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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2000
Commission File Number: 000 - 25291
TUT SYSTEMS, INC.
-----------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-2958543
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2495 Estand Way, Pleasant Hill, California 94523
------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (925) 682-6510
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ]No [ ]
As of April 30, 2000, 15,126,480 shares of the Registrant's Common Stock, $0.001
par value per share, were issued and outstanding.
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TUT SYSTEMS, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
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Item 1. Condensed Consolidated Financial Statements (unaudited): Condensed
Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999.... 3
Condensed Consolidated Statements of Operations for the three months
ended March 31, 2000 and March 31, 1999................................... 4
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2000 and March 31, 1999................................... 5
Notes to Unaudited Condensed Consolidated Financial Statements............ 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk................ 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................... 27
Item 2. Changes in Securities and Use of Proceeds................................. 27
Item 3. Defaults Upon Senior Securities........................................... 27
Item 4. Submission of Matters to a Vote of Security Holders....................... 27
Item 5. Other Information......................................................... 27
Item 6. Exhibits and Reports on Form 8-K.......................................... 27
</TABLE>
2
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<TABLE>
<CAPTION>
Part I. FINANCIAL INFORMATION
Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)
March 31, December 31,
2000 1999
--------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 157,248 $ 13,405
Short-term investments ...................................... 9,246 18,831
Accounts receivable, net of allowance for doubtful accounts
of $335 in 2000 and 1999 ................................. 10,378 11,742
Inventories ................................................. 11,692 8,401
Prepaid expenses and other .................................. 3,007 3,746
--------- ---------
Total current assets ...................................... 191,571 56,125
Property and equipment, net ................................. 4,188 3,476
Other assets ................................................ 32,706 5,755
--------- ---------
Total assets .............................................. $ 228,465 $ 65,356
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................... $ 6,286 $ 5,859
Accrued liabilities ....................................... 6,297 3,551
Line of credit ............................................ 1,571 1,529
Deferred revenue .......................................... 815 770
--------- ---------
Total current liabilities ............................... 14,969 11,709
Deferred revenue, net of current portion .................... 2,338 2,125
Other liabilities ........................................... 376 --
--------- ---------
Total liabilities ....................................... 17,683 13,834
--------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Common stock, $0.001 par value, 100,000 shares authorized,
15,088 and 11,941 shares issued and outstanding in
2000 and 1999, respectively ............................. 15 12
Additional paid in capital .................................. 275,037 108,969
Deferred compensation ....................................... (2,690) (972)
Accumulated comprehensive income ............................ 515 --
Notes receivable from stockholders .......................... (1,372) --
Accumulated deficit ......................................... (60,723) (56,487)
--------- ---------
Total stockholders' equity .............................. 210,782 51,522
--------- ---------
Total liabilities and stockholders' equity .............. $ 228,465 $ 65,356
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
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<TABLE>
<CAPTION>
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
Three months ended
March 31,
------------------------
2000 1999
-------- --------
<S> <C> <C>
Revenues:
Product ............................................ $ 16,164 $ 3,573
License and royalty ................................ 310 318
-------- --------
Total revenues ................................... 16,474 3,891
-------- --------
Cost of goods sold:
Product ............................................ 9,137 2,239
License and royalty ................................ -- 3
-------- --------
Total cost of goods sold ......................... 9,137 2,242
-------- --------
Gross margin ........................................... 7,337 1,649
-------- --------
Operating expenses:
Sales and marketing ................................ 4,819 2,401
Research and development ........................... 3,183 1,671
General and administrative ......................... 2,175 987
In-process research and development ................ 800 --
Amortization of intangibles ........................ 746 --
Noncash compensation expense ....................... 114 114
-------- --------
Total operating expenses ......................... 11,837 5,173
-------- --------
Loss from operations ................................... (4,500) (3,524)
Interest expense ....................................... (310) (176)
Interest income and other .............................. 575 389
-------- --------
Loss before income taxes ............................... (4,235) (3,311)
Income tax expense ..................................... 1 1
-------- --------
Net loss ............................................... (4,236) (3,312)
Dividend accretion on preferred stock .................. -- 235
-------- --------
Net loss attributable to common stockholders ........... $ (4,236) $ (3,547)
======== ========
Net loss per share attributable to common stockholders,
basic and diluted (Note 3) ......................... $ (0.34) $ (0.45)
======== ========
Shares used in computing net loss attributable to common
stockholders, basic and diluted (Note 3) ........... 12,435 7,872
======== ========
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
4
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<TABLE>
<CAPTION>
TUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months ended
March 31,
--------------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss ................................................................... $ (4,236) $ (3,312)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................ 307 176
Provision for allowance for doubtful accounts ............................ -- 50
Provision for excess and obsolete inventory .............................. 732 107
Amortization of premiums (discounts) on investments ...................... 85 (14)
Amortization of deferred compensation included in research and development 260 --
Amortization of intangible assets and noncash compensation ............... 860 114
Write-off of in-process research and development ........................ 800 --
Gain on sale of other assets ............................................. (103) --
Change in assets and liabilities:
Accounts receivable .................................................... 679 (950)
Inventories ............................................................ (3,822) 201
Prepaid expenses and other assets ...................................... (1,649) (1,364)
Accounts payable and accrued liabilities ............................... 246 (75)
Deferred revenue ....................................................... (181) 436
--------- ---------
Net cash used in operating activities ............................... (6,022) (4,631)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment ......................................... (698) (187)
Purchase of short-term investments ......................................... -- (3,096)
Proceeds from maturities and sale of short-term investments ................ 9,500 --
Proceeds from sale of other assets ......................................... 128 --
Acquisition of business, net of cash acquired and purchased
research and development ................................................. (1,292) --
--------- ---------
Net cash provided by (used in) investing activities ................ 7,638 (3,283)
--------- ---------
Cash flows from financing activities:
Payment on lines of credit ................................................. -- (2,882)
Proceeds from lines of credit .............................................. 42 --
Proceeds from issuances of common and preferred stock, net ................. 142,185 53,607
--------- ---------
Net cash provided by financing activities ........................... 142,227 50,725
--------- ---------
Net increase in cash and cash equivalents ........................... 143,843 42,811
Cash and cash equivalents, beginning of period ................................. 13,405 4,452
--------- ---------
Cash and cash equivalents, end of period ....................................... $ 157,248 $ 47,263
========= =========
Supplemental disclosure of cash flow information:
Noncash financing activities:
Common stock issued in connection with Freegate ............................ $ 21,887 $ --
========= =========
Accretion of preferred stock ............................................... $ -- $ 235
========= =========
========= =========
Conversion of preferred stock to common stock .............................. $ -- $ 47,802
========= =========
Unearned compensation related to stock option grants ....................... $ 1,999 $ --
========= =========
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
5
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TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
1. The Company:
Tut Systems, Inc. (the "Company") was founded in 1983 and began operations in
August 1991. The Company designs, develops and markets advanced communications
products which enable high-speed data access over the copper infrastructure of
telephone companies, as well as the copper telephone wires in homes, businesses
and other buildings. The Company's products incorporate high-bandwidth access
multiplexers, associated modems and routers, Ethernet extension products and
integrated network management software.
2. Basis of Presentation:
The accompanying condensed consolidated financial statements for the three
months ended March 31, 2000 and 1999 are unaudited. The unaudited interim
condensed consolidated financial statements have been prepared on the same basis
as the annual financial statements and, in the opinion of management, reflect
all adjustments, which include only normal recurring adjustments, necessary to
present fairly the Company's financial position, results of operations and cash
flows as of and for the three months ended March 31, 2000 and 1999. These
condensed consolidated financial statements and notes thereto are unaudited and
should be read in conjunction with the Company's audited financial statements
included in the Company's Prospectus, filed with the Securities and Exchange
Commission on March 23, 2000. The balance sheet as of December 31, 1999 was
derived from audited financial statements, but does not include all required
disclosures required by generally accepted accounting principles. The results
for the three months ended March 31, 2000 are not necessarily indicative of the
expected results for any other interim period or the year ending December 31,
2000.
3. Summary of Significant Accounting Policies:
Net Loss Per Share:
The Company computes net loss per share in accordance with SFAS No. 128,
"Earnings per Share." Under the provision of SFAS No. 128, basic and diluted net
loss per share is computed by dividing the net loss available to common
stockholders for the period by the weighted average number of common shares
outstanding during the period. Options, warrants and preferred stock were not
included in the computation of diluted net loss per share because the effect
would be antidilutive.
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Three months ended
March 31,
----------------------------
2000 1999
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<S> <C> <C>
Net loss per share attributable to common stockholders,
basic and diluted:
Net loss attributable to common stockholders $ (4,236) $ (3,547)
========= ========
Net loss per share attributable to common stockholders,
basic and diluted $ (0.34) $ (0.45)
========= ========
Shares used in computing net loss attributable to common
stockholders, basic and diluted 12,435 7,872
========= ========
Antidilutive securities including options, warrants and
preferred stock not included in net loss per share
attributable to common stockholders' calculations 2,137 1,017
========= ========
</TABLE>
6
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TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in thousands, except per share amounts)
3. Summary of Significant Accounting Policies, continued:
Comprehensive Loss
Comprehensive loss includes unrealized gains and losses on equity securities
that have been previously excluded from net loss and reflected instead in
stockholders' equity. The following table sets forth the calculation of
comprehensive loss on an interim basis:
<TABLE>
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Three months ended
March 31,
----------------------
2000 1999
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<S> <C> <C>
Net loss ................................ $(4,236) $(3,547)
Unrealized gains on long-term investments $ 515 $ --
------- -------
Total comprehensive loss ................ $(3,721) $(3,547)
======= =======
</TABLE>
7
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TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in thousands, except per share amounts)
3. Summary of Significant Accounting Policies, continued:
Impact of Recently Issued Accounting Standards:
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company, to date, has not engaged in derivative and hedging
activities, and accordingly does not believe that the adoption of SFAS No. 133
will have a material impact on the financial reporting and related disclosures
of the Company. The Company will adopt SFAS No. 133 as required by SFAS No. 137,
"Deferral of the Effective Date of the FASB Statement No. 133," beginning with
the third quarter of fiscal 2000.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the SEC. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. Management
believes that the impact of SAB 101 will not have a material effect on the
financial position or results of the operations of the Company.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, "Accounting for Certain Transactions Involving Stock Compensation-an
interpretation of APB Opinion No. 25" ("FIN 44"). This Interpretation clarifies
the definition of employee for purposes of applying Accounting Practice Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), the
criteria for determining whether a plan qualifies as a noncompensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination. This Interpretation is effective
July 1, 2000, but certain conclusions in this Interpretation cover specific
events that occur after either December 15, 1998, or January 12, 2000.
Management believes that FIN 44 will not have a material effect on the financial
position or results of operations of the Company.
4. Follow on Offering, Initial Public Offering and Conversion of Redeemable
Convertible Preferred Stock and Warrant:
In January 1999, the Company completed its initial public offering and issued
2,875 shares of its common stock at a price of $18.00 per share. The Company
received approximately $47.0 million in cash, net of underwriting discounts,
commissions and other offering costs. Additionally, prior to the initial public
offering, a warrant to purchase 667 shares of Series G convertible preferred
stock at an exercise price of $10.00 per share was exercised for approximately
$6.7 million. Simultaneously with the closing of the initial public offering,
all of the Company's convertible preferred stock and redeemable convertible
preferred stock was automatically converted into an aggregate of 8,120 shares of
common stock.
In March 2000, the Company completed a follow-on offering and issued 2,500
shares of its common stock at a price of $60.00 per share. The Company received
approximately $141.8 million in cash net of underwriters discounts, commissions
and other offering costs.
5. Royalty Obligation
The Company has acquired the rights, title and interests in two patents from a
founder and stockholder of the Company. Under a previous agreement, the Company
was required to pay on-going royalties based on the net sales price of products
sold utilizing the patented technology. In February 1999, the Company paid the
founder $2.5 million as a lump sum payment for all its future royalty
obligations. This payment, net of the current portion, is included in other
assets at March 31, 2000. The Company amortizes the amount ratably over five
years. This period represents the estimated life of the patented technology.
8
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TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in thousands, except per share amounts)
6. Inventories:
Inventories consist of the following: March 31, December 31,
2000 1999
------- -------
Finished goods ...................... $ 9,430 $ 6,731
Raw material ........................ 2,262 1,670
------- -------
$11,692 $ 8,401
======= =======
7. Commitments and Contingencies:
We intend to relocate our principal administrative and engineering facilities
from Pleasant Hill to Pleasanton, California during 2000. We have entered into a
lease for facilities in Pleasanton totaling approximately eighty-nine thousand
square feet. The lease for the Pleasanton facility expires April 2007, with an
option to renew for five years. Under the terms of the lease agreement, the
Company was required to issue a letter of credit in the amount of $1.8 million.
The letter of credit is collateralized by restricted cash and short-term
investments in the amount of $3.0 million. This collateral is included in other
assets at March 31, 2000. The letter of credit is reduced annually by $250
provided the Company is not in default under the terms of the lease agreement.
Minimum base rents of $120 per month, currently estimated to begin June 2000,
will increase annually by approximately $5 per month throughout the life of
the lease. Certain other additional monthly cost allocations related to taxes,
insurance and other common operating expenses will apply.
In the first quarter of 2000, the Company entered into a commitment to procure a
key component for our products from a sole source supplier. This commitment
requires us to purchase approximately $5.6 million of the key component over the
remainder of 2000. The Company decided to entered into the commitment to reduce
any risk of obtaining the component which could result in us having to redesign
our products and could result in a disruption to our operations.
8. Segment Information:
The Company currently operates in a single business segment as there is only one
measurement of profitability for its operations. Revenues are attributed to the
following countries based on location of customers:
Three months ended
March 31,
---------------------
2000 1999
------- -------
United States ......... $ 6,703 $ 3,031
International:
Hong Kong ......... 3,177 23
Korea ............. 5,962 --
All other countries 632 837
------- -------
$16,474 $ 3,891
======= =======
Two customers accounted for 36% and 17%, respectively, of the Company's revenue
for the three months ended March 31, 2000. Two customers accounted for 13% and
10%, respectively, of the Company's revenue for the three months ended March 31,
1999.
9
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TUT SYSTEMS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(in thousands, except per share amounts)
9. Business Combinations:
On February 14, 2000 the Company acquired Freegate, Inc. ("Freegate") for a
total of $24.7 million. The purchase price consisted of 511 shares of common
stock and approximately 20 options to acquire common stock and acquisition
related expenses, consisting primarily of investment advisory, legal and other
professional fees. This acquisition was accounted for as a purchase business
combination.
The allocation of the purchase price was based on the estimated fair value of
the liabilities assumed at the date of the acquisition of $2.3 million, goodwill
and intangibles of $24.7 million and in-process research and development of $0.8
million. The amount allocated to in-process research and development represents
the purchased in-process technology for projects that, as of the date of the
acquisition, had not yet reached technological feasibility and had no
alternative future use. Based on preliminary assessments, the value of these
projects was determined by using the income approach, which discounts expected
future cash flows to present value. The discount rate used in the present value
calculation were typically derived from a weighted average cost of capital
analysis adjusted upwards to reflect additional risks inherent in the
development life cycle. These risk factors are reflected in the discount rate
used of 30%. We expect that the pricing model for products and intellectual
property licenses related to our acquisition of Freegate will be considered
standard within the high-technology communications industry. We do not expect,
however, to achieve expense reductions as a result of integrating the acquired
in-process technology. Therefore, the valuation assumptions do not include any
anticipated cost savings. We expect that products incorporating the acquired
technology from this acquisition will be completed and begin to generate cash
flows over a six to nine month period after integration. Development of these
technologies, however, remains a significant risk due to the remaining effort
to achieve technical viability, rapidly changing customer markets, uncertain
standards for new products and significant competitive threats from numerous
companies. Efforts to develop the acquired technology into commercially viable
products consists principally of planning, designing, and testing activities
necessary to determine that the product can meet market expectations,
including functionality and technical requirements. Failure to bring these
products to market in a timely manner could result in a loss of market share,
or a loss opportunity to capitalize on emerging markets, and could harm our
business and operating results.
The following unaudited pro forma consolidated information gives effect to the
acquisition of Freegate as if it had occurred on January 1, 2000 and January 1,
1999 by consolidating the results of operations of Freegate with the results of
operations of the Company for the three months ended March 31, 2000 and 1999,
respectively. The pro forma results exclude the $0.8 million nonrecurring
write-off of in-process research and development.
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Revenue ....................................................... $ 16,565 $ 4,594
Net loss attributable to common stockholders .................. $ (5,135) $ (7,483)
Net loss attributable to common stockholders, basic and diluted $ (0.40) $ (0.89)
</TABLE>
The above unaudited pro forma consolidated information is not necessarily
indicative of the actual results of operations that would have been reported
if the acquisition had actually occurred as of the beginning of the periods
described above, nor does such information purport to indicate the results of
the Company's future operations. In the opinion of management, all adjustments
necessary to present fairly such pro forma information have been made.
In February, 2000, the Company signed a definitive agreement to acquire certain
assets of OneWorld Systems, Inc. for approximately $2.3 million in cash. This
transaction will be treated as a purchase for accounting purposes. This
transaction was completed on April 28, 2000.
On February 26, 2000, the Company entered into a nonbinding letter of intent to
acquire United Kingdom based holding company Xstreamis, plc. Xstreamis provides
policy-driven traffic management for high-performance, multimedia networking
solutions including routing, switching and bridging functions. The letter of
intent contemplates that the Company and Xstreamis would negotiate a purchase
agreement, under which the Company would issue shares of Tut common stock worth
approximately (pound)13.0 million or approximately $20.0 million at current
exchange rates, to the Xstreamis shareholders. This acquisition is expected to
be accounted for as a purchase.
10
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of operations
should be read in conjunction with the Condensed Consolidated Financial
Statements and the related Notes thereto included elsewhere in this Form 10-Q.
This discussion contains, in addition to historical information, forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from the results discussed in the forward-looking statements. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed below, as well as those discussed in our Registration
Statements on Form S-1, as well as those discussed in our other reports and
filings with the SEC. We disclaim any obligation to update information
contained in any forward-looking statement.
Overview
We design, develop and market multi-service broadband access systems that enable
service providers to deliver high-speed data access over the existing copper
telephone infrastructure found in multi-tenant unit, or MTU, complexes, such as
apartment buildings, hotels, business parks and commercial office buildings. Our
systems enable service providers to deliver high speed Internet access, as well
as enhanced capabilities, such as subscriber management, community based web
pages, firewall protection, virtual private networking, as well as small
business email and web servers.
We commenced operations in August 1991. Through the third quarter of 1998,
substantially all of our revenue was derived from the sale of our XL Ethernet
LAN extension products to the corporate and
11
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university segments of the multi-commercial unit, or MCU, market. In early 1997,
we introduced the first products in our Expresso product line aimed at service
provider markets. During the first quarter of 1998, we began licensing our
HomeRun technology to certain leading semiconductor, computer hardware and
consumer electronics manufacturers for incorporation into integrated circuits
and consumer products including PCs, peripherals, modems and other Internet
appliances. In the third and fourth quarters of 1998, we commenced selling our
Expresso GS products, which are configured for local loop applications, and
Expresso MDU products, which incorporate our HomeRun technology to a broader
range of service providers, primarily those serving apartment complexes, hotels,
university dormitories and military complexes in the multi-dwelling unit, or
MDU, market. In the first quarter of 1999, we commenced selling Expresso MDU
products incorporating our LongRun technology and Expresso MDU Lite to
additional segments of the MDU market. During the fourth quarter of 1999, we
commenced selling our Expresso SMS 2000 and companion Expresso OCS system
providing subscriber management, bandwidth management, credit card billing and
other functions to the MDU market. In the first quarter of 2000, we continued
selling all of these products to customers in the United States and foreign
markets.
We generate revenue primarily from the sale of products and, to a lesser extent,
through the licensing of our HomeRun technology. We recognize revenue from
product sales upon shipment. Estimated sales returns and warranty costs, based
on historical experience by product, are recorded at the time revenue is
recognized. License and royalty revenue consists of non-refundable up-front
license fees, some of which may offset initial royalty payments, and royalties.
Currently, the majority of our license and royalty revenue is comprised of non-
refundable license fees paid in advance. Such revenue is recognized ratably over
the period during which post-contract customer support is expected to be
provided or upon delivery and transfer of agreed upon technical specifications
in contracts where essentially no further support obligations exist. Future
license and royalty revenue is expected to consist primarily of royalties based
on products sold by our licensees. We do not expect that such license and
royalty revenue will constitute a substantial portion of our revenue in future
periods.
Sales price reductions on some of our products may be necessary to remain
competitive. Although we have been historically able to offset most price
declines with reductions in our manufacturing costs, there can be no assurance
that we will be able to offset further price declines with cost reductions. In
addition, some of our licensees may sell products based on our technology to our
competitors or potential competitors. There can be no assurance that our HomeRun
technology will be successfully deployed on a widespread basis or that such
licensing will not result in an erosion of the potential market for our
products.
Sales to customers outside of the United States accounted for approximately
59.4% and 22.1% of revenue in the first quarters of 2000 and 1999, respectively.
We expect international sales to increase in absolute dollars in the future and
to represent approximately one half of our revenue during the remainder of this
year. To date, substantially all international sales have been denominated in
U.S. dollars.
We expect to continue to evaluate product line expansion and new product
opportunities, engage in extensive research, development and engineering
activities and focus on cost-effective design of our products. Accordingly, we
will continue to make significant expenditures on sales and marketing and
research and development activities.
In June 1999, we acquired PublicPort, Inc. in exchange for 168,679 shares of
common stock. This transaction was treated as a pooling of interests for
accounting purposes. PublicPort was located in Ann Arbor, Michigan. PublicPort
designed and developed subscriber management systems that enabled businesses in
the MDU market to provide mobile computer users access to the public Internet or
private corporate networks without having to reconfigure their computer's
network access software.
In November 1999, we acquired Vintel Communications, Inc. for $4.8 million,
consisting of $500,000 cash, 116,370 shares of common stock and approximately
40,000 options to acquire common stock. This transaction was treated as a
purchase for accounting purposes. Vintel was located in Oakland, California.
Vintel designed and developed high-performance integrated service routers that
allowed service providers to offer bundles of services, including voice-over-IP
and high speed Internet services over a common IP infrastructure to customers in
the MTU market.
In February 2000, we acquired FreeGate Corporation for approximately $24.7
million, consisting of 510,931 shares of common stock, approximately 19,600
options to acquire common stock and acquisition
12
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related expenses, consisting primarily of investment advisory, legal and other
professional fees. 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 virtual private networking, and email and web servers on a compact, PC-based
platform.
In February 2000, we signed a definitive agreement to acquire certain assets of
OneWorld Systems, Inc. for approximately $2.3 million in cash. This transaction
will be treated as a purchase for accounting purposes. OneWorld was located in
Sunnyvale, California. OneWorld designed and developed network communication
appliances and network modems. This transaction was completed on April 28, 2000.
On February 26, 2000, the Company entered into a nonbinding letter of intent to
acquire United Kingdom based holding company Xstreamis, plc. Xstreamis provides
policy-driven traffic management for high-performance, multimedia networking
solutions including routing, switching and bridging functions. The letter of
intent contemplates that the Company and Xstreamis would negotiate a purchase
agreement, under which the Company would issue shares of Tut common stock worth
approximately (pound)13.0 million or approximately $20.0 million at current
exchange rates, to the Xstreamis shareholders. This acquisition is expected to
be accounted for as a purchase.
While we expect to derive benefit from sales of product lines acquired through
some of these acquisitions and designed, developed and marketed as a result of
these acquisitions, there can be no assurance that we will be able to sustain or
expand sales of those products or complete the development and commercial
deployment of products expected as a result of these acquisitions.
Through these completed and anticipated transactions, we have added
approximately 65 people to our workforce. The costs associated with personnel
including rent for additional facilities and related general and administrative
costs as well as costs associated with research and development, and sales and
marketing activities will substantially increase our operating costs when
compared to related costs expended in 1999.
We have incurred net operating losses to date and, as of March 31, 2000, had an
accumulated deficit of $60.7 million. Our ability to generate income from
operations will be primarily dependent on increases in sales volume, reductions
in manufacturing costs and the growth of high-speed data access solutions in the
service provider and MTU markets. In view of our limited history of product
revenue from new markets, reliance on growth in deployment of high-speed data
access solutions and the unpredictability of orders and subsequent revenue, we
believe that period to period comparisons of our financial results are not
necessarily meaningful and should not be relied upon as an indication of future
performance. Failure to generate significant revenue from new products, whether
due to lack of market acceptance, competition, technological change or
otherwise, or the inability to reduce manufacturing costs, will harm our
business, financial condition and results of operations.
13
<PAGE>
Results of Operations
The following table sets forth items from our statements of operations as a
percentage of total revenue for the periods indicated:
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------------
2000 1999
--------- --------
<S> <C> <C>
Total revenues ........................ 100.0 % 100.0 %
Total cost of goods sold .............. 55.5 57.6
--------- --------
Gross margin ...................... 44.5 42.4
Operating expenses:
Sales and marketing ............... 29.3 61.7
Research and development .......... 19.3 43.0
General administrative ............ 13.2 25.4
In-process research and development 4.9 --
Amortization of intangibles ....... 4.5 --
Noncash compensation expenses ..... 0.7 2.9
--------- --------
Total operating expenses ........ 71.9 133.0
--------- --------
Loss from operations .................. (27.4) (90.6)
Other income (expense), net ........... 1.6 5.5
--------- --------
Loss before income taxes .............. (25.8) (85.1)
Income tax expense .................... -- --
--------- --------
Net loss .............................. (25.8)% (85.1)%
========= ========
</TABLE>
Three Months Ended March 31, 2000 and 1999
Revenue. We generate revenue primarily from the sale of products and, to a
lesser extent, through the licensing of our HomeRun technology. Our total
revenue increased to $16.5 million for the three months ended March 31, 2000,
from $3.9 million for the three months ended March 31, 1999. The increase in
2000 was primarily due to an increase in sales of Expresso MDU products. License
and royalty revenue was $0.3 million for each of the first quarters of 2000 and
1999. There were no new license and royalty agreements signed in the first
quarter of 2000.
Cost of Goods Sold/Gross Margin. Cost of goods sold consists of raw materials,
contract manufacturing, personnel costs, test and quality assurance for
products, and cost of licensed technology included in the products. Our cost of
goods sold increased to $9.1 million for the three months ended March 31, 2000,
from $2.2 million for the three months ended March 31, 1999. The increase in
2000 was primarily due to increased production of our Expresso MDU products. Our
gross margin on an absolute basis increased to $7.3 million for the three months
ended March 31, 2000, from $1.6 million for the three months ended March 31,
1999. Gross margin as a percentage of revenue increased to 44.5% of revenue for
the three months ended March 31, 2000, from 42.4% of revenue for the three
months ended March 31, 1999. The increase in gross margin as a percent of
revenue in 2000 was primarily due to cost reductions related to our more mature
Expresso MDU products.
Sales and Marketing. Sales and marketing expense primarily consists of personnel
costs, including commissions and costs related to customer support, travel,
trade-shows, promotions, and outside services. Our sales and marketing expenses
increased to $4.8 million for the three months ended March 31, 2000, from $2.4
million for the three months ended March 31, 1999. The increase in 2000 was
primarily due to increased hiring of sales and marketing personnel, travel,
attendance at trade shows, as well as increases in personnel related to customer
support activities and expanded efforts in international markets.
Research and Development. Research and development expense primarily consists of
personnel costs related to engineering and technical support, contract
consultants, outside testing services, equipment and supplies associated with
enhancing existing products and developing new products. Research and
development costs are expensed as incurred. Our research and development
expenses increased to $3.2 million for the three months ended March 31, 2000,
from $1.7 million for the three months ended March 31,
14
<PAGE>
1999. The increase in 2000 was primarily due to further development of the
Expresso MDU products, development of HomeRun-related products, and continued
development of the subscriber management system portion of the Expresso MDU
product line. The research and development expenses of PublicPort, Vintel, and
Freegate were consolidated with our expenses for the periods subsequent to the
respective June 1999, November 1999 and February 2000, acquisitions.
Additionally, in the first quarter of 2000 we amortized $0.3 million of
deferred compensation to research and development related to restricted stock
granted to certain Freegate employees. Approximately $1.7 million of the
remaining deferred compensation has been recorded as a reduction of equity in
the balance sheet. We intend to recognize the expense ratably over the
remaining period in which the restrictions lapse, currently estimated at
sixteen months. We intend to increase investment in research and development
programs in future periods for the purpose of enhancing current products to
provide advanced Internet service applications for both domestic and
international markets, reducing the cost of current products, and developing
and acquiring new products.
General and Administrative. General and administrative expense primarily
consists of personnel costs for administrative officers and support personnel,
and legal, accounting and consulting fees. Our general and administrative
expenses increased to $2.2 million for the three months ended March 31, 2000,
from $1.0 million for the three months ended March 31, 1999. The increase in
2000 was primarily due to additions of administrative personnel and increases in
other costs related to our growth. We intend to increase general and
administrative expenditures and infrastructure costs as we expand our business.
In-process research and development. Amounts expensed as in-process research and
development were $0.8 million in the first quarter of 2000 and were related to
in-process research and development purchased from Freegate. There were no such
costs in the first quarter of 1999. The fair value of such technology currently
under development was determined by using the income approach, which discounts
expected future cash flows to present value. The discount rates used in the
present value calculations were typically derived from a weighted average cost
of capital analysis, adjusted upward to reflect additional risks inherent in the
development life cycle. These risk factors are reflected in the discount rate
used of 30%. We expect that the pricing model for products and intellectual
property licenses related to our acquisition of Freegate will be considered
standard within the high-technology communications industry. We do not expect,
however, to achieve expense reductions as a result of integrating the acquired
in-process technology. Therefore, the valuation assumptions do not include any
anticipated cost savings. We expect that products incorporating the acquired
technology from this acquisition will be completed and begin to generate cash
flows over a six to nine month period after integration. Development of these
technologies, however, remains a significant risk due to the remaining effort to
achieve technical viability, rapidly changing customer markets, uncertain
standards for new products and significant competitive threats from numerous
companies. Efforts to develop the acquired technology into commercially viable
products consists principally of planning, designing and testing activities
necessary to determine that the product can meet market expectations, including
functionality and technical requirements. Failure to bring these products to
market in a timely manner could result in a loss of market share, or a lost
opportunity to capitalize on emerging markets, and could harm our business and
operating results.
Amortization of Intangibles. Amortization of intangibles consists of the
periodic amortization of intangible assets related to purchase acquisitions.
These assets consist primarily of acquired workforce and goodwill and are
amortized over their estimated useful lives of 3 and 5 years, respectively.
Amortization of intangibles in the first quarter of 2000 of $0.7 million relates
to intangible assets acquired from Vintel and Freegate. There were no such costs
in the first quarter of 1999.
Noncash Compensation Expense. Noncash compensation expense in the three months
ended March 31, 2000 and 1999 consisted of the recognition of expense related to
certain employee stock option grants, based on the difference between the deemed
fair value of common stock and the option exercise price at the date of grant.
Our noncash compensation expense was $0.1 million for the three months ended
March 31, 2000 and 1999. We intend to recognize the remaining $1.0 million in
noncash compensation expense related to employee stock options ratably over the
remaining vesting period of the related options. Such deferred expense has been
recorded as a reduction of equity in the balance sheet.
Other Income (Expense), Net. Other income (expense), net consists of interest
income on cash balances, offset by interest expense associated with credit
facilities and gains (losses) on investing activities. Our other income
(expense), net was $0.3 million and $0.2 million for the three months ended
March 31, 2000 and
15
<PAGE>
1999, respectively. For the three months ended March 31, 2000, we recognized a
gain on investments of $0.1 million.
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through the sale
of equity securities. From inception through May 1998, we sold preferred equity
securities for an aggregate of $46.2 million net of offering costs. In January
1999, we completed our initial public offering and issued 2,875,000 shares of
our common stock at a price of $18.00. We received approximately $46.9 million
in cash, net of underwriting discounts, commissions and other offering costs. We
also received approximately $6.7 million as a result of the exercise of a
warrant to purchase 666,836 shares of Series G convertible preferred stock at a
price of $10.00 per share. In March 2000, we completed our follow-on offering
and issued 2,500,000 shares of our common stock at a price of $60.00. We
received approximately $141.8 million in cash, net of underwriting discounts,
commissions and other offering costs.
As of March 31, 2000, we had cash, cash equivalents and short-term investments
of $166.5 million compared to $32.2 million as of December 31, 1999.
The net increase in cash and cash equivalents in the first quarter of 2000 of
$143.8 million resulted primarily from net proceeds of our follow-on offering
and from net proceeds of maturities of short-term investments, offset by a net
loss of $4.2 million, a net decrease in operating assets and liabilities of $1.8
million and the use of working capital of $1.8 million for the purchase of
property and equipment and the acquisition of Freegate.
We have a credit facility to borrow up to $7.5 million. The credit facility is
composed of two revolvers: a formula revolver of up to the lesser of $3.0
million or 85% of qualified accounts receivable bearing interest at prime plus
2.0% per annum; and a non-formula revolver of up to $4.5 million bearing
interest at prime plus 3.5% per annum. The credit facility requires a minimum
monthly interest payment of $10,000. The term of the credit facility is 18
months ending on June 30, 2000 and is automatically renewed for additional terms
of one year unless 60 days' written notice is given by either party. We have
approximately $1.6 million borrowed against the credit facility as of March 31,
2000. We have provided the lender with written notice to terminate the credit
facility on June 30, 2000.
In the first quarter of 2000, we entered into a lease for administrative and
engineering facilities. Under the terms of the lease, we were required to issue
a letter of credit in the amount of $1.8 million . The letter of credit is
collateralized by restricted cash and short-term investments of $3.0 million.
This collateral is included in other assets as of March 31, 2000. The letter of
credit is reduced annually by $250,000 provided we are not in default under the
terms of the lease agreement.
For future periods, we generally anticipate significant increases in working
capital on a period to period basis primarily as a result of planned increased
product sales and higher relative levels of inventory. We will also continue to
expend significant amounts on property and equipment related to the expansion of
systems infrastructure and office equipment and our anticipated move to expanded
headquarter facilities to support our growth. We also expect to continue to
expend significant amounts on lab and test equipment to support on-going
research and development efforts.
We believe that our cash, cash equivalents and short-term investment balances
and funds available under our credit facility will be sufficient to satisfy our
cash requirements for at least the next 12 months.
16
<PAGE>
During the three months ended March 31, 2000 and 1999, we incurred non-cash
expenses related to purchase acquisition and dividend accretion. The table below
sets forth supplemental information concerning the impact of certain non-cash
items on losses from operations. The accompanying supplemental financial
information is presented for informational purposes only and should not be
considered as a substitute for the historical financial information presented in
accordance with generally accepted accounting principles. The Statements of
Operations data has been derived from our audited financial statements.
<TABLE>
<CAPTION>
Three months ended
March 31,
------------------------
2000 1999
-------- --------
<S> <C> <C>
Computation of pro forma net loss per share:
Net loss attributable to common stockholders ..................... $ (4,236) $ (3,547)
Adjustments for certain noncash expenses related to
purchase and acquisition and dividend accretion:
Amortization of intangibles .................................... 746 --
In-process research and development ............................ 800 --
Dividend accretion of preferred stock .......................... -- 235
-------- --------
Pro forma net loss ............................................... $ (2,690) $ (3,312)
======== ========
Pro forma net loss per share ..................................... $ (0.22) $ (0.32)
======== ========
Shares used in computing pro forma net loss, basic and diluted ... 12,435 10,273
======== ========
<CAPTION>
(1) Calculation of pro forma shares, basic and diluted:
<S> <C> <C>
Shares used in computing net loss attributable to common stockholders,
basic and diluted ................................................ 12,435 7,872
Adjustment to reflect the assumed conversion of preferred stock ...... -- 2,401
Shares used in computing pro forma net loss per share,
basic and diluted ................................................ 12,435 10,273
</TABLE>
Year 2000 Compliance
We have addressed computer networks year 2000 compliance in our
systems, accounting software, computer hardware and existing products, and
have communicated with our significant third party vendors with respect to
their respective states of readiness. In order to assess year 2000 compliance
of our products and systems, we identified those systems critical to our
operations and the operations of our technologies and, based upon tests to
such products and systems, believed that all of our systems and technologies,
to the extent developed, were materially compliant. We expended approximately
$70,000 to assess and address the year 2000 problem. Although it is now past
January 1, 2000, and we have not experienced any adverse impact from the
transition to the Year 2000, we cannot assure you that we or our suppliers and
customers have not been affected in a manner that is not yet apparent. In
addition, some computer programs that were date sensitive to the Year 2000 may
not have been programmed to process the Year 2000 as a leap year, and any
negative consequential effects remain unknown. As a result, we will continue
to monitor our Year 2000 compliance and the Year 2000 compliance of our
suppliers and customers.
17
<PAGE>
Forward Looking Statements
This Report on Form 10-Q contains "forward-looking statements." These
forward-looking statements include, but are not limited to, statements about our
plans, objectives, expectations and intentions and other statements contained in
this Report on Form 10-Q that are not historical facts. When used in this Report
on Form 10-Q, the words "anticipates," "believes," "continue," "could,"
"estimates," "expects," "intends," "may," "plans," "seeks," "should" or "will"
or the negative of these terms or similar expressions are generally intended to
identify forward-looking statements. Because these forward-looking statements
involve risks and uncertainties, there are important factors that could cause
actual results to differ materially from those expressed or implied by these
forward-looking statements. Such risks and uncertainties include those discussed
below, as well as those discussed in our Registration Statements on Form S-1,
as well as those discussed in our other reports and filings with the SEC. We
disclaim any obligation to update information contained in any forward-looking
statement.
Risk Factors
We have a history of losses and expect future losses.
We have incurred substantial net losses and experienced negative cash flow each
quarter since our inception. We incurred net losses attributable to common
stockholders of $4.2 million for the three months ended March 31, 2000 and $3.5
million for the three months ended March 31, 1999. As of March 31, 2000, we had
an accumulated deficit of $60.7 million. We expect that we will incur additional
losses in 2000.
To achieve or sustain profitability, we must increase sales of our Expresso
products, reduce manufacturing costs and successfully introduce enhanced
versions of our existing and new products.
We may never achieve or sustain profitability. We have spent substantial amounts
of money on the development of our Expresso products, HomeRun technology and
software products. We intend to continue increasing certain of our operating
expenditures, including our sales and marketing, research and development and
general and administrative expenditures. We cannot assure you that we will
generate a sufficient level of revenue to offset these expenditures, or that we
will be able to adjust spending in a timely manner to respond to any
unanticipated decline in revenue due to the fact that our expenditures for sales
and marketing, research and development, and general administrative functions
are, in the short term, relatively fixed. Our ability to increase revenue or
achieve profitability in the future will primarily depend on our ability to
increase sales of our Expresso products, reduce manufacturing costs, and
successfully introduce and sell enhanced versions of our existing products and
new products.
A number of factors could cause our quarterly and annual financial results to be
worse than expected, which could result in a decline in our stock price.
Our annual and quarterly operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of numerous factors, some of
which are outside of our control. These factors include:
* market acceptance of our products;
* competitive pressures, including pricing pressures from our partners and
competitors;
* the timing or cancellation of orders from, or shipments to, existing and
new customers;
* the timing of new product and service introductions by us, our customers,
our partners or our competitors;
* variations in our sales or distribution channels;
18
<PAGE>
* variations in the mix of products offered by us;
* changes in the pricing policies of our suppliers;
* the availability and cost of key components; and
* the timing of personnel hiring.
We may also experience substantial period to period fluctuations in future
operating results and declines in gross margin as a result of the erosion of
average selling prices for high-speed data access products and services due to a
number of factors, including competition and rapid technological change. We
anticipate that average selling prices for our products will decrease over time
due to competitive pressures and volume pricing agreements. Decreasing average
selling prices could cause us to experience decreased revenue despite an
increase in the number of units sold. We cannot assure you that we will be able
to sustain our gross margins in the future, improve our gross margins by
offering new products or increased product functionality, or offset future price
declines with cost reductions.
As a result of these and other factors, it is possible that in some future
period our operating results will be below the expectations of securities
analysts and investors. In that event, the trading price of our common stock
would likely decline.
Difficulties in forecasting product sales could negatively impact our business.
We base our expense levels in part upon our expectations concerning future
revenue and these expense levels are relatively fixed in the short-term. Orders
for our products, however, may vary from quarter to quarter. In some
circumstances, customers may delay purchasing our current products in favor of
next-generation products. In addition, our new products are generally subject to
technical evaluations that typically last 60 to 90 days. If orders forecasted
for a specific customer for a particular quarter do not occur in that quarter,
our revenue for that quarter would be reduced. If we have lower revenue in a
quarter than expected, we may not be able to reduce our spending in the short-
term in response to this shortfall and reduced revenue would have a direct
impact on our results of operations for that quarter. Further, we purchase
components and contract manufacture our products based on forecasts of sales. If
orders for products exceed our forecasts, we may have difficulty meeting
customers orders in a timely manner, which could damage our reputation or result
in lost sales.
Our market is subject to rapid technological change, and if we do not address
these changes, our products will become obsolete, harming our business and
ability to compete.
The markets for high-speed data access products are characterized by rapid
technological developments, frequent enhancements to existing products and new
product introductions, changes in end user requirements and evolving industry
standards. In addition, the market for high-speed data access products is
dependent in large part on the increased use of the Internet. Issues concerning
the use of the Internet, including security, lost or delayed packets, and
quality of service, may negatively affect the development of the market for our
products. We cannot assure you that we will be able to respond quickly and
effectively to technological change. If we do not address these technological
changes and challenges by regularly introducing new products, our product line
will become obsolete, which would harm our business, financial condition and
results of operations.
Our success depends on our ability to continually introduce new products that
achieve broad market acceptance.
We must also continually improve the performance, features and reliability of
our products, particularly in response to competitive product offerings. To
remain competitive we need to introduce products in a timely manner that
incorporate or are compatible with these new technologies as they emerge. We may
have only a limited amount of time to penetrate certain markets, and we cannot
assure you that we will be successful in achieving widespread acceptance of our
products before competitors offer products and services similar or superior to
our products. Any delay in product introduction could adversely affect our
ability to compete and cause our operating results to be below our expectations
or the expectations of public market analysts or investors. In addition, when we
announce new products or product enhancements that have the potential to replace
or shorten the life cycle of our existing products, customers may defer
purchasing our existing products. These actions could harm our operating results
by unexpectedly decreasing sales, increasing our inventory levels of older
products and exposing us to greater risk of product obsolescence.
19
<PAGE>
Our success depends on continued market acceptance of our Expresso products.
We must devote a substantial amount of human and capital resources in
order to maintain commercial acceptance of our Expresso products and to expand
offerings of the Expresso product line in the MDU and MCU markets and to further
penetrate these markets. Historically, the majority of our Expresso products
have been sold into the MDU market. Our future success depends on the ability to
continue to penetrate this market and to expand our penetration into the MCU
market. Our success also depends on our ability to educate existing and
potential customers and end users about the benefits of our Fast Copper
technology, including HomeRun and LongRun, and the development of new products
to meet changing and expanding demands of service providers, MTU owners and
corporate customers. The continued success of our Expresso products will also
depend on the ability of our service provider customers to market and sell
high-speed data services to end users. We cannot assure you that our Expresso
products will achieve or maintain broad commercial acceptance within the MDU
market, MCU market, or in any other market we enter.
The market in which we operate is highly competitive, and we may not be able to
compete effectively.
The market for multi-service broadband access systems is intensely competitive,
and we expect that this market will become increasingly competitive in the
future. Our most immediate competitors include Cisco, Copper Mountain, Nortel
and Paradyne, and a number of other public and private companies. Many of these
competitors are offering, or may offer, technologies and services that directly
compete with some or all of our high-speed access products and related software
products. In addition, the market in which we compete is characterized by
increasing consolidation, and we cannot predict with certainty how industry
consolidation will affect us or our competitors.
Many of our competitors and potential competitors have substantially greater
name recognition and technical, financial and marketing resources than we do,
and we can give you no assurance that we will be able to compete effectively in
our target markets. These competitors may be able to undertake more extensive
marketing campaigns, adopt more aggressive pricing policies and devote
substantially more resources to developing new products than we can. In
addition, our HomeRun licensees may sell products based on our HomeRun
technology to our competitors or potential competitors. This licensing may cause
an erosion in the potential market for our products. We cannot assure you that
we will have the financial resources, technical expertise or marketing,
manufacturing, distribution and support capabilities to compete successfully.
This competition could result in price reductions, reduced profit margins and
loss of market share, which could harm our business, financial condition and
results of operations.
Our copper-wire based solutions face severe competition from other technologies
and the commercial acceptance of any competing solutions could harm our business
and ability to compete.
The market for high-speed data access products and services is characterized by
several competing technologies, including fiber optic cables, coaxial cables,
satellites and other wireless facilities. These competing solutions provide fast
access, high reliability and are cost-effective for some users. Because many of
our products are based on the use of copper telephone wire, and because there
are physical limits to the speed and distance over which data can be transmitted
over this wire, our products may not be a viable solution for customers
requiring service at performance levels beyond the current limits of copper
telephone wire. To the extent that telecommunications service providers choose
to install fiber optic cable or other transmission media in the last mile, or to
the extent that homes and businesses install other transmission media within
buildings, we expect that demand for our products that are based on copper
telephone wires will decline. Commercial acceptance of any one of these
competing solutions or any technological advancement or product introduction
that provides faster access, greater reliability, increased cost-effectiveness
or other advantages over technologies that utilize existing telephone copper
wires could decrease the demand for our products and reduce average selling
prices and gross margins associated with our products. The occurrence of any one
or more of these events could harm our business, financial condition and results
of operations.
Manufacturing or design defects in our products could harm our reputation and
business.
Any defect or deficiency in our products could reduce the functionality,
effectiveness or marketability of our products. While we consistently attempt
to improve our design, development and manufacturing processes to eliminate or
reduce the possibility of potential defects, from time to time, we discover
product defects from either a design or manufacturing quality perspective. To
date, we have not experienced any significant loss from such defects nor do we
believe that defects discovered during this or previous quarters cause orders
for our products to be canceled or delayed, reduce revenue, or render our
product designs obsolete. In that event, we would be required to devote
substantial financial and other resources for a significant period of time in
order to develop new product designs. We cannot assure you that we would be
successful in addressing any manufacturing or design defects in our products
or in developing new product designs in a timely manner, if at all. Any of
these events, individually or in the aggregate, could harm our business,
financial condition and results of operations.
20
<PAGE>
designs in a timely manner, if at all. Any of these events, individually or in
the aggregate, could harm our business, financial condition and results of
operations.
We must maintain and develop strategic partnerships with third parties to
increase market penetration of our HomeRun technology.
We have established relationships with several strategic partners, including our
collaborative arrangement through the Home Phoneline Network Alliance, or the
Home PNA, with leading semiconductor, computer hardware and consumer electronics
manufacturers. We have also licensed our HomeRun technology to members of the
Home PNA and others. In this regard, the widespread market acceptance of our
HomeRun technology for home networking applications is dependent on the
development and marketing of HomeRun-enabled integrated circuits and consumer
products by our licensees and their customers. We cannot assure you that our
HomeRun technology will continue to be deployed on a widespread basis and future
sales of products containing our HomeRun technology cannot be predicted. The
amount and timing of resources that our licensees devote to developing and
marketing HomeRun-enabled products is not within our control. We cannot assure
you that these licensees will continue to develop and market products as
expected or that significant license and royalty revenue will be forthcoming in
the future. If any of our licensees fails to commercialize or market products
incorporating HomeRun technology, our revenue may not grow as expected and we
may be required to undertake unforeseen additional responsibilities or to devote
additional resources to development, commercialization or marketing of HomeRun,
all of which could harm our business, financial condition and results of
operations.
Changing industry standards may reduce the demand for our products, which will
harm our business.
We will not be competitive unless we continually introduce new products and
product enhancements that address changing industry standards. The emergence of
new industry standards, whether through adoption by official standards
committees or widespread use by telephone companies or other service providers,
could require redesign of our products. If these standards become widespread and
our products are not in compliance, our customers and potential customers may
not purchase our products, which would harm our business, financial condition
and results of operations. The rapid development of new standards increases the
risk that competitors could develop products that make our products obsolete.
Any failure by us to develop and introduce new products or enhancements directed
at new industry standards could harm our business, financial condition and
results of operations. In addition, selection of competing technologies as
standards by standards setting bodies such as the Home PNA could negatively
affect our reputation in the market regardless of whether our products are
standard compliant or demand for our products does not decline. This selection
could be interpreted by the press and others as having a negative impact on our
business which could negatively impact the market price of our stock. A majority
of our sales comes from a small number of customers; if we lose any of these
customers, our sales could decline significantly.
For the three months ended March 31, 2000, 92% of net sales came from 10
customers. Although the customer mix varies from quarter to quarter, we are
dependent upon continued revenue from our major customers. As a result, any
material delay, cancellation or reduction of orders from these major customers
could cause our sales to decline significantly. Some of these customers
individually accounted for more than 10% of our net sales in the first quarter
of 2000. TriGem InfoComm, Corp., and I-Quest Corporation accounted for 36% and
17%, respectively, of our net sales in the first quarter of 2000. There is no
guarantee that we will be able to retain any of our major customers or any other
accounts. In addition, our customers may materially reduce the levels of
services ordered from us at any time. This could cause a significant decline in
our net sales and we may not be able to reduce the accompanying expenses at the
same time.
We depend on contract manufacturers to manufacture all of our products, and rely
upon them to deliver high-quality products in a timely manner.
We do not manufacture any of our products, but instead rely on contract
manufacturers to assemble, test and package our products. We cannot assure you
that these contract manufacturers and suppliers will be able
21
<PAGE>
to meet our future requirements for manufactured products, components and
subassemblies. Any interruption in the operations of one or more of these
contract manufacturers would harm our ability to meet our scheduled product
deliveries to customers. We also intend to regularly introduce new products and
product enhancements, which will require that we rapidly achieve volume
production by coordinating our efforts with those of our suppliers and contract
manufacturers. The inability of our contract manufacturers to provide us with
adequate supplies of high-quality products or the loss of a current contract
manufacturer would cause a delay in our ability to fulfill customer orders while
we obtain a replacement manufacturer and would harm our business, operating
results and financial condition. In addition, our inability to accurately
forecast the actual demand for our products could result in supply,
manufacturing or testing capacity constraints. These constraints could result in
delays in the delivery of our products or the loss of existing or potential
customers, either of which could harm our business, operating results or
financial condition.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. Components are purchased pursuant
to purchase orders based on forecasts, but we or our contract manufacturers
have no guaranteed supply arrangements with these suppliers. the availability
of many of these components is dependent in part on our ability to provide our
contract manufacturers and their suppliers with accurate forecasts of our
future needs. If we or our manufacturers were unable to obtain a sufficient
supply of components from current sources, we could experience difficulties in
obtaining alternative sources or in altering product designs to use
alternative components. For example, we are experiencing, and may continue
experiencing in the future, difficulty obtaining flash memory and switching
integrated circuits. Resulting delays, reductions in product shipments could
damage customer relationships and could harm our business, financial condition
or results of operations. In addition, any increase in component costs that
are passed on to our customers could reduce demand for our products.
We purchase several key components from single or limited sources and could lose
sales if these sources fail to fill our needs.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. In procuring components, our
contract manufacturers rely on some suppliers that are the sole source of
those components, and we are dependent upon supply from these sources to meet
our needs. For example, all of the field programmable gate array supplies used
in our products are purchased from Xilinx and the switching integrated circuit
supplies used in the majority of our products are purchased from Texas
Instruments. Our products are also dependent on various sole source offerings
form Dallas Semiconductor, Intel, Metalink US, Motorola, Oki Semiconductor,
Osicom Technologies, SaRonix, Siemens and Wind River Systems. As announced by
other companies in our industry, there are severe component shortages for
certain key parts. These shortages have led to both longer lead times for such
components and to increased risk of component quality problems. While we have
taken preemptive steps to ensure that an adequate supply of quality components
is in place, there can be no assurance that there would not be an interruption
in the supply of any of the key components currently obtained from a single or
limited source that could substantially increase the period of time it takes
to obtain these components, that could result in component quality problems,
or that could cause us to redesign our products, each or any of which event,
could disrupt our operations and harm our business in any given period.
We rely on third parties to test all of our products and a failure to adequately
control quality could harm our business.
Substantially all of our products are assembled and tested by our contract
manufacturers. Although we perform random spot testing on manufactured products,
we rely on our contract manufacturers for assembly and primary testing of our
products. Any quality assurance problems could increase the costs of
manufacturing, assembling or testing of our products and could harm our
business, financial condition and results of operation. Moreover, defects in
products that are not discovered in the quality assurance process could damage
customer relationships and result in product returns or liability claims, each
of which could harm our business, financial condition and results of operations.
We may not be able to effectively integrate our recent acquisitions into our
existing business.
In June 1999, we acquired PublicPort, Inc., in November 1999, we acquired Vintel
Communications, Inc., and in February 2000, we acquired FreeGate Corporation. In
addition, in February 2000, we signed a definitive agreement to acquire
certain assets of OneWorld Systems, Inc., which transaction was completed
April 28, 2000, and to acquire United Kingdom based holding company Xstreamis,
plc. We will need to overcome significant issues in order to realize any
benefits from these transactions. These issues include:
* integrating the operations of the geographically dispersed businesses acquired
into our own operations;
22
<PAGE>
* incorporating acquired technology, rights and products into our products and
services;
* developing new products and services that utilize the assets of all entities;
* the potential disruption of our ongoing business and the distraction of our
management; and
* the potential impairment of relationships with employees, suppliers and
customers.
We may engage in future acquisitions of companies, technologies or products and
the failure to integrate any future acquisitions could harm our business.
As a part of our business strategy, we expect to make additional acquisitions
of, or significant investments in, complementary companies, products or
technologies. Any future acquisitions would be accompanied by the risks commonly
encountered in acquisitions of companies. These risks include:
* difficulties in assimilating the operations and personnel of the acquired
companies;
* diversion of management's attention from ongoing business concerns;
* our potential inability to maximize our financial and strategic position
through the successful incorporation of acquired technology and rights into
our products and services;
* additional expense associated with amortization of acquired intangible assets;
* maintenance of uniform standards, controls, procedures and policies; and
* impairment of existing relationships with employees, suppliers and customers
as a result of the integration of new personnel.
We cannot assure you that we will be able to successfully integrate any
business, products, technologies or personnel that we may acquire in the future,
and our failure to do so could harm our business, operating results and
financial condition.
If we fail to manage our growth effectively, our business could be harmed.
Our growth has placed, and in the future may continue to place, a significant
strain on our engineering, managerial, administrative, operational, financial
and marketing resources, and increased demands on our systems and controls. To
exploit the market for our products, we must develop new and enhanced products
while managing anticipated growth in sales by implementing effective planning
and operating processes. To manage our anticipated growth, we must, among other
things, continue to implement and improve our operational, financial and
management information systems, hire and train additional qualified personnel,
continue to expand and upgrade core technologies and effectively manage multiple
relationships with various customers, suppliers and other third parties. We
cannot assure you that our systems, procedures or controls will be adequate to
support our operations or that our management will be able to achieve the rapid
execution necessary to exploit fully the market for our products or systems. If
we are unable to manage our growth effectively, our business, financial
condition and results of operations could be harmed.
We depend on international sales for a significant portion of our revenue, which
could subject our business to a number of risks.
Sales to customers outside of the United States accounted for approximately
59.4% and 22.1% of revenue for the three months ended March 31, 2000 and 1999,
respectively. There are a number of risks arising from our international
business, including:
* longer receivables collection periods;
* increased exposure to bad debt write-offs;
* risk of political and economic instability;
* difficulties in enforcing agreements through foreign legal systems;
* unexpected changes in regulatory requirements;
23
<PAGE>
* import or export licensing requirements;
* reduced protection for intellectual property rights in some countries; and
* currency fluctuations.
We expect sales to customers outside of the United States to continue to account
for a significant portion of our revenue. We can give you no assurance that
foreign markets for our products will not develop more slowly than currently
anticipated. Any failure to increase sales to customers outside of the United
States could harm our business, financial condition and results of operations.
We also expend product development and other resources in order to meet
regulatory and technical requirements of foreign countries. We are depending on
sales of our products in these foreign markets in order to recoup the costs
associated with developing products for these markets.
Fluctuations in currency exchange rates may harm our business.
All of our foreign sales are invoiced in U.S. dollars. As a result, fluctuations
in currency exchange rates could cause our products to become relatively more
expensive for international customers and reduce demand for our products. We
anticipate that foreign sales will generally continue to be invoiced in U.S.
dollars. Accordingly, we do not currently engage in foreign currency hedging
transactions. As we expand our current international operations, however, we may
allow payment in foreign currencies and exposure to losses in foreign currency
transactions may increase. To reduce this exposure we may purchase forward
foreign exchange contracts or use other hedging strategies. However, we cannot
assure you that any currency hedging strategy would be successful in avoiding
exchange related losses.
If we fail to protect our intellectual property, or if others use our
proprietary technology without authorization, our competitive position may
suffer.
Our future success and ability to compete is dependent in part upon our
proprietary technology. We rely on a combination of copyright, patent, trademark
and trade secrets laws and nondisclosure agreements to establish and protect our
proprietary technology. We currently hold 20 United States patents and have 13
United States patent applications pending. However, we cannot assure you that
patents will be issued with respect to pending or future patent applications or
that our patents will be upheld as valid or will prevent the development of
competitive products or that any actions we have taken will adequately protect
our intellectual property rights.
We generally enter into confidentiality agreements with our employees,
consultants, resellers, customers and potential customers, strictly limit access
to and distribution of our software, and further limit the disclosure and use of
other of our proprietary information. Despite our efforts to protect our
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
or use our products or technology. We also cannot assure you that our
competitors will not independently develop technologies that are substantially
equivalent or superior to our technology. In addition, the laws of some foreign
countries do not protect our proprietary rights to the same extent as do the
laws of the United States.
We may be subject to intellectual property infringement claims that are costly
to defend and could harm our business and ability to compete.
We are also subject to the risk of adverse claims and litigation alleging
infringement of the intellectual property rights of others. We cannot assure you
that third parties will not assert infringement claims in the future with
respect to our current or future products. Any such assertion, regardless of its
merit, could require us to pay damages or settlement amounts and could require
us to develop non-infringing technology or acquire licenses to the technology
that is the subject of asserted infringement. This litigation or potential
litigation could result in product delays, increased costs or both. In addition,
the cost of any litigation and the resulting distraction of our management
resources could harm our business, results of operations or financial condition.
We also cannot assure you that any licenses of technology necessary for our
business will be
24
<PAGE>
available or that, if available, these licenses can be obtained on commercially
reasonable terms. Our failure to obtain these licenses could harm our business,
results of operations and financial condition.
If our products do not comply with complex government regulations, our products
may not be sold, preventing us from increasing our revenue or achieving
profitability.
We and our customers are subject to varying degrees of federal, state and local
regulation. Our products must comply with various regulations and standards
defined by the Federal Communications Commission. The FCC has issued regulations
that set installation and equipment standards for communications systems. Our
products are also required to meet certain safety requirements. For example,
certain of our products must be certified by Underwriters Laboratories in order
to meet federal safety requirements relating to electrical appliances to be used
inside the home. In addition, certain products must be Network Equipment
Building Standard certified before they may be deployed by certain of our
customers. Any delay in or failure to obtain these approvals could harm our
business, financial condition or results of operations. Outside of the United
States, our products are subject to the regulatory requirements of each country
in which our products are manufactured or sold. These requirements are likely to
vary widely. If we do not obtain timely domestic or foreign regulatory approvals
or certificates we would not be able to sell our products where these
regulations apply, which may prevent us from sustaining our revenue or achieving
profitability.
In addition, regulation of our customers may adversely impact our business,
operating results and financial condition. For example, FCC regulatory policies
affecting the availability of data and Internet services and other terms on
which telecommunications companies conduct their business may impede our
penetration of certain markets. In addition, the increasing demand for
communications systems has exerted pressure on regulatory bodies worldwide to
adopt new standards, generally following extensive investigation of competing
technologies. The delays inherent in this governmental approval process may
cause the cancellation, postponement or rescheduling of the installation of
communications systems by our customers, which in turn may harm the sale of
products by us to these customers.
Our success is dependent on our ability to provide adequate customer support.
Our ability to achieve our planned sales growth and retain current and future
customers will depend in part upon the quality of our customer support
operations. Our customers generally require significant support and training
with respect to our products, particularly in the initial deployment and
implementation stage. As our systems and products become more complex, we
believe our ability to provide adequate customer support will be increasingly
important to our success. We have limited experience with widespread deployment
of our products to a diverse customer base, and we cannot assure you that we
will have adequate personnel to provide the levels of support that our customers
may require during initial product deployment or on an ongoing basis. In
addition, we rely on a third party for a substantial portion of our customer
support functions. 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 successfully manage our business.
We depend on the performance of Matthew Taylor, our Chief Technical Officer, and
Salvatore D'Auria, our President, Chief Executive Officer and Chairman of the
Board, and on other senior management and technical personnel with experience in
the data communications, telecommunications and high-speed data access
industries. The loss of any one of them could harm our ability to execute our
business strategy. Additionally, we do not have employment contracts with any of
our executive officers and we only maintain a "key person" life insurance policy
on Matthew Taylor. We believe that our future success will depend in large part
upon our continued ability to identify, hire, retain and motivate highly skilled
employees, who are in great demand. We cannot assure you that we will be able to
do so.
25
<PAGE>
Our stock price has fluctuated and is likely to continue to fluctuate, and you
may not be able to resell your shares at or above the offering price.
The trading price of our common stock has been and is likely to continue to be
highly volatile. Our stock price could fluctuate widely in response to factors
such as the following:
* actual or anticipated variations in operating results;
* announcements of technological innovations, new products or new services by us
or by our partners, competitors or customers;
* changes in financial estimates or recommendations by stock market analysts
regarding us or our competitors;
* conditions or trends in the telecommunications industry, including regulatory
developments;
* growth of the Internet;
* announcements by us of significant acquisitions, strategic partnerships, joint
ventures or capital commitments;
* additions or departures of key personnel;
* future equity or debt offerings or our announcements of these offerings; and
* general market and general economic conditions.
In addition, in recent years, the stock market in general, and the Nasdaq
National Market and the securities of Internet and technology companies in
particular, have experienced extreme price and volume fluctuations. 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. In addition, trading
prices of the stocks of many technology companies are at or near historic highs
and reflect price-earnings ratios substantially above historic levels. These
trading prices and price-earnings ratios may not be sustained.
Our charter and bylaws and Delaware law contain provisions that could delay or
prevent a change in control.
Certain provisions of our charter and bylaws may have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, control of us. These provisions could limit the
price that certain investors may be willing to pay in the future for shares of
our common stock. Our charter and bylaws provide for a classified board of
directors, eliminate cumulative voting in the election of directors, restrict
our stockholders from acting by written consent and calling special meetings,
and provide for procedures for advance notification of stockholder nominations
and proposals. In addition, our board of directors has the authority to issue up
to 5,000,000 shares of preferred stock and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The issuance of
preferred stock, while providing flexibility in connection with possible
financings or acquisitions or other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of our
outstanding voting stock. These provisions, as well as Section 203 of the
Delaware General Corporation Law, to which we are subject, could discourage
potential acquisition proposals, delay or prevent a change of control and
prevent changes in our management.
Future sales of our common stock could depress our stock price.
Sales of a substantial number of shares of our common stock in the public
market, or the appearance that these shares are available for sale, could harm
the market price of our common stock. These sales also may make it more
difficult for us to sell equity securities or equity-related securities in the
future at a time and price that we deem appropriate. As of April 30, 2000, we
had 14,973,268 shares outstanding. Of these shares, 15,126,480 shares of
common stock are currently available for sale in the public market, some of
which are subject to volume and other limitations under securities laws.
26
<PAGE>
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily to
our investment portfolio. We place our investments with high credit issuers in
short-term securities with maturities of three to twelve months. Our portfolio
includes only marketable securities with active secondary or resale markets to
ensure portfolio liquidity. We have no investments denominated in foreign
country currencies and therefore are not subject to foreign exchange risk.
Part II OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Registrant filed the following Current Reports on Form 8-K during
the quarter ended March 31, 2000:
Current Report on 8-K dated February 7, 2000 included
information relating to Tut's acquisition of Vintel
Communications Corporation on November 12, 1999.
Current Report on 8-K dated February 14, 2000 included
information relating to Tut's acquisition of FreeGate
Corporation on February 14, 2000.
Current Report on 8-K dated March 2, 2000 included information
relating to Tut's signing of a non-binding letter of intent to
acquire Xsteamis, PLC, a United Kingdom company.
27
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 2000
TUT SYSTEMS, INC.
/s/ Nelson Caldwell
-------------------------------------
Nelson Caldwell
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer and Duly
Authorized Officer)
28
<PAGE>
EXHIBIT INDEX
-------------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM TUT
SYSTEMS, INC. AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 157,248
<SECURITIES> 9,246
<RECEIVABLES> 10,713
<ALLOWANCES> (335)
<INVENTORY> 11,692
<CURRENT-ASSETS> 191,571
<PP&E> 6,574
<DEPRECIATION> 2,386
<TOTAL-ASSETS> 228,465
<CURRENT-LIABILITIES> 14,969
<BONDS> 0
0
0
<COMMON> 15
<OTHER-SE> 210,767
<TOTAL-LIABILITY-AND-EQUITY> 228,465
<SALES> 16,164
<TOTAL-REVENUES> 16,474
<CGS> 9,137
<TOTAL-COSTS> 9,137
<OTHER-EXPENSES> 11,837
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 310
<INCOME-PRETAX> (4,235)
<INCOME-TAX> 1
<INCOME-CONTINUING> (4,236)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,236)
<EPS-BASIC> (0.34)
<EPS-DILUTED> (0.34)
</TABLE>
