, if at all, or in altering product designs to use alternative components. Resulting delays and reductions in product shipments could damage customer relationships and could harm our business, financial condition or results of operations. In addition, any increases in component costs that are passed on to our customers could reduce demand for our products.
We rely on third parties to test substantially all of our products; and if, for any reason, these third parties were unable to or did not adequately assist us in controlling the quality of our products, this lack of quality control could harm our business, financial condition and results of operations.
Substantially all of our products are assembled and tested by our contract manufacturers. Although we perform random spot testing on manufactured products, we rely on our contract manufacturers for assembly and primary testing of our products. Any quality assurance problems could increase the cost of manufacturing, assembling or testing our products and could harm our business, financial condition and results of operation. Moreover, defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or product liability claims, each of which could harm our business, financial condition and results of operations.
Based on our building specifications, several key components are purchased from single or limited sources, and we could lose sales if these sources fail to fill our needs; if we lose sales, our business, financial condition and results of operations would be materially and adversely affected.
We currently purchase most of the raw materials and components used in our products through our contract manufacturers. In procuring components for our products, we and our contract manufacturers rely on some suppliers that are the sole source of those components, and we are dependent upon supplies from these sources to meet our needs. We also depend on various sole source offerings from Broadcom, Metalink US and Motorola for certain of our products. If there is any interruption in the supply of any of the key components currently obtained from a single or limited source, our ability to obtain these components from other sources could entail a substantial lead time which could require us to redesign our products or, if we do not redesign our products to avoid such a lead time, could disrupt our operations and harm our business, financial condition and results of operation in any given period.
Our business relies on the continued growth of the Internet; any slowdown in or reversal of the growth of Internet use could materially and adversely impact our business.
The market for high-speed data access products depends in large part on the continued use and popularity of the Internet. Issues concerning the use of the Internet, including security, lost or delayed packets, and quality of service may negatively affect the development of the market for our products.
Our industry is characterized by rapid technological change; we must continually introduce new products that achieve broad market acceptance in order to address this change and remain competitive.
The markets for high-speed data access productssystems are characterized by rapid technological developments, frequent enhancements to existing products and new product introductions, changes in end-user requirements and evolving industry standards. To remain competitive, we must continually improve the performance, features and reliability of our products. For example, advancements in compression technology are leading the video content processing industry to begin the transition to next generation compression standards. These advances will allow for further reductions in the bandwidth required to deliver standard definition video channels and introduce the possibility of delivering high-definition television over bandwidth constrained ADSL lines for the first time. Further advances in compression technology, or the emergence of new industry standards would require that we further redesign our products particularly in response to competitive product offerings. We must introduce products that incorporate, or areand remain compatible with, these newemerging technologies as they emerge and must do so in a timely manner.industry standards.
We cannot assure you that we will be able to respond quickly and effectively to technological change. We may have only limited time to penetrateenter certain markets, and we cannot assure you that we will be successful in achieving widespread acceptance of our products before competitors can offer products and services similar or superior to our products. Any failureIf we fail to introduce new products addressingthat address technological changes or any delayif we experience delays in our product introductions, could adversely affect our ability to compete and cause our operating results to be below our expectations or the expectations of public market analysts or investors. In addition, when we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products, customers may defer purchasing our existing products. These actions could harm our business, financial condition and operating results by unexpectedly decreasing sales, increasing our inventory levels of older products and exposing us to greater risk of product obsolescence.
Manufacturing or design defects in our products could harm our reputation and our business, financial condition and results of operations.
Any defect or deficiency in our products could reduce the functionality, effectiveness or marketability of our products. These defects or deficiencies could cause orders for our products to be canceled or delayed, reduce revenue, or render our product designs obsolete. In that event, we would be required to devote substantial financialadversely affected, thereby harming our revenue, profitability and other resourcesgrowth strategy.
We depend on international sales for a significant periodportion of timeour revenue, which subjects our business to a number of risks. If we are unable to generate significant international sales, our revenue, profitability and share price could be materially and adversely affected.
Sales to customers outside of the developmentUnited States accounted for approximately 56.3%, 43.0% and 18.4% of new product designs.revenue for the years ended December 31, 2001, 2002 and 2003, respectively. Sales and operating activities outside of the United States are subject to inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies; tariffs, quotas, taxes and other market barriers; political and economic instability; restrictions on the export or import of technology; potentially limited intellectual property protection; difficulties in staffing and managing international operations and potentially adverse tax consequences. Any of these factors may have a material adverse effect on our ability to grow or maintain international revenue.
We expect sales to customers outside of the United States to represent a significant and growing portion of our revenue. However, we cannot assure you that 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, results of operations, or cash flows.
Changing industry standards may reduce the demandforeign markets for our products which would harm our business, financial condition and results of operations.will
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We will not be competitive unless we continually introduce new products and product enhancements that meet constantly changing industry standards. The emergence of new industry standards, whether through adoption by official standards committeesdevelop at the rate or through widespread use of such standards by telephone companies or other service providers, could requireto the extent that we redesignanticipate. If we fail to generate significant international sales, our products. If these standards become widespreadrevenue, profitability and our products do not comply with these standards, our customers and potential customers may not purchase our products, which would harm our business, financial condition and results of operations. The rapid development of new standards increases the risk that competitors could develop products that make our products obsolete. Any failure by us to develop and introduce new products or enhancements directed at new industry standards could harm our business, financial condition and results of operations. In addition, selection of competing technologies as standards by standards setting bodies such as the HomePNA technology could negatively affect our reputation in the market, regardless of whether our products are standards-compliant or demand for our products does not decline. This selectionshare price could be interpreted by the pressmaterially and others as having a negative impact on our business, which would negatively impact our stock price.
Further, the marketplace’s anticipation of an emerging standard, such as MPEG-4, Part 10 (H.264) could delay the decision to deploy existing products.
adversely affected.
Fluctuations in interest and currency exchange rates may harmdecrease demand for our business.products.
A majoritySubstantially all of our foreign sales are invoiced in U.S. dollars. As a result, fluctuations in currency exchange rates could cause our products to become relatively more expensive for international customers, thereby reducing demand for our products. We anticipate that foreign saleswe will generally continue to be invoicedinvoice foreign sales in U.S. dollars. Accordingly, weWe do not currently engage in foreign currency hedging transactions. However, as we expand our current international operations, we may allow payment in foreign currencies and, as a result, our exposure to foreign currency transaction losses may increase. To reduce this exposure, we may purchase forward foreign exchange contracts or use other hedging strategies. However, we cannot assure you that any currency hedging strategy would be successful in avoiding exchange-related losses.
Any such losses would adversely impact our profitability.
If our contract manufacturers, third-party OEMs and third-party suppliers fail to produce quality products or parts in a timely manner, we may not be able to meet our customers' demands.
We do not manufacture our products. We rely on contract manufacturers and OEMs to manufacture, assemble, package and test substantially all of our products and to purchase most of the raw materials and components used in our products. Additionally, we depend on third-party suppliers to provide quality parts and materials to our contract manufacturers and OEMs, and we obtain some of the key components and sub-assemblies used in our products from a single supplier or a limited group of suppliers. Neither we nor our contract manufacturers or OEMs have any guaranteed supply arrangements with the suppliers. If our suppliers fail to provide a sufficient supply of key components, we could experience difficulties in obtaining alternative sources at reasonable prices, if at all, or in altering product designs to use alternative components. Moreover, if our contract manufacturers or OEMs fail to deliver quality products in a timely manner, such failure would harm our ability to meet our scheduled product deliveries to customers. Delays and reductions in product shipments could increase our production costs, damage customer relationships and harm our revenue and profitability. In addition, if our contract manufacturers and OEMs fail to perform adequate quality control and testing of our products, we would experience increased production costs for product repair and replacement, and our profitability would be harmed. Moreover, defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or product liability claims, each of which could harm our revenue, profitability and reputation.
Design defects in our products could harm our reputation and our revenue, profitability and reputation.
Any defect or deficiency in our products could reduce the functionality, effectiveness or marketability of our products. These defects or deficiencies could cause customers to cancel or delay their orders for our products, reduce revenue or render our product designs obsolete. In any of these events, we would be required to devote substantial financial and other resources for a significant period of time to develop new product designs. We cannot assure you that we would be successful in addressing any design defects in our products or in developing new product designs in a timely manner, if at all. Any of these events, individually or in the aggregate, could harm our revenue, profitability and reputation.
Our business depends on the integrity of our intellectual property rights. If we fail to adequately protect our intellectual property, our revenue, profitability, reputation or growth strategy could be adversely affected.
We attempt to protect our intellectual property or if others use ourand proprietary technology without our authorization, our competitive position may suffer.
Our future successthrough patents, trademarks and ability to compete depends in part on our proprietary technology. We rely on a combination of copyright, patent, trademark and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. We currently hold 45 United States patents and have 25 United States patent applications pending. However, we cannot assure you that patents will be issued with respect to pendingcopyrights, by generally entering into confidentiality or future patent applications that we have filed or plan to file or that our patents will be upheld as valid or will prevent the development of competitive products or that any actions we have taken will adequately protect our intellectual property rights.
We generally enter into confidentialitylicense agreements with our employees, consultants, resellers,vendors, strategic partners and customers as needed, and potential customers in which we strictly limit by generally limiting
36
access to and distribution of our softwaretrade secret technology and further limit the disclosure and useproprietary information. However, any of our pending or future patent or trademark applications may not ultimately be issued as patents or trademarks of the scope that we sought, if at all, and any of our patents, trademarks or copyrights may be invalidated, deemed unenforceable, or otherwise challenged. In addition, other parties may circumvent or design around our patents and other intellectual property rights, may misappropriate our proprietary information. Despitetechnology, or may otherwise develop similar, duplicate or superior products. Further, the intellectual property laws and our efforts toagreements may not adequately protect our proprietaryintellectual property rights unauthorized partiesand effective intellectual property protection may attemptbe unavailable or limited in certain foreign countries in which we do business or may do business in the future.
The telecommunications and data communications industries are characterized by the existence of extensive patent portfolios and frequent intellectual property litigation. From time to copytime, we have received, and may in the future receive, claims that we are infringing third parties' intellectual property rights. Any present or otherwise obtainfuture claims, with or usewithout merit, could be time-consuming, result in costly litigation, divert management time and attention and other resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us. In addition, any such litigation could force us to cease selling or using certain products or services, or to redesign such products or services. Further, we may in the future initiate claims or litigation against third-parties for infringement of our intellectual property rights or to determine the scope and validity of our intellectual property rights or those of competitors. Such litigation could result in substantial costs and diversion of resources. Any of the foregoing could have an adverse effect upon our revenue, profitability, reputation or growth strategy.
If we fail to provide our customers with adequate and timely customer support, our relationships with our customers could be damaged, which would harm our revenue and profitability.
Our ability to achieve our planned sales growth and retain customers will depend in part on the quality of our customer support operations. Our customers generally require significant support and training with respect to our products, or technology. Our competitors may also independently develop technologies that are substantially equivalent or superiorparticularly 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 technology. In addition,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 lawslevels of some foreign countries do not protectsupport that our proprietary rightscustomers may require during initial product deployment or on an ongoing basis. Our failure to provide sufficient support to our customers could delay or prevent the same extent as the lawssuccessful deployment of the United States.
We may be subjectour products. Failure to intellectual property infringement claims that are costly to defendprovide adequate support could also have an adverse impact on our reputation and relationship with our customers, could thereby prevent us from gaining new customers and could harm our businessrevenue and profitability.
If we fail to manage our expanding operations, our ability to compete.
Our industry is characterized by vigorous protectionincrease our revenues and pursuit of intellectual property rights. We are subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. From time to time, third parties may assert infringement claims with respect toimprove our current or future products. Any such assertion, regardless of its merit, could require us to pay damages or settlement amounts and could require us to develop non-infringing technology or acquire licenses to the technology that is the subject of the asserted infringement. This litigation or potential litigation could result in product delays, increased costs or both. In addition, the cost of any litigation and the resulting distraction of our management resources to address such litigation could harm our business, results of operations orcould be harmed.
We anticipate that, in the future, we may need to expand certain areas of our business to grow our customer base and exploit market opportunities. In particular, we expect to face numerous challenges in the implementation of our business strategy to focus on selling our products to the larger, more established service providers. To manage our operations, we must, among other things, continue to implement and improve our operational, financial condition.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 also cannot assure you that any licenses of technologyour 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 business willproducts or systems. If we are unable to manage our operations effectively, our revenue, operations and share price could be available orharmed.
37
If we are unable to address the material weaknesses in our internal controls that if available, these licenses can be obtained on commercially reasonable terms. Our failureour auditors identified in the fourth quarter of fiscal 2003, such weaknesses could materially and adversely affect our ability to obtain these licensesprovide the public with timely and accurate material information about our company, which could harm our business,reputation and share price.
In January 2004, our auditors identified deficiencies in our internal controls that they considered to be material weaknesses. Based on these weaknesses, our CEO and CFO determined that, as of December 31, 2003, our disclosure controls and procedures were not sufficient to record, process, summarize and report information required to be reported within the time periods specified by the SEC. These material weaknesses related to our inventory and our accounts payable processes, both of which affect our balance sheet and may also affect our income statement reporting. (See page 20 of this Form 10-K/A for further discussion of these weaknesses.) In order for investors and the equity analyst community to make informed investment decisions and recommendations about our securities, it is important that we provide them with accurate and timely information in accordance with the Exchange Act and the rules promulgated thereunder. If we cannot do so, investors will sell our shares and industry analysts will either make incorrect recommendations about our company or else end coverage of our company altogether, any of which results could harm our reputation and adversely impact our share price.
We are currently engaged in two securities class action lawsuits, either of operationswhich, if they were to result in an unfavorable resolution, could adversely affect our reputation, profitability and financial condition.
We are currently engaged as a defendant in two lawsuits (i.e.,In re Tut Systems, Inc. Securities Litigation andWhalen v. Tut Systems, Inc. et al.) that allege securities law violations against us and certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended. While we have reached settlements with the plaintiffs in these lawsuits, the settlements are subject to certain contingencies, including court approval of the terms of settlement. If the courts do not approve these settlements, or any other applicable contingencies are not resolved or otherwise addressed, we would be required to resume litigation in these matters. If we were to resume litigation in these matters, there is no assurance that we would prevail and, if either of the outcomes of such litigation were unfavorable to us, our reputation, profitability and share price could be adversely affected.
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.product sales will suffer.
We and our customers are subject to varying degrees of federal, state and local as well as foreign governmental regulation. Our products must comply with various regulations and standards defined by the Federal Communications Commission, or FCC. The FCC has issued regulations that set installation and equipment standards for communications systems. Our products are also required to meet certain safety requirements. For example, Underwriters Laboratories must certify certain of our products 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.customers may deploy them. Any delay in or failure to obtain these approvals could harm our business, financial condition or results of operations. Outside of the United States, our products are subject to the regulatory requirements of each country in which our products are manufactured or sold. These requirements are likely to vary widely. If we do not obtain timely domestic or foreign regulatory approvals or certificates, we would not be able to sell our products where these regulations apply, which maycould prevent us from sustainingmaintaining or growing our revenue or achieving profitability.
In addition, regulation of our customers may adversely impact our business, operating results and financial condition. For example, FCC regulatory policies affecting the availability of data and Internet services and other terms on which telecommunications companies conduct their business may impede our penetration ofentry into certain markets. In addition, the increasing demand for communications systems has
38
exerted pressure on regulatory bodies worldwide to adopt new standards, generally following extensive investigation of competing technologies. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by our customers, which in turn may harm our sale of products to these customers.
If our customers do not receive adequate and timely customer support from us or our third-party providers, our relationships with our customers could be damaged, which would harm our business, financial condition and results of operations.
Our ability to achieve our planned sales growth and retain customers will depend in part on the quality of our customer support operations. Our customers generally require significant support and training with respect to our products, particularly in the initial deployment and implementation stage. As our systems and products become more complex, we believe our ability to provide adequate customer support will be increasingly important to our success. Moreover, we believe that our IntelliPOP products will add a significant layer of complexity to the demands on our customer support organizations. We have limited experience with widespread deployment of our products to a diverse customer base, and we cannot assure you that we will have adequate personnel to provide the levels of support that our customers may require during initial product deployment or on an ongoing basis. In addition, we rely on a third party for a substantial portion of our customer support functions, and therefore, we may have limited control over the level of support that is provided. Our failure to provide sufficient support to our customers could delay or prevent the successful deployment of our products. Failure to provide adequate support could also have an adverse impact on our reputation and relationship with our customers, could prevent us from gaining new customers and could harm our business, financial condition or results of operations.
If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to manage our business successfully, which could materially and adversely affect our business, financial conditiongrowth strategy, reputation and results of operations.share price.
We depend on the performance of Salvatore D’Auria,D'Auria, our President, Chief Executive Officer and Chairman of the Board, and Douglas Shafer, our Chief Financial Officer, Vice President, Finance and Administration, and Secretary, and on other senior management and technical personnel with experience in the video and data communications, telecommunications and high-speed data access industries. The loss of any one of them could harm our ability to execute our business strategy.strategy, which could adversely affect our reputation and share price. Additionally, we do not have employment contracts with any of our executive
officers. We believe that our future success will depend in large part on our continued ability to identify, hire, retain and motivate highly skilled employees who are in great demand. We cannot assure you that we will be able to do so.
We routinely evaluate acquisition candidates and other diversification strategies.
We have completed a number of acquisitions as part of our efforts to expand and diversify our business. For example, we acquired our video content processing and video transmission businesses from Tektronix in November 2002 when we purchased its subsidiary, VTC. We intend to continue to evaluate new acquisition candidates, divestiture and diversification strategies, and if we fail to manage the integration of acquired companies, it could adversely affect our operations and growth strategy. Any acquisition involves numerous risks, including difficulties in the assimilation of the acquired company's employees, operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company's key employees. Additionally, we may incur unanticipated expenses, difficulties and other adverse consequences relating to the integration of technologies, research and development, and administrative and other functions. Any future acquisitions may also result in potentially dilutive issuances of our equity securities, acquisition or divestiture related write-offs and the assumption of debt and contingent liabilities. Any of the above factors could adversely affect our revenue, profitability, operations or growth strategy.
Our stock price has fluctuatedis volatile, and, is likely to continue to fluctuate, andif you invest in our company, you may not be able to resellsuffer a loss of some or all of your shares at or above their purchase price.investment.
The market price and trading volume of our common stock has been subject to significant volatility, and this trend may continue. In particular, trading volume historically has been low and the market price of our common stock has been and is likely to continue to be highly volatile. Our stock price could fluctuate widelyincreased dramatically in response to many factors, including, but not limited to,recent months. Since the following:
In addition, in recent years,VTC, the stock market in general, and the Nasdaq National Market and the securities of Internet and technology companies in particular, have experienced extremeclosing price and volume fluctuations with severe drops. These fluctuations have often been unrelated or disproportionate to the operating performance of these technology companies. These market and industry factors may harm our stock price, regardless of our operating results.
Ourcommon stock, may be delisted from the Nasdaq National Market.
Nasdaq corporate governance rules require that all shares listedas traded on the Nasdaq National Market, maintainhas fluctuated from a minimum bid price at closinglow of $1.00$1.22 to a high of $7.49 per share. Our failure to maintain such a minimum bidThe value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:
39
Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the Nasdaq National Market. In the second half of 2002, the minimum closing bidmarket price of our common stock was consistently below $1.00 per share. On September 9, 2002, we received a Nasdaq delisting notice becauseare beyond our common stock had closed below $1.00 per share for 30 consecutive trading days. If the bidcontrol. The market price of our common stock hadat any particular time may not closed at $1.00 per share or more forremain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a minimumdiversion of 10 consecutive trading days before December 9, 2002, our stock would have been delisted from the Nasdaq National Market. On November 15, 2002, we received a notice from the Nasdaq that our stock price had traded above $1.00 per share for the required 10 consecutive days. Since that time, our stock has not traded below the required minimum bid price at closingmanagement's attention and resources.
Future sales of $1.00 per share. However, based on the various risks noted elsewhere in this Annual Report on Form 10-K as well as the fact that our stock price continues to trade below $2.00 per share, we nevertheless continue to face the risk of a delisting from the Nasdaq National Market. The delistingshares of our common stock as well as the threat of delistingcould cause our stock price to decline.
Substantially all of our common stock may negatively impactbe sold without restriction in the valuepublic markets, subject only in the case of shares held by our officers and directors and affiliates to volume and manner of sale restrictions (other than as described in the following sentence). The approximately 3.3 million shares of common stock that we issued to Tektronix in connection with our November 2002 acquisition of VTC are restricted securities, as that term is defined in Rule 144 under the Securities Act, and therefore subject to certain restrictions. However, we are contractually obligated to file and keep effective a registration statement in order to allow Tektronix to sell these shares to the public. Likewise, Tektronix has the right (subject to certain exceptions) to include these shares in certain registration statements pursuant to which we may sell shares of our shares because shares that trade on the over-the-counter market, rather than the Nasdaq National Market, are typically less liquid and, therefore, trade with larger variations between the bid and asking price.common stock.
Sales of a substantial number of shares of common stock in the public market, whether or not in connection with this offering, or the perception that these sales could occur could materially and adversely affect our stock price and make it more difficult for us to sell equity securities in the future at a time and price we deem appropriate.
Our charter, bylaws, retention and change of control plans and Delaware law contain provisions that could delay or prevent a change in control.
Certain provisions of our charter and bylaws and our retention and change of control plans, the “Plans,”"Plans," may have the effect of making it more difficult for a third partythird-party to acquire, or of discouraging a third partythird-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 directorsBoard has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third partythird-party to acquire a majority of our outstanding voting stock. The Plans provide for severance payments and accelerated stock option vesting in the event of termination of employment following a change of control. The provisions of the charter and bylaws, and the Plans, as well as Section 203 of the Delaware General Corporation Law, to which we are subject, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management.
Future sales of our common stock could depress our stock price.
Sales of a substantial number of shares of our common stock in the public market, or the appearance that these shares are available for sale, could harm the market price of our common stock. Also, we may from time to time need to register shares of our common stock for resale, which registration and resale may increase the number of our shares that are publicly-traded, thereby adversely impacting the per share price of our common stock. In particular, see page 21 of this Annual Report on Form 10-K regarding our contractual commitment to Tektronix. 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, 2002, we had 19,795,525 shares outstanding. Of these shares, 16,511,928 shares of our common stock are currently available for sale in the public market, some of which are subject to volume and other limitations under securities laws.
Our Pleasanton, California facility is located near known earthquake fault zones, and the occurrence of an earthquake or other natural disaster could cause damage to our facility and equipment which could require us to curtail or cease operations.
Our Pleasanton, California facility is located in the San Francisco Bay Area near known earthquake fault zones and are vulnerable to damage from earthquakes. In October 1989, a major earthquake that caused significant property damage and a number of fatalities struck this area. We are also vulnerable to damage from other types of disasters, including fire, floods, power loss, communications failures and similar events. If any disaster were to occur, our ability to operate our business at our Pleasanton, California facility could be seriously, or completely, impaired. The insurance we maintain may not be adequate to cover our losses resulting from disasters or other business interruptions.
We rely on a continuous power supply to conduct our operations, and a statewide energy crisis could disrupt our operations and increase our expenses.
In the fourth quarter of 2000 and the first quarter of 2001, California suffered an energy crisis that could have disrupted our operations and increased our expenses. In the event of an acute power shortage which occurs when power reserves for the State of California fall below 1.5%, California has on some occasions implemented, and may in the future implement, rolling blackouts throughout the state. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our power supply. If California were to suffer a similar energy crisis in the future and blackouts interrupt our power supply, we would be temporarily unable to continue operations at our Pleasanton, California facility. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
As of December 31, 2002,2003, we did not have investments. An immediate 10% change in interest rate would be immaterial to our financial condition or results of operations.
40
The principal amount of cash and cash equivalents at December 31, 20022003 totaled $25.6$14.4 million with a related weighted average interest rate of 1.6%1.36%. Our long-term debt of $3.3$3.5 million at December 31, 20022003 carries a weighted average fixed interest rate of 8.0% per annum with principal payment of the entire note payable balance due in November 2007. We do not have short term notes payable.
The table below presents principal amounts and related weighted average interest rates by year for our cash and cash equivalents, and debt obligations.
| | Maturity Fiscal Year | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2004 | 2005 | 2006 | 2007 | Thereafter | Total | ||||||||||||||
| | (dollars in thousands) | |||||||||||||||||||
| Assets: | ||||||||||||||||||||
| Cash and cash equivalents | $ | 14,370 | $ | — | $ | — | $ | — | $ | — | $ | 14,370 | ||||||||
| Average interest rate | 1.36 | % | — | — | — | — | 1.36 | % | ||||||||||||
| Liablities: | ||||||||||||||||||||
| Long-term debt | — | — | — | $ | 4,060 | — | $ | 4,060 | ||||||||||||
| Average interest rate | 8.0 | % | 8.0 | % | 8.0 | % | 8.0 | % | — | 8.0 | % | |||||||||
Maturity Fiscal Year | |||||||||||||||||||||
2003 | 2004 | 2005 | 2006 | 2007 | Thereafter | Total | |||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Assets: | |||||||||||||||||||||
Cash and cash equivalents | $ | 25,571 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 25,571 | |||||||
Average interest rate |
| 1.6% |
| — |
| — |
| — |
| — |
| — |
| 1.6% | |||||||
Liablities: | |||||||||||||||||||||
Long-term debt |
| — |
| — |
| — |
| — | $ | 4,060 |
| — | $ | 4,060 | |||||||
Average interest rate |
| 8.0% |
| 8.0% |
| 8.0% |
| 8.0% |
| 8.0% |
| — |
| 8.0% | |||||||
The estimated fair value of our cash and cash equivalents approximates the principal amounts reflected above based on the maturities of these financial instruments.
Although payments under certain of our operating leases for our facilities are tied to market indices, we are not exposed to material interest rate risk associated with our operating leases.
Foreign Currency Risk
We transact business primarily in the US Dollar.U.S. dollar. To date, the effect of changes in foreign currency exchange rates on revenuesrevenue has not been material, as the majority of our revenues arerevenue is earned in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, reduce the demand for our product.
For our foreign subsidiaries whose functional currency is the local currency, we translate assets and liabilities to U.S. dollars using the period-end exchange rates and translate revenues and expenses to U.S. dollars using average exchange rates during the period. ExchangeForeign currency exchange gains and losses arising from translation of foreign subsidiary financial statements are reported as a separate component on our Statement of Stockholders’Stockholders' Equity. To date, the effect of changes in foreign currency exchange rates on translation has not been material.
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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TUT SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | |||
|---|---|---|---|
| Consolidated Financial Statements | |||
| Report of Independent Auditors | 43 | ||
| Consolidated Balance Sheets as of December 31, 2002 and December 31, 2003 (Restated) | 44 | ||
| Consolidated Statements of Operations for the Years Ended December 31, 2001, December 31, 2002 and December 31, 2003 | 45 | ||
| Consolidated Statements of Stockholders' Equity as of December 31, 2001, December 31, 2002 and December 31, 2003 | 46 | ||
| Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, December 31, 2002 and December 31, 2003 | 47 | ||
| Notes to Consolidated Financial Statements | 48 | ||
| Financial Statement Schedule | 78 | ||
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REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors of
Tut Systems, Inc.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Tut Systems, Inc. (the Company) and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 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 accompanying index 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 the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the 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.
As discussed in Note 2 to the financial statements, the Company changed the manner in which it accounts for goodwill as of January 1, 2002. As further indicated in Note 2 to the consolidated financial statements, the Company has restated its December 31, 2003 consolidated balance sheet.
| /s/ PRICEWATERHOUSECOOPERS LLP |
Portland, Oregon
February 2, 2004, except as to the Restatement
caption under Note 2 to the consolidated financial
statements, which is as of March 24, 2004
43
TUT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
December 31, | ||||||||
2002 | 2001 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 25,571 |
| $ | 46,338 |
| ||
Short-term investments |
| — |
|
| 3,029 |
| ||
Accounts receivable, net of allowance for doubtful accounts of $10 and $6,908 in 2002 and 2001, respectively |
| 2,844 |
|
| 550 |
| ||
Inventories, net |
| 3,876 |
|
| 11,839 |
| ||
Prepaid expenses and other |
| 1,082 |
|
| 1,742 |
| ||
Total current assets |
| 33,373 |
|
| 63,498 |
| ||
Property and equipment, net |
| 1,630 |
|
| 8,171 |
| ||
Intangibles and other assets |
| 5,586 |
|
| 7,323 |
| ||
Total assets | $ | 40,589 |
| $ | 78,992 |
| ||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 1,272 |
| $ | 1,204 |
| ||
Accrued liabilities |
| 5,924 |
|
| 9,856 |
| ||
Deferred revenue |
| 1,781 |
|
| 954 |
| ||
Total current liabilities |
| 8,977 |
|
| 12,014 |
| ||
Deferred revenue, net of current portion |
| 35 |
|
| 553 |
| ||
Note payable |
| 3,262 |
|
| — |
| ||
Other liabilities |
| 84 |
|
| 329 |
| ||
Total liabilities |
| 12,358 |
|
| 12,896 |
| ||
Commitments and contingencies (Note 9) | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding in 2002 and 2001, respectively |
| — |
|
| — |
| ||
Common stock, $0.001 par value, 100,000 shares authorized, 19,796 and 16,411 shares issued and outstanding in 2002 and 2001, respectively |
| 20 |
|
| 16 |
| ||
Additional paid-in capital |
| 304,888 |
|
| 301,182 |
| ||
Deferred compensation |
| — |
|
| (17 | ) | ||
Notes receivable from stockholders |
| — |
|
| (96 | ) | ||
Accumulated other comprehensive loss |
| (141 | ) |
| (78 | ) | ||
Accumulated deficit |
| (276,536 | ) |
| (234,911 | ) | ||
Total stockholders’ equity |
| 28,231 |
|
| 66,096 |
| ||
Total liabilities and stockholders’ equity | $ | 40,589 |
| $ | 78,992 |
| ||
| | December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| | 2002 | 2003 Restated | |||||||
| ASSETS | |||||||||
| Current assets: | |||||||||
| Cash and cash equivalents | $ | 25,571 | $ | 14,370 | |||||
| Accounts receivable, net of allowance for doubtful accounts of $10 and $47 in 2002 and 2003, respectively | 1,972 | 7,062 | |||||||
| Insurance settlement receivable | — | 10,725 | |||||||
| Inventories, net | 3,888 | 4,181 | |||||||
| Prepaid expenses and other | 1,082 | 1,026 | |||||||
| Total current assets | 32,513 | 37,364 | |||||||
| Property and equipment, net | 1,630 | 1,722 | |||||||
| Intangibles and other assets | 5,586 | 3,685 | |||||||
| Total assets | $ | 39,729 | $ | 42,771 | |||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||||
| Current liabilities: | |||||||||
| Accounts payable | $ | 1,272 | $ | 3,055 | |||||
| Accrued liabilities | 5,924 | 1,516 | |||||||
| Legal settlement liability | — | 10,725 | |||||||
| Deferred revenue | 921 | 253 | |||||||
| Total current liabilities | 8,117 | 15,549 | |||||||
| Deferred revenue, net of current portion | 35 | — | |||||||
| Note payable | 3,262 | 3,523 | |||||||
| Other liabilities | 84 | 44 | |||||||
| Total liabilities | 11,498 | 19,116 | |||||||
| Commitments and contingencies (Note 9) | |||||||||
| Stockholders' equity: | |||||||||
| Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding in 2002 and 2003, respectively | — | — | |||||||
| Common stock, $0.001 par value, 100,000 shares authorized, 19,796 and 20,274 shares issued and outstanding in 2002 and 2003, respectively | 20 | 20 | |||||||
| Additional paid-in capital | 304,888 | 305,777 | |||||||
| Accumulated other comprehensive loss | (141 | ) | (89 | ) | |||||
| Accumulated deficit | (276,536 | ) | (282,053 | ) | |||||
| Total stockholders' equity | 28,231 | 23,655 | |||||||
| Total liabilities and stockholders' equity | $ | 39,729 | $ | 42,771 | |||||
The accompanying notes are an integral part of these consolidated financial statements.
44
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Revenues: | ||||||||||||
Product | $ | 8,582 |
| $ | 12,866 |
| $ | 69,981 |
| |||
License and royalty |
| 789 |
|
| 882 |
|
| 2,010 |
| |||
Total revenues |
| 9,371 |
|
| 13,748 |
|
| 71,991 |
| |||
Cost of goods sold: | ||||||||||||
Product |
| 13,909 |
|
| 40,489 |
|
| 42,760 |
| |||
Provision for loss on purchase commitments and abandoned products (Note 8) |
| — |
|
| — |
|
| 27,223 |
| |||
Total cost of goods sold |
| 13,909 |
|
| 40,489 |
|
| 69,983 |
| |||
Gross (loss) margin |
| (4,538 | ) |
| (26,741 | ) |
| 2,008 |
| |||
Operating expenses: | ||||||||||||
Sales and marketing |
| 8,695 |
|
| 12,413 |
|
| 19,945 |
| |||
Research and development |
| 12,337 |
|
| 15,044 |
|
| 17,149 |
| |||
General and administrative |
| 5,060 |
|
| 10,148 |
|
| 34,487 |
| |||
Restructuring costs |
| 9,147 |
|
| 2,311 |
|
| — |
| |||
In-process research and development |
| 562 |
|
| 1,160 |
|
| 800 |
| |||
Impairment of intangibles and goodwill |
| — |
|
| 32,551 |
|
| — |
| |||
Amortization of intangibles and goodwill |
| 1,304 |
|
| 8,085 |
|
| 7,623 |
| |||
Total operating expenses |
| 37,105 |
|
| 81,712 |
|
| 80,004 |
| |||
Loss from operations |
| (41,643 | ) |
| (108,453 | ) |
| (77,996 | ) | |||
Impairment of certain equity investments |
| (592 | ) |
| — |
|
| (3,100 | ) | |||
Interest and other income (expense), net |
| 610 |
|
| 4,127 |
|
| 6,998 |
| |||
Net loss | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Net loss per share, basic and diluted (Note 2) | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | |||
Shares used in computing net loss per share, basic and diluted (Note 2) |
| 16,957 |
|
| 16,326 |
|
| 14,866 |
| |||
| | Years Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | |||||||||
| Revenues: | ||||||||||||
| Product | $ | 12,866 | $ | 8,582 | $ | 31,474 | ||||||
| License and royalty | 882 | 789 | 718 | |||||||||
| Total revenues | 13,748 | 9,371 | 32,192 | |||||||||
| Cost of goods sold | 40,489 | 13,909 | 15,646 | |||||||||
| Gross profit (loss) | (26,741 | ) | (4,538 | ) | 16,546 | |||||||
| Operating expenses: | ||||||||||||
| Sales and marketing | 12,413 | 8,695 | 7,479 | |||||||||
| Research and development | 15,044 | 12,337 | 7,909 | |||||||||
| General and administrative | 10,148 | 5,060 | 4,476 | |||||||||
| Restructuring costs | 2,311 | 9,147 | 292 | |||||||||
| In-process research and development | 1,160 | 562 | — | |||||||||
| Impairment of intangible assets | 32,551 | — | 128 | |||||||||
| Amortization of intangible assets | 8,085 | 1,304 | 1,809 | |||||||||
| Total operating expenses | 81,712 | 37,105 | 22,093 | |||||||||
| Loss from operations | (108,453 | ) | (41,643 | ) | (5,547 | ) | ||||||
| Impairment of certain equity investments | — | (592 | ) | — | ||||||||
| Interest and other income, net | 4,127 | 610 | 30 | |||||||||
| Net loss | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | |||
| Net loss per share, basic and diluted (Note 2) | $ | (6.39 | ) | $ | (2.45 | ) | $ | (0.28 | ) | |||
| Shares used in computing net loss per share, basic and diluted (Note 2) | 16,326 | 16,957 | 19,996 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
45
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’STOCKHOLDERS' EQUITY
(in thousands)
Common Stock | Additional Paid-in Capital | Deferred Compensation | Notes Receivable From Stockholders | Accumulated Other Comprehensive Income (Loss) | Accumulated Deficit | Total Stockholders’ Equity | |||||||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||||||||
Balance, January 1, 2000 | 11,941 |
| 12 |
| 108,969 |
|
| (972 | ) |
| — |
|
| — |
|
| (56,487 | ) |
| 51,522 |
| ||||||||
Components of comprehensive loss: | |||||||||||||||||||||||||||||
Unrealized gains on other investments | — |
| — |
| — |
|
| — |
|
| — |
|
| 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 |
| ||||||||
Components of comprehensive loss: | |||||||||||||||||||||||||||||
Unrealized losses on other investments | — |
| — |
| — |
|
| — |
|
| — |
|
| (70 | ) |
| — |
|
| (70 | ) | ||||||||
Foreign currency translation adjustment | — |
| — |
| — |
|
| — |
|
| — |
|
| (14 | ) |
| — |
|
| (14 | ) | ||||||||
Net loss | — |
| — |
| — |
|
| — |
|
| — |
|
| — |
|
| (104,326 | ) |
| (104,326 | ) | ||||||||
Total comprehensive loss |
| (104,410 | ) | ||||||||||||||||||||||||||
Common stock issued in conjunction with ActiveTelco purchase acquisition | 321 |
| — |
| 2,944 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 2,944 |
| ||||||||
Common stock issued for cash upon exercise of stock options | 67 |
| — |
| 58 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 58 |
| ||||||||
Common stock issued under employee stock purchase plan | 104 |
| — |
| 188 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 188 |
| ||||||||
Unearned compensation related to common stock | 8 |
| — |
| 64 |
|
| (64 | ) |
| — |
|
| — |
|
| — |
|
| — |
| ||||||||
Reversal of deferred compensation related to the workforce reduction | — |
| — |
| (404 | ) |
| 404 |
|
| — |
|
| — |
|
| — |
|
| — |
| ||||||||
Amortization related to unearned compensation | — |
| — |
| — |
|
| 684 |
|
| — |
|
| — |
|
| — |
|
| 684 |
| ||||||||
Forgiveness of notes receivable issued to stockholders | — |
| — |
| — |
|
| — |
|
| 479 |
|
| — |
|
| — |
|
| 479 |
| ||||||||
Notes receivable issued to stockholders | — |
| — |
| — |
|
| — |
|
| (20 | ) |
| — |
|
| — |
|
| (20 | ) | ||||||||
Balance, December 31, 2001 | 16,411 |
| 16 |
| 301,182 |
|
| (17 | ) |
| (96 | ) |
| (78 | ) |
| (234,911 | ) |
| 66,096 |
| ||||||||
Components of comprehensive loss: | |||||||||||||||||||||||||||||
Unrealized losses on other investments | — |
| — |
| — |
|
| — |
|
| — |
|
| (48 | ) |
| — |
|
| (48 | ) | ||||||||
Foreign currency translation adjustment | — |
| — |
| — |
|
| — |
|
| — |
|
| (15 | ) |
| — |
|
| (15 | ) | ||||||||
Net loss | — |
| — |
| — |
|
| — |
|
| — |
|
| — |
|
| (41,625 | ) |
| (41,625 | ) | ||||||||
Total comprehensive loss |
| (41,688 | ) | ||||||||||||||||||||||||||
Common stock issued in conjunction with VideoTele.com purchase acquisition | 3,283 |
| 4 |
| 3,608 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 3,612 |
| ||||||||
Common stock issued for cash upon exercise of stock options | 11 |
| — |
| 14 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 14 |
| ||||||||
Common stock issued under employee stock purchase plan | 91 |
| — |
| 84 |
|
| — |
|
| — |
|
| — |
|
| — |
|
| 84 |
| ||||||||
Amortization related to unearned compensation | — |
| — |
| — |
|
| 17 |
|
| — |
|
| — |
|
| — |
|
| 17 |
| ||||||||
Repayment/forgiveness of notes receivable issued to stockholders | — |
| — |
| — |
|
| — |
|
| 96 |
|
| — |
|
| — |
|
| 96 |
| ||||||||
Balance, December 31, 2002 | 19,796 | $ | 20 | $ | 304,888 |
| $ | — |
| $ | — |
| $ | (141 | ) | $ | (276,536 | ) | $ | 28,231 |
| ||||||||
| | Common Stock | | | Notes Receivable From Stockholders | Accumulated Other Comprehensive (Loss) Income | | | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Additional Paid-in Capital | Deferred Compensation | Accumulated Deficit | Total Stockholders' Equity | |||||||||||||||||||||
| | Shares | Amount | |||||||||||||||||||||||
| Balance, January 1, 2001 | 15,911 | $ | 16 | $ | 298,332 | $ | (1,041 | ) | $ | (555 | ) | $ | 6 | $ | (130,585 | ) | $ | 166,173 | |||||||
| Components of comprehensive loss: | |||||||||||||||||||||||||
| Unrealized losses on other investments | — | — | — | — | — | (70 | ) | — | (70 | ) | |||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | (14 | ) | — | (14 | ) | |||||||||||||||
| Net loss | — | — | — | — | — | — | (104,326 | ) | (104,326 | ) | |||||||||||||||
| Total comprehensive loss | (104,410 | ) | |||||||||||||||||||||||
| Common stock issued in conjunction with ActiveTelco purchase acquisition | 321 | — | 2,944 | — | — | — | — | 2,944 | |||||||||||||||||
| Common stock issued for cash upon exercise of stock options | 67 | — | 58 | — | — | — | — | 58 | |||||||||||||||||
| Common stock issued under employee stock purchase plan | 104 | — | 188 | — | — | — | — | 188 | |||||||||||||||||
| Unearned compensation related to common stock | 8 | — | 64 | (64 | ) | — | — | — | — | ||||||||||||||||
| Reversal of deferred compensation related to the workforce reduction | — | — | (404 | ) | 404 | — | — | — | — | ||||||||||||||||
| Amortization related to unearned compensation | — | — | — | 684 | — | — | — | 684 | |||||||||||||||||
| Forgiveness of notes receivable issued to stockholders | — | — | — | — | 479 | — | — | 479 | |||||||||||||||||
| Notes receivable issued to stockholders | — | — | — | — | (20 | ) | — | — | (20 | ) | |||||||||||||||
| Balance, December 31, 2001 | 16,411 | 16 | 301,182 | (17 | ) | (96 | ) | (78 | ) | (234,911 | ) | 66,096 | |||||||||||||
| Components of comprehensive loss: | |||||||||||||||||||||||||
| Unrealized losses on other investments | — | — | — | — | — | (48 | ) | — | (48 | ) | |||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | (15 | ) | — | (15 | ) | |||||||||||||||
| Net loss | — | — | — | — | — | — | (41,625 | ) | (41,625 | ) | |||||||||||||||
| Total comprehensive loss | (41,688 | ) | |||||||||||||||||||||||
| Common stock issued in conjunction with VideoTele.com purchase acquisition | 3,283 | 4 | 3,608 | — | — | — | — | 3,612 | |||||||||||||||||
| Common stock issued for cash upon exercise of stock options | 11 | — | 14 | — | — | — | — | 14 | |||||||||||||||||
| Common stock issued under employee stock purchase plan | 91 | — | 84 | — | — | — | — | 84 | |||||||||||||||||
| Amortization related to unearned compensation | — | — | — | 17 | — | — | — | 17 | |||||||||||||||||
| Repayment/forgiveness of notes receivable issued to stockholders | — | — | — | — | 96 | — | — | 96 | |||||||||||||||||
| Balance, December 31, 2002 | 19,796 | 20 | 304,888 | — | — | (141 | ) | (276,536 | ) | 28,231 | |||||||||||||||
| Components of comprehensive loss: | |||||||||||||||||||||||||
| Unrealized gain on other investments | — | — | — | — | — | 74 | — | 74 | |||||||||||||||||
| Foreign currency translation adjustment | — | — | — | — | — | (22 | ) | — | (22 | ) | |||||||||||||||
| Net loss | — | — | — | — | — | — | (5,517 | ) | (5,517 | ) | |||||||||||||||
| Total comprehensive loss | — | — | — | — | — | — | — | (5,465 | ) | ||||||||||||||||
| Common stock issued for cash upon exercise of stock options | 440 | — | 831 | — | — | — | — | 831 | |||||||||||||||||
| Common stock issued under employee stock purchase plan | 38 | — | 58 | — | — | — | — | 58 | |||||||||||||||||
| Balance, December 31, 2003 | 20,274 | $ | 20 | $ | 305,777 | $ | — | $ | — | $ | (89 | ) | $ | (282,053 | ) | $ | 23,655 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements.
46
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net loss | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Depreciation and other |
| 3,163 |
|
| 3,679 |
|
| 2,164 |
| |||
Noncash interest income and amortization of discounts on investments |
| 37 |
|
| (168 | ) |
| (4,375 | ) | |||
Abandonment of fixed assets |
| 4,822 |
|
| — |
|
| — |
| |||
Provision for (recovery of) doubtful accounts |
| (2,277 | ) |
| (954 | ) |
| 22,546 |
| |||
Provision for excess and obsolete inventory and abandoned products |
| 7,125 |
|
| 34,237 |
|
| 14,468 |
| |||
Write-off of certain equity investments |
| 592 |
|
| — |
|
| 3,100 |
| |||
Impairment of intangibles and goodwill |
| — |
|
| 32,551 |
|
| — |
| |||
Amortization of intangibles and goodwill |
| 1,304 |
|
| 8,085 |
|
| 7,623 |
| |||
Amortization of deferred compensation and notes receivable related to acquisitions |
| — |
|
| 1,099 |
|
| 2,434 |
| |||
Write-off of in-process research and development |
| 562 |
|
| 1,160 |
|
| 800 |
| |||
Change in operating assets and liabilities, net of businesses acquired: | ||||||||||||
Accounts receivable |
| 1,218 |
|
| 6,528 |
|
| (17,613 | ) | |||
Inventories |
| 3,207 |
|
| (9,148 | ) |
| (42,151 | ) | |||
Prepaid expenses and other assets |
| 3,390 |
|
| 4,547 |
|
| (1,979 | ) | |||
Accounts payable and accrued liabilities |
| (5,828 | ) |
| (27,451 | ) |
| 24,112 |
| |||
Deferred revenue |
| (29 | ) |
| (1,001 | ) |
| (826 | ) | |||
Net cash used in operating activities |
| (24,339 | ) |
| (51,162 | ) |
| (63,795 | ) | |||
Cash flows from investing activities: | ||||||||||||
Purchase of property and equipment |
| (426 | ) |
| (1,189 | ) |
| (8,620 | ) | |||
Purchase of short-term investments |
| — |
|
| (7,002 | ) |
| (164,063 | ) | |||
Purchase of other assets |
| — |
|
| (1,196 | ) |
| (4,373 | ) | |||
Proceeds from maturities of short-term investments |
| 3,105 |
|
| 59,423 |
|
| 131,889 |
| |||
Acquisition of businesses, net of cash acquired |
| 758 |
|
| (169 | ) |
| (1,788 | ) | |||
Net cash provided by (used in) investing activities |
| 3,437 |
|
| 49,867 |
|
| (46,955 | ) | |||
Cash flows from financing activities: | ||||||||||||
Payment on lines of credit |
| — |
|
| — |
|
| (1,529 | ) | |||
Proceeds from issuances of common stock, net |
| 98 |
|
| 246 |
|
| 146,634 |
| |||
Other |
| 37 |
|
| 80 |
|
| (453 | ) | |||
Net cash provided by financing activities |
| 135 |
|
| 326 |
|
| 144,652 |
| |||
Net increase (decrease) in cash and cash equivalents |
| (20,767 | ) |
| (969 | ) |
| 33,902 |
| |||
Cash and cash equivalents, beginning of year |
| 46,338 |
|
| 47,307 |
|
| 13,405 |
| |||
Cash and cash equivalents, end of year | $ | 25,571 |
| $ | 46,338 |
| $ | 47,307 |
| |||
Supplemental disclosure of cash flow information: | ||||||||||||
Interest paid during the year | $ | 47 |
| $ | 20 |
| $ | 1,036 |
| |||
Income taxes paid during the year | $ | 1 |
| $ | 1 |
| $ | 1 |
| |||
Noncash financing activities: | ||||||||||||
Common stock issued in connection with the VideoTele.com acquisition in 2002, the ActiveTelco acquisition in 2001 and the FreeGate and Xstreamis acquisitions in 2000 | $ | 3,612 |
| $ | 2,944 |
| $ | 41,119 |
| |||
Unearned compensation related to stock and stock option grants | $ | — |
| $ | 64 |
| $ | 1,614 |
| |||
| | Years Ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | ||||||||||||
| Cash flows from operating activities: | |||||||||||||||
| Net loss | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | ||||||
| Adjustments to reconcile net loss to net cash used in operating activities: | |||||||||||||||
| Depreciation | 3,679 | 3,163 | 1,097 | ||||||||||||
| Noncash interest income and amortization of discounts on investments | (168 | ) | 37 | — | |||||||||||
| Abandonment of fixed assets | — | 4,822 | — | ||||||||||||
| Provision for (recovery of) doubtful accounts | (954 | ) | (2,277 | ) | 36 | ||||||||||
| Provision for excess and obsolete inventory and abandoned products | 34,237 | 7,125 | 225 | ||||||||||||
| Write-off of certain equity investments | — | 592 | — | ||||||||||||
| Impairment of intangible assets | 32,551 | — | 128 | ||||||||||||
| Amortization of intangible assets | 8,085 | 1,304 | 1,809 | ||||||||||||
| Amortization of deferred compensation and notes receivable related to acquisitions | 1,099 | — | — | ||||||||||||
| Write-off of in-process research and development | 1,160 | 562 | — | ||||||||||||
| Deferred interest on note payable | — | — | 261 | ||||||||||||
| Change in operating assets and liabilities, net of businesses acquired: | |||||||||||||||
| Accounts receivable | 6,528 | 2,090 | (5,126 | ) | |||||||||||
| Inventories | (9,148 | ) | 3,195 | (518 | ) | ||||||||||
| Prepaid expenses and other assets | 4,547 | 3,390 | 72 | ||||||||||||
| Accounts payable and accrued liabilities | (27,451 | ) | (5,828 | ) | (2,665 | ) | |||||||||
| Deferred revenue | (1,001 | ) | (889 | ) | (703 | ) | |||||||||
| Net cash used in operating activities | (51,162 | ) | (24,339 | ) | (10,901 | ) | |||||||||
| Cash flows from investing activities: | |||||||||||||||
| Purchase of property and equipment | (1,189 | ) | (426 | ) | (1,189 | ) | |||||||||
| Purchase of short-term investments | (7,002 | ) | — | — | |||||||||||
| Purchase of other assets | (1,196 | ) | — | — | |||||||||||
| Proceeds from maturities of short-term investments | 59,423 | 3,105 | — | ||||||||||||
| Acquisition of businesses, net of cash acquired | (169 | ) | 758 | — | |||||||||||
| Net cash provided by (used in) investing activities | 49,867 | 3,437 | (1,189 | ) | |||||||||||
| Cash flows from financing activities: | |||||||||||||||
| Proceeds from issuances of common stock, net | 246 | 98 | 889 | ||||||||||||
| Other | 80 | 37 | — | ||||||||||||
| Net cash provided by financing activities | 326 | 135 | 889 | ||||||||||||
| Net decrease in cash and cash equivalents | (969 | ) | (20,767 | ) | (11,201 | ) | |||||||||
| Cash and cash equivalents, beginning of year | 47,307 | 46,338 | 25,571 | ||||||||||||
| Cash and cash equivalents, end of year | $ | 46,338 | $ | 25,571 | $ | 14,370 | |||||||||
| Supplemental disclosure of cash flow information: | |||||||||||||||
| Interest paid during the year | $ | 20 | $ | 47 | $ | 3 | |||||||||
| Income taxes paid during the year | $ | 1 | $ | 1 | $ | 1 | |||||||||
| Noncash financing activities: | |||||||||||||||
| Common stock issued in connection with the VideoTele.com acquisition in 2002 and the ActiveTelco acquisition in 2001 | $ | 2,944 | $ | 3,612 | $ | — | |||||||||
| Unearned compensation related to stock and stock option grants | $ | 64 | $ | — | $ | — | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
47
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, markets and sells digital video content processing systems optimizedthat enable telephony-based service providers to deliver broadcast quality digital video signals over their networks. The Company also offers video processing systems that enable private enterprise and government entities to transport video signals over satellite, fiber, radio, or copper networks for surveillance, distance learning, and TV production applications. The Company also designs, develops and markets broadband transport and service management products that enable the provisioning of public broadcast digital TV services across telephone companyhigh speed Internet access and cable company facilities, digital video trunking systems for applications across TV broadcast, government and education facilities, andother broadband data transmission systems for applicationservices over existing copper networks within hotels and private campus or building facilities.
Historically, the Company derived most of the Company’sits sales were derived from its broadband data transmission systems. With the Company’stransport and service management products. In November 2002, acquisition of VideoTele.com (VTC), formerly a subsidiary of Tektronix, Inc., the Company extendedacquired VideoTele.com, or VTC, from Tektronix, Inc. to extend its product offerings to include digital video content processing and video trunking systems. As a result, the Company's revenue increased from $9,371 in 2002 to $32,192 in 2003. Video-based products now represent a majority of the Company's sales.
The Company has incurred substantial losses and negative cashflowscash flows from operations since inception. For the year ended December 31, 2002,2003, the Company incurred a net loss of $41,625$5,517 and negative cashflowscash flows from operationsoperating activities of $24,339,$10,901, and has an accumulated deficit of $276,536$282,053 at December 31, 2002.2003. Management believes that the cash and cash equivalents as of December 31, 20022003 are sufficient to fund its operating activities and capital expenditure needs for the next twelve months. Management expects the amount of cash used to fund operations will decrease in 2003.2004. However, toin the extent the Company’s business continues to be affected by poorevent that general economic conditions impacting the telecommunications industry,worsen, it will continue tomay require additional cash to fund its operations. The Company will seek additional funding for operations from alternative debt and equity sources, if necessary, to maintain reasonable operating levels. The Company cannot assure that such funding efforts will be successful. Failure to generate positive cashflowcash flow in the future could have a material impact on the Company’sCompany's ability to achieve its intended business objectives.
NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Restatement
Subsequent to issuance of the December 31, 2003 consolidated financial statements, management determined that it should have reflected a liability of $10,000 for theIn re: Tut Systems Inc. Securities Litigation matter (see Note 9) and $725 for theLefkowitz v. D'Auria matter (see Note 9) as of December 31, 2003. In addition, the consolidated financial statements should have reflected a receivable from the Company's insurance carriers of $10,725. Consequently, the Company has restated its December 31, 2003 balance sheet to reflect these matters. These adjustments had no effect on the consolidated statements of operations, the consolidated statements of stockholders' equity or the consolidated statements of cash flows.
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 in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
48
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, estimation of percentage-of-completion on revenue contracts and the recoverability of long-lived assets. Actual results could differ from those estimates.
Fair value of financial instruments
The fair value of the Company’sCompany's cash and cash equivalents, short-term investments, accounts receivable, accounts payable and note payable approximate their carrying value due to the short maturity or market rate structure of those instruments.
Cash and cash equivalents and investments
Cash cash equivalents and short-term investments are stated at cost or amortized cost, which approximates fair value. The Company includes in cash and cash equivalents all highly liquid investments which mature within three months of their purchase date. 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, 2002, the Company only held cash and cash equivalents.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Short-term Investments
December 31, | ||||||
2002 | 2001 | |||||
US government agency notes | $ | — | $ | 3,029 | ||
The cost of short-term investments approximated the fair value at December 31, 2001. During 2001, the Company held an investment in commercial paper issued by Southern California Edison Company. This investment had been included in short-term investments at a carrying value of approximately $9,025 and matured in January 2001 but was in default. In November 2001, the Company sold this investment for $8,793, realizing a loss of $232. This loss was included in other income (expense), net for 2001.
Inventories
Inventories are stated at the lower of cost or market. Cost is computed using standard cost which approximates actual cost on a first-in, first-out basis. The Company records provisions to write down its inventory and related purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than those estimated by the Company, additional inventory provisions may be required.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation. The Company provides for depreciation by charges to expense which are sufficient to write off the cost of the assets over their estimated useful lives on the straight-line basis. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful life of the improvement. Useful lives by principal classifications are as follows:
Office equipment | 3–5 years | |
Computers and software |
| |
Test equipment | 3–5 years | |
Leasehold improvements |
|
When assets are sold or otherwise disposed of, the cost and accumulated depreciation are removed from the asset and allowance foraccumulated 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’sasset's useful life are capitalized.
49
Intangible assets
Intangible assets are stated at cost less amortization. Intangible assets consistedconsist of completed technology and patents, contract backlog, customer lists, maintenance contract renewals and trademarks. These intangible assets are amortized on a straight line basis over the estimated periods of benefit, which are as follows:
Completed technology and patents | 5 years | |
Contract backlog | 14 months | |
Customer lists | 7 years | |
Maintenance contract renewals | 5 years | |
Trademarks | 7 years |
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Accounting for long-lived assets
The Company periodically assesses the impairment of long-lived assets (and assessed related goodwill) periodicallyassets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends, a significant decline in the stock price for a sustained period and the Company's market capitalization relative to net book value.
When management determines that the carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment, any impairment measured is based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in the Company’sCompany's current business model.
During 2001, the Company determined that certain intangible long-lived assets were impaired, and recorded losses accordingly under Statement of Financial Accounting Standards (SFAS) No. 121. No such impairment was recorded in 2002. During 2003, the Company determined that certain long-lived assets were impaired and recorded losses accordingly under SFAS No. 144. During 2003, the Company determined that certain intangible long-lived assets were impaired and recorded losses accordingly, under SFAS No. 144. Future events could cause the Company to conclude that impairment indicators once again exist. Any resulting impairment loss could have a material adverse impact on the Company's financial condition and results of operations.
Revenue recognitionRecognition
The Company generates revenue primarily from the sale of hardware products, including third-party products, through professional services, the licensing of its HomeRun technology and through the sale of its software products. The Company sells products through direct sales channels and through distributors. Generally, product revenue is generated from the sale of video processing systems and components and the sale of broadband transport and service management products. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyer's specifications.
50
Product revenues
Product revenue is generated primarily from the sale of complete end-to-end video processing systems generally referred to as turnkey solutions. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services and post contract support. Sales of turnkey solutions are classified as product revenue in the statement of operations.
Product revenue is also generated from the sale of video processing component products and the sale of broadband transport and service management products. The Company sells these products through its own direct sales channels and also through distributors.
The Company's revenue recognition policies for turnkey solutions are in accordance with SOP 97-2,Software Revenue Recognition, as amended, which is the authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP 97-2 requires that revenue recognized from software arrangements be allocated to each element of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or other elements. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by SOP 98-4,Deferral of the Effective Date of a Provision of SOP 97-2and was amended again in December 1998 by SOP 98-9,Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments deferred and then clarified, respectively, the specification of what was considered vendor specific objective evidence of fair value for the various elements in a multiple element arrangement.
In the case of software arrangements which require significant production, modification or customization of software, which encompasses all of the Company's turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1,Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company recognizes productrevenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the PCS element, for which the Company has established vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally recognized using the percentage-of-completion method, as stipulated by SOP 81-1. The percentage-of-completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value of the arrangement prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are generally considered to be incidental to the arrangement in its entirety because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.
For direct sales of video processing systems component products not included as part of turnkey solutions and the direct sale of broadband transport and service management products, the Company
51
recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable.reasonably assured.
Significant management judgments and estimates must be made in connection with the measurement of revenue in a given period. The Company follows specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, the Company assesses a number of factors, including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, the Company may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. Revenue from service obligations included in product revenues is deferred and recognized ratably overIn order to recognize revenue, the periodCompany must also make a judgment regarding collectibility of the obligation.arrangement fee. Management's judgment of collectibility is applied on a customer-by-customer basis pursuant to the Company's credit review policy. The Company sells to customers for which there is a history of successful collection and to new customers for which no similar history may exist. New customers are subject to a credit review process, which evaluates the customers' financial position and ability to pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are increased only after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility is not probable based upon the Company's credit review process, no credit is extended and revenue is recognized on a cash-collected basis.
The Company also maintains accruals and allowances for all cooperative marketing and other programs.programs, as necessary. Estimated sales returns and warranty costs are based on historical experience and are recorded at the time revenue is recognized.recognized, as necessary. The Company’sCompany's products generally carry a one year warranty from the date of purchase.
Turnkey solution revenues
Revenue from turnkey solution sales is generally recognized using the percentage of completion method. Under the percentage of completion method, revenue recognized reflects the portion of the anticipated contract revenue that has To date, warranty costs have been earned, equalinsignificant to the ratio of labor costs expended to date to anticipated final labor costs, based on current estimates of labor costs to complete the project. Generally, the terms of turnkey solution sales provide for billing for products at the time of delivery and for services at the time of substantial completion of the project.overall financial statements taken as a whole.
License and royalty revenuesRoyalty Revenue
TheLicense and royalty revenue consists of nonrefundable up-front license fees, some of which may offset initial royalty payments, and royalties received by the Company has entered into non-exclusive technology agreements with variousfor products sold by its licensees. These agreements provideCurrently, 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 termmajority of the agreement.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Contract fees for the services provided under these licensing agreements are generallyCompany's license and royalty revenue is comprised of non-refundable license fees and non-refundable, prepaid royalties which arepaid in advance. Such revenue is 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 period during which the post-contract customer support is expected to be provided. This period representsprovided 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 received by the estimated life of the technology. The Company begins to recognize revenue under the contract once it has delivered the implementation package that 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 salefor products sold by its licensees. The terms of the royalty agreements generally require licensees to notify the Company and pay royalties within 60 days of the end of the quarter during which the sales occur.
Software license and post contract support revenues
Currently,Should changes in conditions cause us to determine that the Company’s software revenue is derived from two separate sources, software license fees and post-contract maintenance and support fees. The software license fee typically grants a perpetual license to the customer. The Company generally recognizes revenue from the sale of the software license when all criteria for revenue recognition have beenare not met similar to the Company’s hardware product sales. Thefor certain future transactions, revenue recognition for maintenance and support fees is recognized ratably over the term of the separate support contract.
any reporting period could be adversely affected.
Accounting for stock based compensation
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”("APB") Opinion No. 25, and “Accounting"Accounting for Stock Issued to Employees,”" Financial Accounting Standard Board Interpretation No. 44 (“("FIN 44”44") “Accounting"Accounting for Certain Transactions Involving Stock Compensation—an Interpretation of APB 25,”" and complies with
52
the disclosure provisions of SFAS No. 148, “Accounting"Accounting for Stock-Based Compensation, Transition and Disclosure.”" Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company’sCompany's stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 148 and the EITF Issue No. 96-18, “Accounting"Accounting for Equity Instruments that are Issued to other than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”"
We amortizeThe Company amortizes stock-based compensation using the straight-line method over the remaining vesting periods of the related options, which is generally four years. Pro forma information regarding net loss and earnings per share is required. This information is required to be determined as if we had accounted for employee stock options under the fair value method of SFAS No. 123, as amended by SFAS No. 148.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
The following table illustrates the effect on net loss and earningsloss per share if the Company’sCompany's had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 148, to stock-based employee compensation:
| | Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | ||||||||
| Net loss—as reported | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | ||
| Add: | |||||||||||
| Unearned stock-based employee compensation expense included in reported net loss | 684 | 17 | — | ||||||||
| Deduct | |||||||||||
| Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax effects | (8,432 | ) | (14,053 | ) | (3,646 | ) | |||||
| Net loss—pro forma | $ | (112,074 | ) | $ | (55,661 | ) | $ | (9,163 | ) | ||
| Basic and diluted net loss per share—as reported | $ | (6.39 | ) | $ | (2.45 | ) | $ | (0.28 | ) | ||
| Basic and diluted net loss per share—pro forma | $ | (6.86 | ) | $ | (3.28 | ) | $ | (0.46 | ) | ||
Year Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Net loss—as reported | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Add: | ||||||||||||
Unearned stock-based employee compensation expense included in reported net loss |
| 17 |
|
| 684 |
|
| 1,545 |
| |||
Deduct | ||||||||||||
Total stock-based employee compensation expense determined under a fair value based method for all grants, net of related tax effects |
| (14,053 | ) |
| (8,432 | ) |
| (15,065 | ) | |||
Net loss—pro forma | $ | (55,661 | ) | $ | (112,074 | ) | $ | (87,618 | ) | |||
Basic and diluted net loss per share—as reported | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | |||
Basic and diluted net loss per share—pro forma | $ | (3.28 | ) | $ | (6.86 | ) | $ | (5.89 | ) | |||
The fair value of options and shares issued pursuant to the option plans and at the grant date were estimated using the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. 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 employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’smanagement's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of options.
The effects of applying pro forma disclosures of net loss and earnings per share are not likely to be representative of the pro forma effects on net loss/income and earnings per share in the future years, as the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.
53
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 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:
| | Stock Option Plans Year Ended December 31, | Employee Stock Purchase Plan Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | 2001 | 2002 | 2003 | |||||||
| Expected dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | |
| Risk-free interest rate | 4.2 | % | 3.0 | % | 2.5 | % | 4.6 | % | 3.5 | % | 1.26 | % | |
| Expected volatility | 137.4 | % | 95.2 | % | 80.7 | % | 137.4 | % | 95.2 | % | 80.7 | % | |
| Expected life (in years) | 4.0 | 4.0 | 4.0 | 0.5 | 0.5 | 0.5 | |||||||
Stock Option Plans Year Ended December 31, | Employee Stock Purchase Plan Year Ended December 31, | |||||||||||||||||
2002 | 2001 | 2000 | 2002 | 2001 | 2000 | |||||||||||||
Expected dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | ||||||
Risk-free interest rate | 3.0 | % | 4.2 | % | 6.2 | % | 3.5 | % | 4.6 | % | 5.8 | % | ||||||
Expected volatility | 120.0 | % | 120.0 | % | 120.0 | % | 120 | % | 120.0 | % | 120.0 | % | ||||||
Expected life (in years) | 4.0 |
| 4.0 |
| 4.0 |
| 0.5 |
| 0.5 |
| 0.5 |
| ||||||
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Generally, the Company grants options at a price equal to the fair market value of the Company’sCompany's stock on the date of the grant. The weighted-average estimated fair values of stock options granted during fiscal 2001, 2002 2001 and 20002003 as calculated using the Black-Scholes option pricing model were $1.84, $1.06 $1.84 and $31.51$1.82 per share, respectively.
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, 2002 2001 and 20002003 was zero, and $103 and $371, respectively.
for the year ended December 31, 2001.
Research and development
Research and development expenditures are charged to expense as incurred.
Software Development Costs
Costs incurred in the research and development of new software products are expensed as incurred until technological feasibility has been established at which time such costs are capitalized, subject to a net realizable value evaluation. Technology feasibility is established upon the completion of an integrated working model. Costs incurred between completion of the working model and the point at which the product is ready for general release have not been significant. Accordingly, the Company has charged all costs to research and development expense in the period 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.
54
Foreign currency translation
The functional currency for the Company’sCompany'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 other comprehensive loss as a separate component of stockholders’stockholders' equity. Gains or losses resulting from foreign currency transactions are included in the results of operations and have been immaterial for all periods presented.
Net loss per share
Basic and diluted net loss per share is computed using the weighted average number of common shares outstanding. Options were not included in the computation of diluted net loss per share because the effect would be antidilutive.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
The calculation of net loss per share follows:
Years Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Net loss per share, basic and diluted: | ||||||||||||
Net loss | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Shares used in computing net loss per share, basic and diluted |
| 16,957 |
|
| 16,326 |
|
| 14,866 |
| |||
Net loss per share, basic and diluted | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | |||
Antidilutive securities, including options, not included in net loss per share calculations |
| 4,204 |
|
| 3,054 |
|
| 2,895 |
| |||
| | Years Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | ||||||||
| Net loss per share, basic and diluted: | |||||||||||
| Net loss | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | ||
| Shares used in computing net loss per share, basic and diluted | 16,326 | 16,957 | 19,996 | ||||||||
| Net loss per share, basic and diluted | $ | (6.39 | ) | $ | (2.45 | ) | $ | (0.28 | ) | ||
| Antidilutive securities, including only options, not included in net loss per share calculations | 3,054 | 4,204 | 3,649 | ||||||||
Accumulated otherOther comprehensive loss(loss) income
Accumulated otherOther comprehensive loss(loss) income includes unrealized gains and losses on other assets and foreign currency translation adjustmentadjustments that have been previously excluded from net loss and reflected instead in stockholders’stockholders' equity. The following table sets forth the components of accumulated other comprehensive loss:(loss) income:
Years Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Unrealized gains (losses) on investments |
| (92 | ) |
| (44 | ) |
| 26 |
| |||
Foreign currency translation adjustment |
| (49 | ) |
| (34 | ) |
| (20 | ) | |||
Total | $ | (141 | ) | $ | (78 | ) | $ | 6 |
| |||
| | Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | |||||||
| Unrealized gains (losses) on investments | $ | (70 | ) | $ | (48 | ) | $ | 74 | ||
| Foreign currency translation adjustment | (14 | ) | (15 | ) | (22 | ) | ||||
| Total | $ | (84 | ) | $ | (63 | ) | $ | 52 | ||
Concentrations
The Company operates in one business segment, designing, developing and selling video content processing systems optimized for the provisioning of public broadcast digital TV services across telephone company and cable company facilities, digital video trunking systems for applications across
55
TV broadcast, government and education facilities, and broadband data transmission systems for application over existing private campus or building facilities.
The market for these products is characterized by rapid technological developments, frequent new product introductions, changes in end-user requirements and constantly evolving industry standards. The Company’sCompany's future success depends on its ability to develop, introduce and market enhancements to its existing products, to introduce new products in a timely manner that meet customer requirements and to respond effectively to competitive pressures and technological advances. Further, the emergence of new industry standards, whether formally adopted by official standards committees or informally through widespread use of such standards by telephone companies or other service providers, could require the Company to redesign its products.
Currently, the Company relies on contract manufacturers and certain single source suppliers of materials for certain product components. As a result, should the Company’sCompany'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.
From time to time, the Company maintains a substantial portion of its cash and cash equivalents in money market accounts with one financial institution. The Company invests its excess cash in debt instruments of the
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
U.S. Treasury, governmental agencies and corporations with strong credit ratings. The Company has established guidelines relating to diversification and maturities in order to maintain the safety and liquidity of these assets. To date, the Company has not experienced any significant losses on its cash equivalents or short-term investments. During 2001, the Company held an investment in commercial paper issued by Southern California Edison Company. This investment had been included in short-term investments at a carrying value of approximately $9,025 and matured in January 2001 but was in default. In November 2001, the Company sold this investment for $8,793, realizing a loss of $232. This loss was included in other income (expense), net for 2001.
Recent accounting pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)SFAS No. 142, “Goodwill"Goodwill and Other Intangible Assets,”" which addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes Accounting Principles Board (APB) Opinion No. 17, “Intangible"Intangible Assets.”" It addresses how intangible assets that are acquired individually or with a group of other assets, but not those acquired in a business combination, should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. We adopted the provisions of SFAS No. 142 on January 1, 2002. The following table presents the impact of SFAS No. 142 on net loss and net loss per share had the standard been in effect for the years ended December 31, 2001, 2002, 2001 and 2000:2003:
| | Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | |||||||
| Net loss—as reported | $ | (104,326 | ) | $ | (41,625 | ) | $ | (5,517 | ) | |
| Adjustment: | ||||||||||
| Amortization of goodwill | 5,618 | — | — | |||||||
| Net loss—as adjusted | $ | (98,708 | ) | $ | (41,625 | ) | $ | (5,517 | ) | |
| Net loss per share, basic and diluted—as reported | $ | (6.39 | ) | $ | (2.45 | ) | $ | (0.28 | ) | |
| Net loss per share, basic and diluted—as adjusted | $ | (6.05 | ) | $ | (2.45 | ) | $ | (0.28 | ) | |
56
Years Ended December 31, | ||||||||||||
2002 | 2001 | 2000 | ||||||||||
Net loss—as reported | $ | (41,625 | ) | $ | (104,326 | ) | $ | (74,098 | ) | |||
Adjustment: | ||||||||||||
Amortization of goodwill |
| — |
|
| 5,618 |
|
| 5,294 |
| |||
Net loss—as adjusted | $ | (41,625 | ) | $ | (98,708 | ) | $ | (68,804 | ) | |||
Net loss per share, basic and diluted—as reported | $ | (2.45 | ) | $ | (6.39 | ) | $ | (4.98 | ) | |||
Net loss per share, basic and diluted—as adjusted | $ | (2.45 | ) | $ | (6.05 | ) | $ | (4.63 | ) | |||
In September 2001, the EITF Issued EITF Issue No. 01-09, “Accounting for Consideration Given by Vendor to a Customer or a Reseller of the Vendor’s Products,” which is a codification of EITF Issues No. 00-14, No. 00-25 and No. 00-22 “Accounting for ‘Points’ and Certain Other Time- or Volume-Based Sales Incentive Offers and Offers for Free Products or Services to be Delivered in the Future.” The adoption of these Issues did not impact the Company’s financial statements.
On October 3, 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supercedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” SFAS No. 144 applies to all long-lived assets, including discontinued operations, and consequently amends APB Opinion No. 30, “Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that: (a) can be distinguished from the rest of the entity, and (b) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for the Company for all financial statements issued in 2002. The adoption of SFAS No. 144 did not impact the Company’s financial statements.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
In July 2002, the FASB issued SFAS 146, “Accounting"Accounting for Costs Associated with Exit or Disposal Activities.”" SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS 146 eliminates the definition and requirement for recognition of exit costs in Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability"Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),”" where a liability for an exit cost was recognized at the date of an entity’sentity's commitment to an exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe that the adoption of this statement willStatement did not have a material impact on itsthe Company's results of operations, financial position or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The disclosure requirements of FIN 45 are effective for financial statements of interim or annual periods ending after December 15, 2002 and have been implemented in the Company’s financial statements. The Company is currently assessing what the impact of the remaining guidance would be on its financial statements.
In November 2002, the Emerging Issues Task Force (EITF)EITF reached a consensus on Issue No. 00-21, “Revenue"Revenue Arrangements with Multiple Deliverables.”" EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company is currently evaluatingadoption of this Issue and itsStatement did not have a material impact on the Company’sCompany's results of operations, financial statements.position or cash flows.
In December 2002, the FASB issued SFAS No. 148, “Accounting"Accounting for Stock-Based Compensation, Transition and Disclosure.”" SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods beginning after December 15, 2002. The annual disclosure requirements of SFAS No. 148 have been implemented in the Company’sCompany's financial statements. The Company is currently evaluatingadoption of this standard and itsStatement did not have a material impact on the Company’sCompany's results of operations, financial statements.position or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation"Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 4651, Consolidated Financial Statements," and subsequently revised in December 2003 with the issuance of FIN46-R. This interpretation requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46Application of this Interpretation is effective immediatelyrequired in financial statements for all new variable interest entities created or acquiredperiods ending after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after JuneMarch 15, 2003.2004. The Company believesdoes not believe that the adoption of this standardInterpretation will have a material impact on its results of operations, financial position or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for contracts entered into or modified after September 30, 2003, and for hedging relationships designated after September 30, 2003. The adoption of this Statement did not have a material impact on the Company's results of operations, financial position or cash flows.
57
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is effective for financial statements.
instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after September 15, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. On November 7, 2003, the FASB issued FASB Staff Position No. FAS 150-3 (FSP 150-3), "Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150,TUT SYSTEMS, INC.Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)." FSP 150-3 deferred certain aspects of FAS 150. The adoption of FAS 150 and FAS 150-3 did not have a material impact on the Company's results of operations, financial position or cash flows.
( On December 17, 2003, the Staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 104 (SAB 104),Revenue Recognition, which supersedes SAB 101,Revenue Recognition in thousands, except per share amounts)Financial Statements
. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." Additionally, SAB 104 rescinds the SEC'sRevenue Recognition in Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with SAB 101 that had been codified in SAB Topic 13,Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 in December 2003 did not materially affect the Company's revenue recognition policies, nor the Company's results of operations, financial position or cash flows.
Reclassifications
Certain reclassifications have been made to prior year balances in order to conform to the current year presentation.
Such reclassifications had no impact on net loss or net stockholders' equity.
NOTE 3—ACQUISITIONS:
a) 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 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. In fiscal 2001, the Company abandoned the in-process research and development associated with FreeGate and therefore will not incur additional costs in this regard.
b) 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.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
The following unaudited pro forma consolidated information gives effect to the acquisitions of FreeGate and Xstreamis as if they had occurred on January 1, 2000, by consolidating the results of operations of FreeGate and Xstreamis with the results of operations of the Company for the year ended December 31, 2000. These pro forma results exclude the nonrecurring write-off of in-process research and development of $800 related to the FreeGate acquisition for the year ended December 31, 2000.
Year Ended December 31, 2000 | ||||
(unaudited) | ||||
Revenue | $ | 72,082 |
| |
Net loss | $ | (77,430 | ) | |
Net loss per share, basic and diluted | $ | (5.13 | ) | |
c) ActiveTelco
On January 11, 2001, the Company acquired ActiveTelco, Inc. (ActiveTelco) for approximately $4,850, consisting of an aggregate of 321 shares of the Company’sCompany's common stock and 19 options to purchase shares of the Company’sCompany's common stock, acquisition related expenses consisting primarily of legal and 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 was 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.
58
The 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 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 aredid not expected to have a material impact on the Company’s futureCompany's results of operations, or cashflows. The results of operations of ActiveTelco have been included in the consolidated statement of operations from January 11, 2001.
b) ViaGate
On September 14, 2001, the Company acquired certain assets of ViaGate Technologies, Inc. (ViaGate) for $550 in cash and assumed liabilities of $46 for certain capital leases. 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 $5, and the estimated fair value of completed technology and patents of $591.
d) c) VideoTele.com
On November 7, 2002, the Company acquired VideoTele.com, Inc. (VTC) from Tektronix, Inc. (Tektronix) for approximately $7,155, consisting of an aggregate of 3,2843,283 shares of the Company’sCompany's common stock valued at $3,612, acquisition related expenses consisting primarily of legal and other professional fees of $320, and a note payable to Tektronix in the amount of $3,223. The results of operations of VTC have been included in the consolidated statement of operations from November 7, 2002 to December 31, 2002. VTCAs a result of this acquisition, the Company now offers video content processing systems that optimize the provisioning of digital head-end solutions enabling home entertainment delivery via the broadband Internet.TV services across telephone company networks.
The Company determined the fair value of the acquired intangibles, including in-process technology based on an appraisal using established valuation techniques. The in-process research and development percentage of completion was estimated to be 20%, 40% and 50% for the Astria, M2 and software product lines, respectively. The value of this in-process research and development was determined by estimating the costs to develop the purchased in-process research and development into a commercially viable product, estimating the resulting net
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
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 the in-process research and development to technological feasibility are estimated to be $1,000 and are expected to be incurred in 2003.
The fair value of the net assets acquired of $14,624 exceeded the purchase price of $7,155, thereby resulting in negative goodwill of $7,469. All long-lived assets, including in-process research and development, were reduced on a pro rata basis by the amount of the negative goodwill. The net amount allocated to purchased in-process research and development was expensed upon acquisition
59
because technological feasibility had not been established and no future alternative uses existed. The allocation of the purchase price was as follows:
| Net current assets | $ | 3,035 | |
| Property and equipment | 1,006 | ||
| Other assets | 70 | ||
| In-process research and development | 562 | ||
| Completed technology and patents | 1,784 | ||
| Contract backlog | 247 | ||
| Customer list | 86 | ||
| Maintenance contract renewals | 50 | ||
| Trademarks | 315 | ||
| $ | 7,155 | ||
Net current assets | $ | 3,035 | |
Property and equipment |
| 1,006 | |
Other assets |
| 70 | |
In-process research and development |
| 562 | |
Completed technology and patents |
| 1,784 | |
Contract backlog |
| 247 | |
Customer list |
| 86 | |
Maintenance contract renewals |
| 50 | |
Trademarks |
| 315 | |
$ | 7,155 | ||
The following unaudited pro forma consolidated information gives effect to the acquisition of VTC as if it had occurred on January 1, 20022001 and 20012002 by consolidating the results of operations of VTC with the results of operations of the the Company for the years ended December 31, 20022001 and 2001.2002. These pro forma results exclude the nonrecurring write-off of in-process research and development of $562 related to the VTC acquisition for the years ended December 31, 20022001 and 2001.2002.
| | Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | |||||
| | (unaudited) | ||||||
| Revenue | $ | 46,383 | $ | 21,895 | |||
| Net loss | $ | (104,867 | ) | $ | (46,904 | ) | |
| Net loss per share, basic and diluted | $ | (5.35 | ) | $ | (2.38 | ) | |
60
Year Ended December 31, | ||||||||
2002 | 2001 | |||||||
(unaudited) | ||||||||
Revenue | $ | 21,895 |
| $ | 46,383 |
| ||
Net loss | $ | (46,904 | ) | $ | (104,867 | ) | ||
Net loss per share, basic and diluted | $ | (2.38 | ) | $ | (5.35 | ) | ||
e) OneWorld
On April 28, 2000, the Company acquired certain assets of OneWorld Systems, Inc. (OneWorld) 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.
f) ViaGate
On September 14, 2001, the Company acquired certain assets of ViaGate Technologies, Inc. (ViaGate) for $550 in cash and assumed liabilities of $46 for certain capital leases. 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 $5, and the estimated fair value of completed technology and patents of $591.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
NOTE 4—BALANCE SHEET COMPONENTS:
| | December 31, | |||||||
|---|---|---|---|---|---|---|---|---|
| | 2002 | 2003 | ||||||
| Inventories, net: | ||||||||
| Finished goods | $ | 38,599 | $ | 4,015 | ||||
| Raw materials | 3,007 | 391 | ||||||
| Allowance for excess and obsolete inventory and abandoned product | (37,718 | ) | (225 | ) | ||||
| $ | 3,888 | $ | 4,181 | |||||
| Property and equipment: | ||||||||
| Computers and software | $ | 932 | $ | 1,328 | ||||
| Test equipment | 420 | 2,277 | ||||||
| Office equipment | 1,114 | 41 | ||||||
| 2,466 | 3,646 | |||||||
| Less: accumulated depreciation | (836 | ) | (1,924 | ) | ||||
| $ | 1,630 | $ | 1,722 | |||||
| Accrued liabilities: | ||||||||
| Provision for loss on purchase commitments (see Note 8) | $ | 3,700 | $ | — | ||||
| Professional services | 612 | 494 | ||||||
| Compensation | 604 | 652 | ||||||
| Restructuring accrual (see Note 6) | 473 | — | ||||||
| Other | 535 | 370 | ||||||
| $ | 5,924 | $ | 1,516 | |||||
December 31, | ||||||||
2002 | 2001 | |||||||
Inventories, net: | ||||||||
Finished goods | $ | 3,655 |
| $ | 10,967 |
| ||
Raw materials |
| 221 |
|
| 872 |
| ||
$ | 3,876 |
| $ | 11,839 |
| |||
Prepaid expenses and other: | ||||||||
Receivables from contract manufacturers | $ | — |
| $ | 28 |
| ||
Prepaid expenses |
| 1,082 |
|
| 1,714 |
| ||
$ | 1,082 |
| $ | 1,742 |
| |||
Property and equipment: | ||||||||
Computers and software | $ | 932 |
| $ | 6,677 |
| ||
Leasehold improvements |
| — |
|
| 4,437 |
| ||
Test equipment |
| 420 |
|
| 3,624 |
| ||
Office equipment |
| 1,114 |
|
| 1,395 |
| ||
| 2,466 |
|
| 16,133 |
| |||
Less: accumulated depreciation |
| (836 | ) |
| (7,962 | ) | ||
$ | 1,630 |
| $ | 8,171 |
| |||
Accrued liabilities: | ||||||||
Provision for loss on purchase commitments (see Note 8) | $ | 3,700 |
| $ | 4,421 |
| ||
Professional services |
| 612 |
|
| 846 |
| ||
Compensation |
| 604 |
|
| 1,014 |
| ||
Restructuring accrual (see Note 6) |
| 473 |
|
| 402 |
| ||
Bankruptcy preference item |
| — |
|
| 1,500 |
| ||
Other |
| 535 |
|
| 1,673 |
| ||
$ | 5,924 |
| $ | 9,856 |
| |||
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Intangibles and other assets:
| | As of December 31, 2002 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| | Gross Carrying Amount | Accumulated Amortization | Net Intangibles | ||||||
| Amortized intangible assets: | |||||||||
| Completed technology and patents | $ | 8,253 | $ | (3,473 | ) | $ | 4,780 | ||
| Contract backlog | 247 | (35 | ) | 212 | |||||
| Customer list | 86 | (2 | ) | 84 | |||||
| Maintenance contract renewals | 50 | (2 | ) | 48 | |||||
| Trademarks | 315 | (8 | ) | 307 | |||||
| $ | 8,951 | $ | (3,520 | ) | 5,431 | ||||
| Other non-current assets | 155 | ||||||||
| $ | 5,586 | ||||||||
61
| | As of December 31, 2003 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| | Gross Carrying Amount | Accumulated Amortization | Net Intangibles | ||||||
| Amortized intangible assets: | |||||||||
| Completed technology and patents | $ | 8,125 | $ | (5,003 | ) | $ | 3,122 | ||
| Contract backlog | 247 | (247 | ) | — | |||||
| Customer list | 86 | (14 | ) | 72 | |||||
| Maintenance contract renewals | 50 | (12 | ) | 38 | |||||
| Trademarks | 315 | (52 | ) | 263 | |||||
| $ | 8,823 | $ | (5,328 | ) | 3,495 | ||||
| Other non-current assets | 190 | ||||||||
| $ | 3,685 | ||||||||
As of December 31, 2002 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Intangibles | ||||||||
Amortized intangible assets: | ||||||||||
Completed technology and patents | $ | 8,253 | $ | (3,473 | ) | $ | 4,780 | |||
Contract backlog |
| 247 |
| (35 | ) |
| 212 | |||
Customer list |
| 86 |
| (2 | ) |
| 84 | |||
Maintenance contract renewals |
| 50 |
| (2 | ) |
| 48 | |||
Trademarks |
| 315 |
| (8 | ) |
| 307 | |||
$ | 8,951 | $ | (3,520 | ) | $ | 5,431 | ||||
Other non-current assets |
| 155 | ||||||||
$ | 5,586 | |||||||||
As of December 31, 2001 | ||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Intangibles | ||||||||
Completed technology and patents | $ | 6,467 | $ | (2,215 | ) | $ | 4,252 | |||
Restricted cash |
| 1,718 | ||||||||
Other non-current assets |
| 1,353 | ||||||||
$ | 7,323 | |||||||||
The aggregate amortization expense for the years ended December 31, 2002, 2001 and 2000 was $1,304, $8,085 and $7,623, respectively. | ||||||||||
Minimum future amortization expense at December 31, 2002 are as follows:
| ||||||||||
2003 | $ | 1,835 | ||||||||
2004 |
| 1,623 | ||||||||
2005 |
| 993 | ||||||||
2006 |
| 513 | ||||||||
2007 |
| 363 | ||||||||
Thereafter |
| 104 | ||||||||
$ | 5,431 | |||||||||
TUT SYSTEMS, INC.The aggregate amortization expense for the years ended December 31, 2001, 2002, and 2003 was $8,085, $1,304, and $1,809, respectively.
Minimum future amortization expense for subsequent years are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
| 2004 | 1,586 | ||
| 2005 | 955 | ||
| 2006 | 485 | ||
| 2007 | 363 | ||
| 2008 and thereafter | 106 | ||
| $ | 3,495 | ||
NOTE 5—NOTE PAYABLE:
As part of the Company’sCompany's acquisition of VTC from Tektronix, Inc. in November 2002, the Company issued a note payable to Tektronix, Inc. for $3,223,$3,232, with repayment in sixty months, or November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is added to the principal balance of the note. Thereafter, the Company will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and October 31 thereafter until the principal balance is paid in full. As of December 31, 2002,2003, this note payable balance, including accrued interest, was $3,262.
$3,523.
NOTE 6—RESTRUCTURING COSTS, IMPAIRMENT OF CERTAIN INTANGIBLE ASSETS AND PROVISION FOR INVENTORY:
Restructuring costs
During 2001, the Company recorded $2,311 in restructuring costs and related facility costs in connection with its April 2001 and October 2001 workforce reductions.
In April 2001, the Company announced a restructuring program which included a workforce reduction, closure of excess facilities, and disposal of certain of its fixed assets. As a result of this restructuring program, the Company recorded restructuring costs of $2,092. The restructuring program
62
resulted in the reduction of approximately 28% of the Company's employees, and the Company recorded a workforce reduction charge of approximately $1,235 relating primarily to severance and fringe benefits. In addition, the number of temporary and contract workers employed by the Company was significantly reduced. The Company recorded costs of restructuring of $785 relating to closure of excess facilities. The closure of excess facilities included the closure of certain satellite facilities due to workforce reductions and the Company's effort to reduce operating expenses as a result of the restructuring. This cost of restructuring is primarily comprised of non-cancelable lease and operating costs. Other fixed assets retired as a result of the workforce reductions totaled $72. Cash expenditures relating to these workforce reductions were paid in the second quarter of 2001. Amounts related to the closure of excess facilities were accrued in the second quarter of 2001 and were paid over the respective lease terms through August 2002. As of December 31, 2001, the Company had a remaining accrual of $402, related to the Sunnyvale facility shut down in the second quarter of 2001, which was paid monthly through August 2002.
In October 2001, the Company further reduced its workforce by approximately 11%. The Company recorded a workforce reduction charge of $219. Cash expenditures relating to this workforce reduction were paid in the fourth quarter of 2001.
During 2002, the Company recorded $9,147 in restructuring costs and related facility costs in connection with its August 2002 and November 2002 workforce reductions, which resulted in an aggregate workforce reduction of 53%.
In August 2002, the Company announced a restructuring program that included a workforce reduction, closure of its Bridgewater Township, New Jersey research and development facility and disposal of certain of its fixed assets located in New Jersey. As a result of this restructuring program, the Company recorded restructuring costs of $870, which included severance and outplacement expenses of $531 and costs to close the New Jersey facility of $339. As of December 31, 2002, the Company had paid all of the costs related to this restructuring program.
In November 2002, the Company announced a restructuring program that included a workforce reduction, termination of its Pleasanton, California headquarters facility lease and disposal of certain of its fixed assets. As a result of this restructuring program, the Company recorded restructuring costs of $8,277, which was comprised of severance and outplacement expenses of $635, costs to terminate the Pleasanton, California lease of $2,444, $2,271 for abandonment of leasehold improvements, $2,447 for abandonment of fixed assets and $480 to terminate various equipment leases. As of December 31, 2002, the Company had a remaining accrual of $473 comprised of costs to terminate various equipment leases and the severance payments, which was paid in the first quarter of 2003.
During 2001,In August 2003, the Company recorded $2,311 in restructuring costs and related facility costs in connection with its April 2001 and October 2001 workforce reductions.
In April 2001, the Company announcedimplemented a restructuring program whichthat included a workforce reduction closure of excess facilities, and disposal of certain of its fixed assets.relocation. As a result of this restructuring program, the Company recorded restructuring costs of $2,092.$292. The restructuring program resulted in theworkforce reduction ofwas approximately 28%11% of the Company’sCompany's employees, and the Company recorded a workforce reduction charge of approximately $1,235 relating primarily toresulting in severance and fringe benefits. In addition, the numberbenefit expenses of temporary and contract workers employed by the Company was significantly reduced. The Company recordedapproximately $192 along with relocation costs of restructuring of $785 relating to closure of excess facilities. The closure of excess facilities included the closure of certain satellite facilities due to workforce reductions and the Company’s effort to reduce operating expenses as a result of the restructuring. This cost of restructuring is primarily comprised of non-cancelable lease and operating costs. Other fixed assets retired as a result of the workforce reductions totaled $72. Cash expenditures relating to these workforce reductions were paid in the second quarter of 2001. Amounts related to the closure of excess facilities were accrued in the second quarter of 2001 and were paid over the respective lease terms
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
through August 2002.$100. As of December 31, 2001,2003, the Company had a remaining accrual of $402, related topaid all the Sunnyvale facility shut down in the second quarter of 2001, which was paid monthly through August 2002.
In October 2001, the Company further reduced its workforce by approximately 11%. The Company recorded a workforce reduction charge of $219. Cash expenditurescosts relating to this workforce reduction were paid in the fourth quarter of 2001.restructuring program.
Impairment of intangibles and goodwillintangible assets
The Company recorded impairment charges totaling $32,551 in 2001 and $128 in 2003, there was no such impairment charge in 2002 or 2000.2002.
63
During the first quarter of 2001, the Company recorded a $2,692 impairment charge relating to completed technology and patents. This resulted from the Company's decision not to pursue further incorporation of the related OneGate product and other intellectual property acquired from FreeGate on February 14, 2000 into the design of future products.
Based on the impairment review performed during the third quarter of 2001, the Company recorded a $29,859 impairment charge to reduce goodwill, assembled workforce, and completed technology and patents. The charge was determined based upon estimated discounted future cash flows using a discount rate of 20%. The assumptions supporting future cash flows, including the discount rate, were determined using management’smanagement's best estimates. The underlying factors contributing to the decline in expected future cash flows included a slowdown in the telecommunications market and the indefinite postponement of capital expenditures, especially within the hospitality industry.
During the firstsecond quarter of 2001,2003, the Company determined that certain of the technology acquired as part of the purchase of the ViaGate assets had become impaired. As a result, the Company recorded a $2,692an impairment charge relating to completed technology and patents. This resulted from the Company’s decision not to pursue further incorporation of the related OneGate product and other intellectual property acquired from FreeGate into the design of future products.$128.
Provision for inventory
The Company recorded a provision for inventory totaling $7,125 in 2002,within cost of which $265, $4,918 and $1,942 were recorded in the first, second and fourth quarters of 2002, respectively. These provisions related to the costs of raw materials and finished goods in excess of what the Company reasonably expected to sell in the foreseeable future, based on the continued decline in the telecommunications market and current economic conditions.
The Company recorded a provision for inventorysold totaling $18,500 in the first quarter of 2001, related to the costs of raw materials and finished goods in excess of what the Company reasonably expected to sell in the foreseeable future as of the first quarter of 2001. The Company recorded an additional provision for inventory totaling $11,425 during the third quarter of 2001, related to the costs of raw materials and finished goods in excess of revised projections of what the Company reasonably expected to sell in the foreseeable future as of the third quarter of 2001. These revised projections were a result of continued decline in the telecommunications market, and, following the events surrounding September 11, 2001, the indefinite postponement of capital expenditures, especially within the hospitality industry. The Company recorded an additional provision for inventory totaling $4,312 in the fourth quarter of 2001 as a part of our normal business operations and product inventory assessments.
The Company recorded a provision, within costs of goods sold, for inventory totaling $7,125 in 2002, of which $265, $4,918 and $1,942 were recorded in the first, second and fourth quarters of 2002, respectively. These provisions related to the costs of raw materials and finished goods in excess of what the Company reasonably expected to sell in the foreseeable future, based on the continued decline in the telecommunications market and current economic conditions. In 2003, the Company sold $1,491 of inventory which had been reserved for in 2002.
TUT SYSTEMS, INC.64
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 2002, 2001 and 2000 relates to the state minimum franchise tax. The components of net deferred tax assets and liabilities as of December 31, 2002 and 20012003 are as follows:
| | December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | 2002 | 2003 | ||||||||
| Deferred tax assets: | ||||||||||
| Net operating loss carryforwards | $ | 70,349 | $ | 75,018 | ||||||
| Research and development credit | 5,035 | 5,051 | ||||||||
| Deferred research and development costs | 1,762 | 1,762 | ||||||||
| Deferred revenue | 499 | 76 | ||||||||
| Accruals and reserves | 18,024 | 16,179 | ||||||||
| Acquired intangibles | 7,688 | 7,818 | ||||||||
| Other | 1,698 | 1,755 | ||||||||
| Gross deferred tax assets | 105,055 | 107,659 | ||||||||
| Less: valuation allowance | (105,055 | ) | (107,659 | ) | ||||||
| Net deferred tax assets | $ | — | $ | — | ||||||
December 31, | ||||||||
2002 | 2001 | |||||||
Deferred tax assets: | ||||||||
Net operating loss carryforwards | $ | 70,349 |
| $ | 43,408 |
| ||
Research and development credit |
| 5,035 |
|
| 2,944 |
| ||
Deferred research and development costs |
| 1,762 |
|
| 1,696 |
| ||
Deferred revenue |
| 499 |
|
| 220 |
| ||
Accruals and reserves |
| 18,024 |
|
| 30,662 |
| ||
Acquired intangibles |
| 7,688 |
|
| 6,235 |
| ||
Investment write-offs |
| — |
|
| 1,234 |
| ||
Other |
| 1,698 |
|
| 235 |
| ||
Gross deferred tax assets |
| 105,055 |
|
| 86,634 |
| ||
Deferred tax liabilities: | ||||||||
Deferred compensation |
| — |
|
| (7 | ) | ||
Gross deferred tax liabilities |
| — |
|
| (7 | ) | ||
Less: valuation allowance |
| (105,055 | ) |
| (86,627 | ) | ||
Net deferred tax assets | $ | — |
| $ | — |
| ||
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, 2002,2003, the Company has approximately $193,968$205,640 in federal and $75,869$87,943 in state net operating loss, or NOL, carryforwards to reduce future taxable income. Of these amounts, $28,054 and $12,058 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, 2002,2003, the Company also has research and experimentation tax credit carryforwards of approximately $3,164$3,180 and $1,872 for federal and state income tax purposes, respectively. The NOL and credit carryforwards expire in 2007 to 2022.2023.
The Company’sCompany's ability to use its federal and state net operating loss carryforwards and federal and state tax credit carryforwards to reduce future taxable income and future taxes, respectively, may be subject to restrictions attributable to equity transactions that may have resulted in a change of ownership as defined by Internal Revenue Code Section 382. In the event the Company has had such a change in ownership, utilization of these carryforwards could be severely restricted and could result in significant amounts of these carryforwards expiring prior to benefiting the Company. The Company is currently assessing whether such a change in ownership has occurred.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
The Company's effective tax rate of zero is a result of the tax benefit calculated at the statutory tax rate completely offset by the deferred tax asset valuation allowance.
NOTE 8—LOSS ON PURCHASE COMMITMENTS AND ABANDONED PRODUCTS
At December 31, 2000, the Company accrued a provision for estimated loss on purchase commitments in the amount of $19,042 related to cancelled purchase orders. In addition, at
65
December 31, 2000, the Company recorded a provision for loss on abandoned products of $8,181 related to the Company’sCompany's decision to abandon the further development and sale of certain product lines. This amount excluded $6,287 already recorded as a provision for excess and obsolete inventory included in the cost of goods sold related to product for the year ended December 31, 2000.
During 2001, the Company reversed $2,869 of the provision for loss on purchase commitments against cost of goods sold and the Company paid its suppliers $11,752 upon receipt of raw material components related to its provision for loss on purchase commitments recorded in the fourth quarter of 2001. At December 31, 2001, these components were included in inventory offset by the provision for $11,752. There were no additional provisions recorded in 2001 related to these raw material components.
During 2002, the Company settled the last of the 2000 purchase commitment cancellations with one of its suppliers. Due to favorable negotiations, the Company reversed $721 of the provision for loss on purchase commitments against cost of goods sold in the fourth quarter of 2002. At December 31, 2002, components valued at $9,813 remained of the purchase commitments settled in 2001 and 2002 and were included in inventory offset by a provision for $9,813. This decrease in component inventory during 2002 was primarily a result of sales of components through outside brokers, the proceeds from which were recorded as a reduction of cost of goods sold in the period in which the cash was received and totaled $1,233. There were no additional provisions recorded in 2002 related to these raw material components.
NOTE 9—COMMITMENTS AND CONTINGENCIES:
Lease obligations
The Company leases office, manufacturing and warehouse space under noncancelable operating leases that expire in 20032004 and 2005. In connection with business combinations in 1999 and 2000, the Company assumed operating leases that expired in December 2001 and in August 2002. In connection with business combination in 2002, the Company assumed an operating lease that expires in July 2005.
In August 2002, the Company entered into an agreement to terminate its lease for engineering facilities in Bridgewater Township, New Jersey for $257, which consistsconsisted of forfeiture of a $116 letter of credit and a cash payment of $141. As part of its November 2002 restructuring program, the Company entered into an agreement to terminate its lease for its headquarters facility in Pleasanton, California for $2,409, which consists of forfeiture of a $1,350 letter of credit and a cash payment of $1,059. The Company also incurred $327 in legal costs related to this lease termination. The letters of credit were secured by restricted cash of $1,718, which was included in other assets on the Company’sCompany's balance sheet as of December 31, 2001. In December 2002,2003, the Company entered into a lease agreement for a facility in Pleasanton, California that expires in December 2003.September 2004.
Minimum future lease payments under operating leases at December 31, 20022003 are as follows:
| 2004 | $ | 955 | |
| 2005 | 266 | ||
| Thereafter | — | ||
| $ | 1,221 | ||
66
2003 | $1,153 | |
2004 | 762 | |
2005 | 228 | |
Thereafter | — | |
$2,143 | ||
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
Rent expense for the years ended December 31, 2001, 2002, 2000 and 19992003 was $2,630, $2,467, $2,630 and $2,165,$1,233, respectively.
Purchase commitments
The Company had noncancellable commitments to purchase finished goods inventory totaling $421 and $531$1,009 in aggregate at December 31, 2002 and 2001,2003, respectively. These purchase commitments represent outstanding purchase orders submitted to the Company's third party manufacturers for goods to be produced and delivered to the Company in 2004.
Royalty obligation
In February 1999, the Company paid one of its founders, a former employee of the Company, $2,500 as a lump sum payment for all its future royalty obligations for the rights, title and interests in two patents. These two patents gave the Company exclusive control of the Balun technology required in the Company’sCompany's products. The Company was amortizing this royalty payment ratably over the five year period beginning February 1999. Amortization expense for the years ended December 31, 2002, 2001, and 20002002 was approximately $500 each year. During the fourth quarter of 2002, the remaining unamortized royalty balance of $542 was charged to cost of goods sold since the technology was no longer required in the Company’sCompany's products.
Contingencies
Beginning July 12, 2001, six putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against Tut Systems, Inc. and certain of its current and former officers and directors. The complaints were filed on behalf of a purported class of people who purchased the Company’s stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that the Company and certain of its current and former officers and directors made false and misleading statements about its business during the putative class period. Specifically, the complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints have been consolidated under the nameIn re Tut Systems, Inc. Securities Litigation, Civil Action No. C-01-2659-JCS (the “Securities Litigation Action”). Lead plaintiffs and lead counsel for plaintiffs have been appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the court granted in part and denied in part the Motion to Dismiss. On September 23, 2002, the plaintiffs filed an amended complaint. Defendants filed a motion to dismiss portions of the amended complaint. The Court has not ruled on that motion. The Company believes the allegations against it are without merit and intends to defend the action vigorously. An unfavorable resolution of this litigation could have a material adverse effect on the Company’s business, results of operations, financial condition, or cashflows. No estimate can be made of the possible loss or range of loss associated with this matter.
In March 2003, Chesky Lefkowitz, a shareholder of the Company, filed a derivative complaint entitled Lefkowitz v. D’Auria, et al., No. RG03087467, in the Superior Court of the State of California, County of Alameda, against certain of the Company’s current and former officers and directors. The complaint alleges causes of action for breach of fiduciary duty, gross negligence, breach of contract, unjust enrichment and improper inside stock trading, based on the same factual allegations contained in the Securities Litigation Action. The complaint seeks unspecified damages against the individual defendants on behalf of the Company, equitable relief, and attorneys’ fees. There has not been a response filed to the complaint, discovery has not commenced, and no trial date has been established. No estimate can be made of the possible loss or range of loss associated with this matter.
On August 3, 2001, a complaint,Arrow Electronics, Inc. v. Tut Systems, Inc., Case No. CV 800433, was filed in the Superior Court of the State of California for the County of Santa Clara against the Company. The complaint was filed by one of the Company’sCompany's suppliers and alleges causes of action for breach of contract and for
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
money on common counts. The complaint sought damages in the amount of $10,469. The Company settled this case on December 20, 2002 for $3,700. This payment and the related costs have been recorded in the Company's consolidated financial statements.
statements as of December 31, 2002. The amounts due under the settlement agreement were paid in full in 2003.
Whalen v. Tut Systems, Inc. et al
On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants inWhalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from the Company’sCompany's January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, (the “1933 Act”) and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the 1933Securities Act. The complaintscomplaint also namenames as defendants the underwriters for the Company’sCompany's initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public offerings and secondary offerings conducted in 1999 and 2000. Therefore, for pretrial purposes, theWhalen action is being coordinated with the approximately 300 other suits before United States District Court
67
Judge Shira Scheindlin of the Southern District of New York under the matterIn Re Initial Public Offering Securities Litigation. The individual defendants in theWhalen action, namely, Nelson Caldwell, Salvatore D'Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, has deniedapproving the Company’sparties' October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying the Company's motion to dismissdismiss.
In June and July 2003, nearly all of the issuers named as defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the "issuer-defendants"), including the Company, approved a tentative settlement proposal that is reflected in a memorandum of understanding. The Company's Board of Directors approved the memorandum of understanding in June 2003 on certain conditions, including the number of issuers participating in the settlement. The memorandum of understanding is not a legally binding agreement. Further, any final settlement agreement would be subject to a number of conditions, most of which would be outside of the Company's control, including approval by the Court. The underwriter-defendants in theIn Re Initial Public Offering Securities Litigation (collectively, the "underwriter-defendants"), including the underwriters in theWhalen suit, are not parties to the memorandum of understanding.
The memorandum of understanding provides that, in exchange for a release of claims against the settling issuer-defendants, the insurers of all of the settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the underwriter-defendants. The ultimate amount, if any, that may be paid on behalf of the Company will therefore depend on the final terms of the settlement agreement, including the number of issuer-defendants that ultimately approve the final settlement agreement, and the case will now proceedamounts, if any, recovered by the plaintiffs from the underwriter-defendants and other non-settling defendants. In the event that all or substantially all of the issuer-defendants approve the final settlement agreement, the amount that the Company would be required to discovery. Thepay to the plaintiffs could range from zero to approximately $3.5 million, depending on plaintiffs' recovery from the underwriter-defendants and from other non-settling parties. If the plaintiffs recover at least $1 billion from the underwriter-defendants, the Company would have no liability for settlement payments under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, the Company believes the allegations against it are without merit and intends to defend the action vigorously. An unfavorable resolutionthat its insurance will likely cover some or all of this litigation could have a material adverse effect on the Company’s business, resultsits share of operations, financial condition, or cashflows. No estimate can be made of the possible loss orany payments towards satisfying plaintiffs' $1 billion recovery deficit. Management estimates that its range of loss associated withrelative to this matter is zero to $3.5 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount the Company will ultimately be required to pay, if any, as of December 31, 2003, the Company has not accrued a liability for this matter.
In re Tut Systems, Inc. Securities Litigation, Civil Action No. C-01-2659-JCS (the "Securities Litigation Action").
Beginning July 12, 2001, nine putative stockholder class action lawsuits were filed in the United States District Court for the Northern District of California against the Company and certain of its current and former officers and directors. The complaints were filed on behalf of a purported class of investors who purchased the Company's stock during the period between July 20, 2000 and January 31, 2001, seeking unspecified damages. The complaints allege that the Company and certain of its current and former officers and directors made false and misleading statements about the Company's business during the putative class period. Specifically, the complaints allege violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints were consolidated under the nameIn re Tut Systems, Inc. Securities Litigation, Master File No. C-01-2659-CW (the "Securities Litigation
68
Action"). Lead plaintiffs and lead counsel for plaintiffs were appointed. Plaintiffs filed a consolidated class action complaint on February 4, 2002. Defendants filed a Motion to Dismiss on March 29, 2002. On August 15, 2002, the Court granted in part and denied in part the Motion to Dismiss. On September 23, 2002, plaintiffs filed an amended complaint. Defendants filed a Motion to Dismiss the amended complaint, and on August 6, 2003 the Court granted in part that Motion. On September 24, 2003, defendants answered the remaining allegations of the amended complaint. Defendants reached a settlement of the Securities Litigation Action in December 2003. Subject to preliminary and final approval by the Court, the Company's insurance carriers agreed to pay $10 million, on behalf of the Company, to settle the suit. The settlement includes a release of all defendants. The Company has recorded a liability in its financial statements for the proposed amount of the settlement. In addition, because the insurance carriers agreed to pay the entire $10 million settlement amount and, therefore, recovery from the insurance carriers was probable, a receivable was also recorded for the same amount. Accordingly, there is no impact to the statement of operations because the amounts of the settlement and the insurance recovery fully offset each other. The insurance carriers paid the settlement amount to plaintiffs' escrow agent in January 2004. The Court preliminarily approved the settlement on February 24, 2004. The settlement amount will be paid out of escrow if and when the Court finally approves the settlement. A hearing before the Court to consider final approval of the terms of settlement is currently scheduled for May 14, 2004. Because the settlement is subject to Court approval, there is no guarantee the settlement will become final.
Lefkowitz v. D'Auria, et al
On March 19, 2003, Chesky Lefkowitz, a stockholder of the Company, filed a derivative complaint entitledLefkowitz v. D'Auria, et al., No. RG03087467, in the Superior Court of the State of California, County of Alameda, against certain of the Company's current and former officers and directors. The complaint alleges causes of action for breach of fiduciary duty, gross negligence, breach of contract, unjust enrichment, and improper insider stock trading based on the same factual allegations contained in the Securities Litigation Action. The complaint seeks unspecified damages against the individual defendants on behalf of the Company, equitable relief, and attorneys' fees. On May 21, 2003, the Company and the individual defendants filed separate demurrers to the complaint. The Company and the individual defendants reached a settlement of the derivative action in December 2003. The settlement involves the Company's adoption of certain corporate governance measures and payment of attorneys' fees and expenses to the derivative plaintiff's counsel in the amount of $722,000 and an incentive award to the derivative plaintiff in the amount of $3,000. The Company has recorded a liability in its financial statements for the proposed amount of the settlement. In addition, because the insurance carrier involved in this suit agreed to pay the entire $725,000 settlement amount and, therefore, recovery from the insurance carrier was probable, a receivable was also recorded for the same amount. Accordingly, there is no impact to the statement of operations because the amounts of the settlement and the insurance recovery fully offset each other. The settlement was approved by the Court on January 12, 2004, and, shortly thereafter, the insurance carrier paid the settlement amount to the derivative plaintiff's counsel. The settlement includes a release of the Company and the individual defendants.
The Company is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. The Company’sCompany's management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’sCompany's consolidated financial position, results of operations, or cash flows.
69
NOTE 10—STOCKHOLDERS’STOCKHOLDERS' EQUITY
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, 20022003 or 2001.
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.
2002.
NOTE 11—EQUITY BENEFIT PLANS
Stock option plans
In November 1993, the Company adopted the 1992 Stock Plan (the “1992 Plan”"1992 Plan"), under which the Company may grant both incentive stock options and nonstatutory stock options to employees, consultants and directors. Options issued under the 1992 Plan can have an exercise price of no less than 85% of the fair market value, as defined under the 1992 Plan, of the stock at the date of grant. The 1992 Plan, including amendments, allows for the issuance of a maximum of 178 shares of the Company’sCompany's common stock. This number of shares of common stock has been reserved for issuance under the 1992 Plan. The Company is no longer granting stock options from the 1992 Plan. As stock options are terminated or cancelled from the 1992 Plan, the stock options are being retired and are no longer available for future grant.
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
The Company’sCompany's 1998 Stock Plan (the “1998 Plan”"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’sCompany's common stock with annual increases starting in 2000, subject to certain limitations. In January 2000, the 1998 Plan was amended to increase the maximum number of shares that may be issued to 1,358. In January 2001, the 1998 Plan was amended to increase the maximum number of shares that may be issued by 375 to 1,733. In January 2002, the 1998 Plan was amended to increase the maximum number of shares by 375 to 2,108.
The Company’sCompany's 1999 Nonstatutory Stock Option Plan (the “1999 Plan”"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’sCompany's common stock. Additions to the Plan may be approved by the Board of Directors. The 1999 Plan has rights and privileges similar to the 1998 Plan. In April 2000, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 1,425. In October 2000, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 1,825. In October 2002, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 2,625.
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.
70
Activity under the 1992, 1998 and 1999 Plans (the “Plans”"Plans") are summarized as follows:
| | | | Outstanding Options | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Shares Available For Grant | Options Exercised | Number of Shares | Price Per Share | Aggregate Price | Weighted Average Exercise Price | ||||||||||
| Balance, January 1, 2001 | 587 | 1,055 | 2,755 | $ | 0.36–100.63 | $ | 91,858 | $ | 33.34 | |||||||
| Options authorized | 375 | — | — | — | — | — | ||||||||||
| Options granted | (2,450 | ) | — | 2,450 | 0.11–6.19 | 5,566 | 2.27 | |||||||||
| Options exercised | — | 66 | (66 | ) | 0.11–3.60 | (59 | ) | 0.89 | ||||||||
| Options terminated | 2,144 | — | (2,235 | ) | 0.52–100.63 | (75,454 | ) | 33.76 | ||||||||
| Restricted stock issued | (13 | ) | — | — | — | — | — | |||||||||
| Repurchases of unvested shares | 5 | — | — | — | — | — | ||||||||||
| Balance, December 31, 2001 | 648 | 1,121 | 2,904 | 0.11–68.25 | 21,911 | 7.54 | ||||||||||
| Options authorized | 1,175 | — | — | — | — | — | ||||||||||
| Options granted | (2,371 | ) | — | 2,371 | 0.76–1.81 | 3,208 | 1.35 | |||||||||
| Options exercised | — | 11 | (11 | ) | 0.48–1.45 | (12 | ) | 1.09 | ||||||||
| Options terminated | 1,104 | — | (1,060 | ) | 0.11–54.88 | (4,799 | ) | 4.53 | ||||||||
| Balance, December 31, 2002 | 556 | 1,132 | 4,204 | 0.11–68.25 | 20,308 | 4.83 | ||||||||||
| Options authorized | 375 | |||||||||||||||
| Options granted | (604 | ) | 604 | 1.25–5.77 | 1,405 | 2.33 | ||||||||||
| Options exercised | 440 | (440 | ) | 0.11–3.75 | (831 | ) | 1.89 | |||||||||
| Options terminated | 719 | (719 | ) | 1.21–54.88 | (1,364 | ) | 1.89 | |||||||||
| Balance, December 31, 2003 | 1,046 | 1,572 | 3,649 | $ | 0.11-68.25 | $ | 19,518 | $ | 5.35 | |||||||
Shares Available For Grant | Options Exercised | Outstanding Options | ||||||||||||||||
Number of Shares | Price Per Share | Aggregate Price | Weighted Average Exercise Price | |||||||||||||||
Balance, January 1, 2000 | 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 | 644 |
| — | (698 | ) |
| 0.48– 94.50 |
| (25,146 | ) |
| 36.03 | ||||||
Restricted stock issued | (46 | ) | — | — |
|
| — |
| — |
|
| — | ||||||
Balance, December 31, 2000 | 587 |
| 1,055 | 2,755 |
|
| 0.36– 100.63 |
| 91,858 |
|
| 33.34 | ||||||
Options authorized | 375 |
| — | — |
|
| — |
| — |
|
| — | ||||||
Options granted | (2,450 | ) | — | 2,450 |
|
| 0.11– 6.19 |
| 5,566 |
|
| 2.27 | ||||||
Options exercised | — |
| 66 | (66 | ) |
| 0.11– 3.60 |
| (59 | ) |
| 0.89 | ||||||
Options terminated | 2,144 |
| — | (2,235 | ) |
| 0.52– 100.63 |
| (75,454 | ) | ||||||||
Restricted stock issued | (13 | ) | — | — |
|
| — |
| — |
|
| — | ||||||
Repurchases of unvested shares | 5 |
| — | — |
|
| — |
| — |
|
| — | ||||||
Balance, December 31, 2001 | 648 |
| 1,121 | 2,904 |
|
| 0.11– 68.25 |
| 21,911 |
|
| 7.54 | ||||||
Options authorized | 1,175 |
| — | — |
|
| — |
| — |
|
| — | ||||||
Options granted | (2,371 | ) | — | 2,371 |
|
| 0.76– 1.81 |
| 3,208 |
|
| 1.35 | ||||||
Options exercised | — |
| 11 | (11 | ) |
| 0.48– 1.45 |
| (12 | ) |
| 1.08 | ||||||
Options terminated | 1,104 |
| — | (1,135 | ) |
| 0.11– 54.88 |
| (4,799 | ) |
| 4.23 | ||||||
Balance, December 31, 2002 | 556 |
| 1,132 | 4,129 |
| $ | 0.11–$ 68.25 | $ | 20,308 |
| $ | 4.92 | ||||||
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
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, which were cancelled in September 2002.
In addition, during 2001 and 2000 restricted stock was granted with repurchase rights which lapse over an eighteen month period to certain employees as part of the acquisitions of FreeGate, the OneWorld assets and ActiveTelco. The unearned compensation associated with restricted stock grants is amortized on a straight line basis over the eighteen month period. Accordingly, the Company amortized $17, $502 and $1,107 for the years ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2002, all amortization related to these restricted stock grants had been recorded.
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. In September 2001, the Company further reduced this deferred compensation by $101 to $1,468 before amortization, reflecting employee terminations through September 2001. This deferred compensation was amortized over the vesting period relating to these options. The Company amortized $182 and $438 for the years ended December 31, 2001 and 2000, respectively. At December 31, 2001, this deferred compensation had been fully amortized.
The Company uses the Black-Scholes option pricing model to value options granted to consultants. The total estimated fair value of these grants during the periods presented was not significant and was expensed over the applicable vesting periods. No options were granted to consultants during 2003.
At December 31, 2001, 2002, 2001 and 2000,2003, vested options to purchase 1,108, 2,014, 1,108 and 4182,432 shares of common stock, respectively were unexercised. The weighted average exercise price of these options was $11.75, $8.29 $11.75 and $19.92$8.29, per share for 2001, 2002, 2001 and 2000,2003, respectively.
71
The following table summarizes information about stock options outstanding at December 31, 2002:2003:
Options Outstanding | Options Exercisable | |||||||||||
Range of Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||
$ 0.11 – $ 1.09 | 198 | 7.44 | $ | 0.74 | 134 | $ | 0.75 | |||||
1.21 – 1.21 | 870 | 9.85 |
| 1.21 | 187 |
| 1.21 | |||||
1.34 – 1.36 | 82 | 9.01 |
| 1.34 | 20 |
| 1.34 | |||||
1.41 – 1.41 | 695 | 9.87 |
| 1.41 | 50 |
| 1.41 | |||||
1.45 – 1.47 | 381 | 9.11 |
| 1.45 | 215 |
| 1.45 | |||||
1.49 – 1.49 | 500 | 8.48 |
| 1.49 | 302 |
| 1.49 | |||||
1.75 – 2.00 | 162 | 9.19 |
| 1.79 | 89 |
| 1.79 | |||||
2.15 – 2.15 | 452 | 8.95 |
| 2.15 | 374 |
| 2.15 | |||||
2.40 – 22.94 | 517 | 7.22 |
| 8.83 | 399 |
| 9.16 | |||||
28.00 – 68.25 | 347 | 7.39 |
| 42.44 | 244 |
| 44.57 | |||||
4,204 | 2,014 | |||||||||||
TUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(in thousands, except per share amounts)
| | Options Outstanding | Options Exercisable | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Range of Exercise Prices | Number Outstanding | Weighted Average Remaining Contractual Life (years) | Weighted Average Exercise Price | Number Exercisable | Weighted Average Exercise Price | |||||||
| $ 0.36–1.09 | 193 | 6.42 | $ | 0.75 | 182 | $ | 0.76 | |||||
| 1.21–1.21 | 621 | 8.85 | 1.21 | 332 | 1.21 | |||||||
| 1.25–1.41 | 430 | 8.89 | 1.40 | 189 | 1.41 | |||||||
| 1.43–1.49 | 907 | 7.99 | 1.47 | 628 | 1.48 | |||||||
| 1.58–2.00 | 172 | 8.47 | 1.74 | 139 | 1.78 | |||||||
| 2.09–2.40 | 472 | 7.91 | 2.18 | 274 | 2.22 | |||||||
| 3.50–3.75 | 266 | 7.49 | 3.72 | 206 | 3.75 | |||||||
| 4.45–8.00 | 105 | 9.61 | 4.72 | 29 | 4.83 | |||||||
| 15.00–39.00 | 303 | 6.06 | 27.06 | 284 | 26.88 | |||||||
| 41.75–68.25 | 180 | 6.33 | 52.87 | 169 | 53.29 | |||||||
| 3,649 | 2,432 | |||||||||||
Employee stock purchase plan
The Company’sCompany's 1998 Employee Stock Purchase Plan (the “1998"1998 Purchase Plan”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’sCompany'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. In 1998, the Company reserved 250 shares of common stock for issuance under the 1998 Purchase Plan. In 2001, the Company allocated an additional 250 shares of common stock, increasing the number of shares reserved for issuance under the 1998 Purchase Plan to 500 of which 224263 have been issued, leaving 276237 for future issuances under the 1998 Purchase Plan as of December 31, 2002.2003. The 1998 Purchase Plan is subject to annual increases, subject to certain limitations.
401(k) plan
In April 1995, the Company adopted the Tut Systems’Systems' Inc. 401(k) Plan (the “401(k) Plan”"401(k) Plan") covering all eligible employees. Through December 31, 2001, contributions were limited to 15% of each employee’semployee's annual compensation, and further limited by IRS annual contribution limitations. Effective January 1, 2002, contributions are allowed up to 100% of each employee’semployee's annual compensation, but are still limited by IRS annual contribution limitations, depending on the age of the eligible employee. Contributions to the 401(k) Plan by the Company are discretionary. The Company did not make any contributions for the years ended December 31, 2001, 2002, 2001 and 2000.2003.
72
NOTE 12—SEGMENT INFORMATION:
Revenue
The Company currently targets its sales and marketing efforts to both public and private service providers and users across two related markets. The Company currently operates in a single business segment as there is only one measurement of profitability for its operations. Revenue relating to the broadband transport and service management products was $13,748, $8,245 and $8,263 for the years ended December 31, 2001, 2002 and 2003 respectively. Revenue related to video processing systems was $0, $1,126 and $23,929 for the years ended December 31, 2001, 2002 and 2003 respectively. Revenues are attributed to the following countries based on the location of customers:
| | Years Ended December 31, | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | 2001 | 2002 | 2003 | |||||||
| United States | $ | 6,007 | $ | 5,345 | $ | 26,263 | ||||
| International: | ||||||||||
| Japan | 5,331 | 1,340 | 393 | |||||||
| Korea | 3 | — | — | |||||||
| All other countries | 2,407 | 2,686 | 5,536 | |||||||
| $ | 13,748 | $ | 9,371 | $ | 32,192 | |||||
Years Ended December 31, | |||||||||
2002 | 2001 | 2000 | |||||||
United States | $ | 5,345 | $ | 6,007 | $ | 42,474 | |||
International: | |||||||||
Japan |
| 1,340 |
| 5,331 |
| 5,500 | |||
Korea |
| — |
| 3 |
| 12,791 | |||
All other countries |
| 2,686 |
| 2,407 |
| 11,226 | |||
$ | 9,371 | $ | 13,748 | $ | 71,991 | ||||
It is impracticableTwo customers, Kanematsu Computer System Ltd. and RIKEI Corporation, accounted for 19% and 16%, respectively, of the Company's revenue for the Company to compute product revenues by product type for the yearsyear ended December 31, 2002, 2001 and 2000.
2001. One customer, Ingram Micro, accounted for 11% of the Company’sCompany's revenue for the year ended December 31, 2002. Two customers, Kanematsu Computer System Ltd. and RIKEI Corporation, respectivelyNo individual customer accounted for 19% and 16%, respectively,greater than 10% of the Company’sCompany's revenue for the year ended December 31, 2001. Three customers, TriGemm InfoComm, Inc., Reflex Communications, Inc. and Darwin Networks Inc., accounted for 18%, 12% and 11%, respectively, of the Company’s revenue for the year ended December 31, 2000.
TUT SYSTEMS, INC.Products
The Company designs, develops, and sells video processing systems and broadband transport and service management products. Video processing systems include both digital TV headend systems and video systems. The digital TV headend system enables telephony-based service providers to transport broadcast quality digital video signals across their networks and our digital video transmission systems optimize the delivery of video signals across enterprise, government and education networks. The broadband transport and service management products enable the transmission of broadband data over existing hotels and private campus networks.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)73
(in thousands, except per share amounts)
Long-lived Assets
The Company has long-lived assets, which consist of property and equipment, intangibles, and other assets. Long-lived assets are located in the following countries:
December 31, | ||||||
2002 | 2001 | |||||
United States | $ | 4,555 | $ | 11,711 | ||
United Kingdom |
| 2,661 |
| 3,783 | ||
$ | 7,216 | $ | 15,494 | |||
| | December 31, | |||||
|---|---|---|---|---|---|---|
| | 2002 | 2003 | ||||
| United States | $ | 4,555 | $ | 3,654 | ||
| United Kingdom | 2,661 | 1,753 | ||||
| $ | 7,216 | $ | 5,407 | |||
NOTE 13—TENDER OFFER:
On May 14, 2001, the Company made an offer to exchange all stock options outstanding under its 1992 Stock Plan, 1998 Stock Plan and the 1999 Nonstatutory Stock Option Plan to purchase shares of the Company’sCompany's common stock held by eligible employees for new stock options that willwere be granted under the Company’sCompany's 1998 Stock Plan or the 1999 Nonstatutory Stock Option Plan, upon the terms and subject to the conditions set forth in the Offer to Exchange. An “eligible employee”"eligible employee" refers to all employees of Tut Systems, Inc. and its U.S. subsidiaries who were employees at the time the new stock options were granted, other than all executive officers, vice-presidents, members of the Board of Directors and employees receiving Workers’Workers' Adjustment and Retraining Notification Act pay, all of whom were not eligible to participate in the offer. The number of shares of common stock subject to the new stock options would be equal to the number of shares of common stock subject to the unexercised stock options tendered by such eligible employees and accepted for exchange and cancelled. The offer expired on June 8, 2001. Pursuant to the offer, the Company accepted, for cancellation, stock options to purchase approximately 1,057 shares of the Company’sCompany's common stock at a weighted average exercise price of $35.99. Subject to the terms and conditions of the offer, the Company granted new stock options to purchase 851 shares of the Company’sCompany's common stock on December 13, 2001 at an exercise price of $2.15 to those employees who were employed by the Company at that time, in exchange for the stock options tendered in response to the offer and accepted for exchange and cancelled. ThereIn accordance withFIN 44: Accounting for Certain Transactions involving Stock Compensation an interpretation, there was no compensation charge related to the exchange.
NOTE 14—PRODUCT WARRANTY
The Company generally warrants its products for a specific period of time against material defects. The Company provides for the estimated future costs of warranty obligations in costs of goods sold when the related revenue is recognized. The accrued warranty costs represents the best estimate at the time of sale of the total costs that the Company expects to incur to repair or replace product parts, which fail while still under warranty. The amount of accrued estimated warranty costs are primarily based on historical experience as to product failure as well as current information on repair costs. On a quarterly basis, the Company reviews the accrued balances and updates the historical warranty cost trends. The following table reflects the change in the Company’s warranty accrual duringWarranty costs for the year ended December 31, 2002.
2002 | ||||
Balance, January 1 | $ | 326 |
| |
Charges to costs and expenses |
| (215 | ) | |
Actual warranty expenditures |
| (11 | ) | |
Balance, December 31 | $ | 100 |
| |
REPORT OF INDEPENDENT ACCOUNTANTS
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 80 present fairly, in all material respects, the financial position of Tut Systems, Inc. and its subsidiaries at December 31,2001, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 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 15(a)(2) on page 80 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 is2003 were immaterial 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.statements.
74
SUPPLEMENTARY DATA
The following table presents certain unaudited consolidated quarterly financial information for each of the eight quarters ended December 31, 2002.2003. 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.
| | Quarter Ended | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Mar. 31, 2002 | Jun. 30, 2002 | Sep. 30, 2002 | Dec. 31, 2002(4) | Mar. 31, 2003(4) | Jun. 30, 2003(4) | Sep. 30, 2003(4) | Dec. 31, 2003(4) | |||||||||||||||||
| | (in thousands, except per share data) (unaudited) | ||||||||||||||||||||||||
| Total revenues | $ | 2,358 | $ | 2,514 | $ | 2,035 | $ | 2,464 | $ | 6,601 | $ | 7,865 | $ | 8,522 | $ | 9,204 | |||||||||
| Gross profit (loss) | 835 | (4,054 | ) | 786 | (2,105 | ) | 3,342 | 3,850 | 4,771 | 4,583 | |||||||||||||||
| Net loss | (6,781 | )(3) | (11,972 | )(2) | (5,867 | ) | (17,005 | )(1) | (2,231 | ) | (2,025 | ) | (742 | ) | (519 | ) | |||||||||
| Net loss per share, basic and diluted | $ | (0.41 | ) | $ | (0.73 | ) | $ | (0.36 | ) | $ | (0.92 | ) | $ | (0.11 | ) | $ | (0.10 | ) | $ | (0.04 | ) | $ | (0.03 | ) | |
| Shares used in computing net loss per share, basic and diluted | 16,407 | 16,455 | 16,482 | 18,460 | 19,801 | 19,894 | 20,040 | 20,202 | |||||||||||||||||
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Quarter Ended | ||||||||||||||||||||||||||||||||
Dec. 31, 2002 | Sep. 30, 2002 | Jun. 30, 2002 | Mar. 31, 2002 | Dec. 31, 2001 | Sep. 30, 2001 | Jun. 30, 2001 | Mar. 31, 2001 | |||||||||||||||||||||||||
(in thousands, except per share data) | ||||||||||||||||||||||||||||||||
(unaudited) | ||||||||||||||||||||||||||||||||
Total revenues | $ | 2,464 |
| $ | 2,035 |
| $ | 2,514 |
| $ | 2,358 |
| $ | 2,172 |
| $ | 3,967 |
| $ | 2,722 |
| $ | 4,887 |
| ||||||||
Gross (loss) margin |
| (2,105 | ) |
| 786 |
|
| (4,054 | ) |
| 835 |
|
| (588 | ) |
| (10,648 | ) |
| 179 |
|
| (16,860 | ) | ||||||||
Net loss |
| (17,005 | )(1) |
| (5,867 | ) |
| (11,972 | )(2) |
| (6,781 | )(3) |
| (6,526 | )(4) |
| (49,832 | )(5) |
| (13,999 | ) |
| (33,969 | )(6) | ||||||||
Net loss per share, basic and | $ | (0.92 | ) | $ | (0.36 | ) | $ | (0.73 | ) | $ | (0.41 | ) | $ | (0.40 | ) | $ | (3.05 | ) | $ | (0.86 | ) | $ | (2.10 | ) | ||||||||
Shares used in computing net loss per share, basic and diluted |
| 18,460 |
|
| 16,482 |
|
| 16,455 |
|
| 16,407 |
|
| 16,395 |
|
| 16,353 |
|
| 16,316 |
|
| 16,213 |
| ||||||||
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 or auditing scope of procedure that would require our independent accountants to qualify or disclaimmake reference to such disagreement in their report on our consolidated financial statements and financial statement schedule, or otherwise require disclosure in this Amendment No. 1 to the Annual Report on Form 10-K.
75
ITEM 9A. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2003. This evaluation included various steps that our Chief Executive Officer and Chief Financial Officer undertook in an effort to ensure that information required to be disclosed in our SEC reports is recorded, processed, summarized and reported within the time periods specified by the SEC. This evaluation also included consideration of our internal controls and procedures for the preparation of our financial statements.
In connection with the completion of its audit of our financial statements for the year ended December 31, 2003, PricewaterhouseCoopers LLP advised management and the audit committee of the Board of Directors that it had identified deficiencies in our internal controls and processes relating to inventory management and reporting that it considers to be material weaknesses, as defined by Statement on Auditing Standards No. 60, "Communication of Internal Control Related Matters Noted in an Audit." PricewaterhouseCoopers LLP identified the following two material weaknesses in our internal controls and processes:
These material weaknesses may also constitute deficiencies in our disclosure controls. In light of these material weaknesses and the requirements enacted by the Sarbanes-Oxley Act of 2002 and the related rules and regulations adopted by the SEC, our Chief Executive Officer and Chief Financial Officer concluded, as of December 31, 2003, that our disclosure controls and procedures needed improvement and were not adequately effective. Management believes that there are no material inaccuracies, or omissions of material facts necessary to make the statements not misleading in light of the circumstances under which they were made, in this Form 10-K/A.
The Company’saudit committee is taking an active role in responding to the deficiencies identified by PricewaterhouseCoopers LLP, including overseeing management's implementation of corrective measures. In this regard, we are in the process of implementing the following measures:
Management believes its new controls and procedures will address the conditions identified by PricewaterhouseCoopers LLP as material weaknesses. We plan to continue to monitor the effectiveness of our internal controls and procedures on an ongoing basis and will take further action as appropriate.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's Proxy Statement for its 20022003 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended, (the “Exchange Act”),or the Exchange Act, will be incorporated by reference in this Amendment No. 1 to the Annual Report on Form 10-K10-K/A pursuant to General Instruction G(3) and will provide the information required in Item 10.
76
Section 16(a) Beneficial Ownership Reporting Compliance
With respect to Section 16(a) compliance, the Company’sCompany's Proxy Statement for its 20022003 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Exchange Act, will be incorporated by reference in this Amendment No. 1 to the Annual Report on Form 10-K10-K/A pursuant to General Instruction G(3) and will provide the information required in Item 10.
ITEM 11. EXECUTIVE COMPENSATION
The Company’sCompany's Proxy Statement for its 20022003 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Exchange Act, will be incorporated by reference in this Amendment No. 1 to the Annual Report on Form 10-K10-K/A 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’sCompany's Proxy Statement for its 20022003 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Exchange Act, will be incorporated by reference in this Amendment No. 1 to the Annual Report on Form 10-K10-K/A pursuant to General Instruction G(3) and will provide the information required in Item 12.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company’sCompany's Proxy Statement for its 20022003 Annual Meeting of Stockholders, when filed pursuant to Regulation 14A under the Exchange Act, will be incorporated by reference in this Amendment No. 1 to the Annual Report on Form 10-K10-K/A pursuant to General Instruction G(3) and will provide the information required in Item 13.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
EvaluationThe Company's Proxy Statement for its 2003 Annual Meeting of disclosure controls and procedures. Based onStockholders, when filed pursuant to Regulation 14A under the evaluation as of a date within 90 days ofExchange Act, will be incorporated by reference in this Amendment No. 1 to the filing date of this annual reportAnnual Report on Form 10-K, our Chief Executive Officer10-K/A pursuant to General Instruction G(3) and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) underwill provide the Securities Exchange Act of 1934, as amended) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.Item 14.
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Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore, there were no corrective actions taken.ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
PART IV
1. Financial Statements
The following documents are filed as part of this Amendment No. 1 to the Annual Report on Form 10-K:
10-K/A:
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| Report of Independent Auditors |
43 | |
Consolidated Balance Sheets as of December 31, 2002 and |
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Consolidated Statements of Operations for the years ended December 31, 2001, 2002 |
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Consolidated Statements of |
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Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2002 |
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Notes to Consolidated Financial Statements |
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2. Financial Statements Schedules
The following financial statement schedule is filed as part of this Amendment No. 1 to the Annual Report on Form 10-K:10-K/A:
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 certifications are filed as part of, or incorporated by reference into, this Amendment No. 1 to the Annual Report on Form 10-K.10-K/A.
(b) Reports on Form 8-K
None
We filed the following Reports on Form 8-K during the fourth quarter ended December 31, 2002:78
Form 8-K dated October 29, 2002 regarding our issuance of a press release on October 28, 2002 announcing that we had signed a definitive agreement with Tektronix, Inc. to acquire VideoTele.com, Inc., a subsidiary of Tektronix, Inc.
Form 8-K dated November 12, 2002 regarding our issuance of a press release on November 7, 2002, announcing that we closed the transaction contemplated by a definitive agreement dated as of October 28, 2002, as amended as of November 7, 2002, by and among Tut Systems, Inc., Tiger Acquisition Corp., Tektronix, Inc. and VideoTele.com, Inc.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 2003April 7, 2004
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TUT SYSTEMS, INC. | ||||
/s/ SALVATORE D'AURIA Salvatore D'Auria President and Chief Executive Officer (Principal Executive Officer) | ||||
By: | /s/ RANDALL K. GAUSMAN Randall K. Gausman Vice President, Finance and
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KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Salvatore D’AuriaD'Auria and Douglas C. Shafer,Randall K. Gausman, 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 Amendment No. 1 to the Annual Report on Form 10-K,10-K/A, 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 Exchange Act of 1934, as amended, this Amendment No. 1 to the Annual Report on Form 10-K10-K/A has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
| Signature | Title | Date | |||
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| /s/ SALVATORE D'AURIA Salvatore D'Auria |
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| President, Chief Executive Officer and Chairman of the Board |
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April 7, 2004 | |||
Neal Douglas |
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April 7, 2004 | ||
Clifford H. Higgerson |
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April 7, 2004 | ||
George M. Middlemas |
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April 7, 2004 | ||
Roger H. Moore |
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April 7, 2004 |
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SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
| | Balance at Beginning of Period | Additions (reductions) to Costs and Expenses | Write-offs | Reclasses from Other Accounts | Balance at End of Period | ||||||
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| Allowance for doubtful accounts: | |||||||||||
| Year ended December 31, 2001 | 21,167 | (954 | )(1) | (13,305 | ) | — | 6,908 | ||||
| Year ended December 31, 2002 | 6,908 | (2,277 | )(2) | (5,821 | ) | 1,200 | (5) | 10 | |||
| Year ended December 31, 2003 | 10 | 37 | — | — | 47 | ||||||
Allowance for doubtful notes receivable: | |||||||||||
| Year ended December 31, 2001 | — | 3,820 | — | — | 3,820 | ||||||
| Year ended December 31, 2002 | 3,820 | 89 | (3) | (3,909 | )(4) | — | — | ||||
| Year ended December 31, 2003 | — | — | — | — | — | ||||||
Valuation allowance for deferred tax assets: | |||||||||||
| Year ended December 31, 2001 | 55,241 | 31,386 | — | — | 86,627 | ||||||
| Year ended December 31, 2002 | 86,627 | 18,428 | — | — | 105,055 | ||||||
| Year ended December 31, 2003 | 105,055 | 2,604 | — | — | 107,659 | ||||||
Allowance for excess and obsolete inventory and abandoned product: | |||||||||||
| Year ended December 31, 2001 | 13,755 | 34,237 | (6,412 | ) | 11,752 | (6) | 53,332 | ||||
| Year ended December 31, 2002 | 53,332 | 7,125 | (22,739 | ) | — | 37,718 | |||||
| Year ended December 31, 2003 | 37,718 | (1,266 | )(7) | (36,227 | ) | — | 225 | ||||
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Balance at Beginning of Period | Additions (reductions) to Costs and Expenses | Write-offs | Reclasses from Other Accounts | Balance at End of Period | |||||||||
Allowance for doubtful accounts: | |||||||||||||
Year ended December 31, 2000 | 335 | 22,546 |
| (1,714 | ) | — |
| 21,167 | |||||
Year ended December 31, 2001 | 21,167 | (954 | )(1) | (13,305 | ) | — |
| 6,908 | |||||
Year ended December 31, 2002 | 6,908 | (2,277 | )(2) | (5,821 | ) | 1,200 | (5) | 10 | |||||
Allowance for doubtful notes receivable: | |||||||||||||
Year ended December 31, 2000 | — | — |
| — |
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Year ended December 31, 2001 | — | 3,820 |
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| 3,820 | |||||
Year ended December 31, 2002 | 3,820 | 89 | (3) | (3,909 | )(4) | — |
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Valuation allowance for deferred tax assets: | |||||||||||||
Year ended December 31, 2000 | 19,751 | 35,490 |
| — |
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| 55,241 | |||||
Year ended December 31, 2001 | 55,241 | 31,386 |
| — |
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| 86,627 | |||||
Year ended December 31, 2002 | 86,627 | 18,428 |
| — |
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| 105,055 | |||||
Allowance for excess and obsolete inventory and abandoned product: | |||||||||||||
Year ended December 31, 2000 | 418 | 14,468 |
| (1,131 | ) | — |
| 13,755 | |||||
Year ended December 31, 2001 | 13,755 | 34,237 |
| (6,412 | ) | 11,752 | (6) | 53,332 | |||||
Year ended December 31, 2002 | 53,332 | 7,125 |
| (22,739 | ) | — |
| 37,718 |
| Exhibit Number | Description | |
|---|---|---|
I, Salvatore D’Auria, certify that:
Date: March 31, 2003
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I, Douglas C. Shafer, certify that:
Date: March 31, 2003
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INDEX TO EXHIBITS
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| Agreement and Plan of Merger by and among Tut Systems, Inc., Tiger Acquisition Corporation, Tektronix, Inc. and VideoTele.com, Inc. dated as of October 28, 2002. | |
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10.7 |
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10.8 |
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10.9 |
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10.10 |
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10.11 |
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10.12* |
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10.13* |
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10.14* |
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10.15* |
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10.16 |
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10.17 |
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10.18 | Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of Xstreamis plc and Philip Corbishley.(5) | |
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11.1 | Calculation of earnings per share (contained in Note 2 of Notes to Consolidated Financial Statements). | |
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31.1 | Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. | |
31.2 |
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32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 |
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