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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2000
[_] Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number: 000-25291
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TUT SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-2958543
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
5964 West Las Positas Blvd.
Pleasanton, California 94588
(address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (925) 460-3900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$0.001 par value
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $130,349,604 as of December 31, 2000 based on the
closing price of the Common Stock as reported on The Nasdaq Stock Market for
December 29, 2000. There were 15,910,796 shares of the Registrant's Common
Stock issued and outstanding on December 31, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information called for by Part III is incorporated by reference to
the definitive proxy statement for the annual meeting of the stockholders,
which will be filed with the Securities and Exchange Commission not later than
120 days after December 31, 2000.
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TUT SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
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ITEM NO.
PART I
1. BUSINESS.......................................................... 1
2. FACILITIES........................................................ 11
3. LEGAL PROCEEDINGS................................................. 12
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............... 12
PART II
5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.......................................................... 13
6. SELECTED CONSOLIDATED FINANCIAL DATA.............................. 14
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................. 15
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........ 35
8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......... 36
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE............................................. 61
PART III
10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................ 61
11. EXECUTIVE COMPENSATION............................................ 61
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.... 61
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................... 61
PART IV
14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K......................................................... 61
PART I
IMPORTANT NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains "forward-looking statements." These
forward-looking statements include, but are not limited to, statements about
our plans, objectives, expectations and intentions and other statements
contained in this Annual Report on Form 10-K that are not historical facts.
When used in this Annual Report on Form 10-K, the words "anticipates,"
"believes," "continue," "could," "estimates," "expects," "intends," "may,"
"plans," "seeks," "should" or "will" or the negative of these terms or similar
expressions are generally intended to identify forward-looking statements.
Because these forward-looking statements involve risks and uncertainties, there
are important factors that could cause actual results to differ materially from
those expressed or implied by these forward-looking statements. Such risks and
uncertainties include those set forth in Part II, Item 7--Management's
Discussion and Analysis of Financial Condition and Results of Operations. These
forward-looking statements reflect current views of our management with respect
to future events and are subject to these and other risks, uncertainties and
assumptions relating to our operations, results of operations, growth strategy
and liquidity. All subsequent written and oral forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in
their entirety by this paragraph.
ITEM 1. BUSINESS
Overview
Our principal executive offices are located at 5964 West Las Positas
Boulevard, Pleasanton, California 94588. Our telephone number is (925) 460-
3900. We were incorporated in California in August 1983, began operations in
August 1991, and reincorporated in Delaware in September 1998.
We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access to multi-tenant
buildings. We use our proprietary FastCopper technologies to deliver cost-
effective, scalable and easy to deploy solutions that exploit the underutilized
bandwidth of copper telephone wires within these buildings. Our products also
provide service providers with enhanced capabilities such as subscriber
management, bandwidth management, plug and play installation, portal
redirection, internet protocol address management, or IP address management,
service authorization and network address translation. In addition, we recently
introduced our IntelliPOPTM product which utilizes our proprietary Signature
SwitchTM technology and is designed to allow service providers to manage and
guarantee bandwidth and service performance across applications such as IP
telephony, virtual private networking, or VPN networking, videoconferencing,
video-on-demand, file transfer and Internet access and to efficiently configure
IntelliPOP for the delivery of these services according to the unique market
requirements of multi-tenant building owners and end-user subscribers on an
individual or collective basis. Our systems and related services are designed
with the specific requirements of the multi-tenant unit, or MTU, market in mind
and enable service providers in this market to increase their revenue by
providing additional services and increase customer retention through bundled
service offerings.
Industry Background
Increasing Demand for High-Speed Internet Access
In recent years, there has been a dramatic increase in demand by businesses
and consumers for high-speed data access to the Internet and to private
corporate networks. This demand is being driven by the growth in users who are
accessing networks for a variety of applications, including communications via
the Internet and corporate intranets, electronic commerce, and telecommuting.
This growth is projected to continue to increase rapidly over the next several
years. As an example of the growth in high-speed access, the Vertical Systems
Group has projected that total digital subscriber line, or DSL, connections in
the United States will increase from 560 thousand in 1999 to over 7.7 million
in 2003. Vertical Systems Group also projected that worldwide DSL connections
would grow from 637 thousand in 1999 to over 16 million in 2003.
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To meet this increasing need for high-speed access, telecommunications
service providers have significantly upgraded both backbone and local networks
with broadband fiber optic facilities and high-speed switches, routers, and
multiplexers. In some cases, these service providers are bringing fiber optic
links all the way to residential neighborhoods or to the basements of
commercial office buildings. In addition, other service providers are building
wireless broadband access networks using recently available radio spectrum, or
are using hybrid fiber coaxial cable networks that are traditionally used to
provide cable TV service. Service providers may also use the copper-based
infrastructure of an incumbent local exchange carrier, or ILEC, or a government
controlled post, telephone and telegraph company, or PTT, to offer DSL-based
services. These new networks offer speeds more than 20 times faster than
today's 56 kbps dial-up modems.
Although service providers are bringing broadband facilities closer to
residential and commercial end users, they remain challenged by the cost and
logistics associated with extending this bandwidth all the way to Internet
devices in a consumer's home or to the local area network, or LAN, of a small
business office. These challenges are particularly acute in MTU complexes where
the end-user typically does not directly own the network infrastructure in
place, and where the majority of the existing infrastructure tends to be the
copper wires being used to provide existing telephone service.
The MTU market can be separated into two markets: residential and
commercial. The residential MTU market, also known as the multi-dwelling unit,
or MDU, market, consists primarily of apartments, hotels, and university
dormitories. Data from the U.S. Census Bureau indicates that the domestic
apartment market totals over 21 million individual tenant units, with 9 million
of these units being located in buildings or complexes of 50 or more units.
Data from the U.S. Department of Commerce indicates that the domestic hotel
market consists of 1.7 million rooms, with 1.4 million rooms in buildings of
more than 100 rooms. We believe that these larger buildings and complexes are
the initial target for high-speed Internet access. The commercial MTU market,
also known as the multi-tenant commercial unit, or MCU, market, represents
office complexes and other business-related facilities. According to data from
Torto Wheaton Research, there is more than 2.5 billion square feet of rentable
commercial office space in the 54 largest metropolitan markets across the
United States.
MTU Market Characteristics
Since the demand for high-speed Internet access has increased significantly
over the last couple of years, we believe that owners and managers of
apartments, hotels and commercial properties have begun to view high-speed
Internet access as a critical enhanced service for their residents, guests and
tenants. There is demand from owners of MTU complexes and buildings to offer
Internet access and other broadband services as an amenity that effectively
attracts and retains occupants, thereby increasing revenue and profitability.
Given the complexity and cost of deploying broadband services, many property
owners prefer to outsource ownership, installation, operation and management of
high-speed Internet solutions to an MTU-focused service provider. In exchange
for granting a service provider the ability to market and provide
telecommunications services to their properties, these MTU owners have an
opportunity to offer new Internet-enabled services and to potentially share in
some of the service revenues generated from their buildings. These services
enable on-line reservation of building amenities, community message boards, e-
commerce and electronic payment of rent.
A set of specialized service providers and divisions of incumbent service
providers have emerged over the last few years to fill the growing demand for
high-speed Internet service to the MTU market. While high-speed Internet access
is the primary service delivered by these service providers today, we believe
that the delivery of multiple services, such as high-speed corporate
networking, packet voice and IP video, will be the key to meeting future
customer needs and driving service provider profitability through bundled
service offerings. The MTU market is attractive to these service providers
because of the efficiency of delivering multiple services, often on an
exclusive basis, to a geographically concentrated and demographically similar
customer base.
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Infrastructure Requirements for MTU Service Providers
Service providers marketing to MTU owners and tenants typically concentrate
their networks, as well as sales and marketing efforts within major
metropolitan areas. In each local service area, a service provider will locate
a metropolitan point-of-presence, or metro POP, that will concentrate high-
speed, last mile access links from multiple MTUs, provide value-added services
such as web hosting and e-mail, manage subscriber access, centralize billing,
and provide an efficient link to backbone Internet or intranet networks.
The high-speed links from a service provider's metro POP to individual MTU
buildings or complexes may consist of local T1 facilities sourced from an ILEC,
xDSL facilities sourced from a competitive local exchange carrier, or CLEC, or
self-provisioned fiber, coaxial cable, or radio facilities.
Once broadband access is brought to the MTU, another broadband distribution
network needs to be created within the building to bring the offered services
to tenants. Alternatives for creating this network include rewiring the
building with Category 5 copper wire for Ethernet, laying a new fiber-based
infrastructure or reusing the copper infrastructure that is already in place to
provide telephone service. Rewiring with Category 5 wire or laying new fiber
links can be prohibitively expensive on a per-subscriber basis because in most
cases a service provider will only have demand from a limited number of tenants
in the building, yet the entire building will need to be rewired to accommodate
future and changing requirements. Similarly, carrier class DSL access
multiplexers, known as DSLAMs, which are designed to serve hundreds of
subscribers over the existing telephone wires, are prohibitively expensive when
only serving a limited number of tenants.
We believe that service providers for the MTU market require systems that:
. deliver reliable high-quality broadband access services in a cost
effective manner;
. are easy to deploy and provision, and are economically scalable from as
few as four subscribers in small buildings to hundreds of subscribers in
large complexes;
. support and manage the bandwidth for multiple services such as voice,
video, and VPN networking so as to maximize both the network
infrastructure and the sales, marketing and operations infrastructure of
the service provider; and
. are remotely controlled, maintained and upgraded as required.
We believe that systems with these characteristics enable service providers
to increase their revenue by providing additional services and increase
customer retention through bundled service offerings.
The Tut Systems Solution
We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access over the existing
copper telephone infrastructure found in MTU complexes, such as apartment
buildings, hotels, business parks and commercial office buildings. Our systems
also provide service providers with enhanced capabilities such as subscriber
management, bandwidth management, plug and play installation, portal
redirection, IP address management, service authorization and network address
translation. Our systems are designed with the specific requirements of the MTU
market in mind and provide the following benefits to our customers:
. Reliable, high performance, cost-effective, broadband access. Our access
products use our proprietary FastCopper technology to exploit the
underutilized bandwidth of existing MTU infrastructures by reducing the
noise, radio frequency interference and signal cross talk inherent in
high-speed data transmission over copper telephone wires. Our technology
enables cost-effective Ethernet LANs to be quickly implemented over
these telephone wires, without interfering with existing telephone
service that may be running over these same wires. Our proprietary
HomeRun technology has been adopted as the first generation standard for
home networking over copper telephone wires by the Home Phone Network
Alliance, or HomePNA, and is licensed to leading semiconductor, computer
hardware and consumer
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electronics manufacturers. Our proprietary LongRun technology is similar in
operation to our HomeRun technology, but provides higher performance in the
presence of noise and cross-talk, and transmits over longer distances than
HomeRun.
. Easy-to-deploy, scalable systems. Our Expresso GS, MDU and MDU Lite
systems, which are integrated with our proprietary FastCopper
technologies, provide low cost, high-speed bandwidth to multiple tenants
within an MTU complex or building while meeting our service provider
customers' ease-of-use and scalability requirements. The Expresso MDU
unit is intended for deployment in the basements of apartment buildings,
in wiring rooms of hotels and in other residential locations where
access lines are centrally concentrated. Our compact MDU Lite product
extends the delivery of high-speed services to tenants living in the
smaller buildings typically found in garden style apartment complexes.
. Multiple value-added, revenue-enhancing services. Our Expresso SMS 2000
and Expresso OCS systems provide plug-and-play functionality, subscriber
management, community web pages, credit card billing and other functions
for the MDU market. When used to provide high-speed Internet access to
hotel guests, the Expresso SMS 2000 system interfaces with our Expresso
MDU system to provide a simple plug-and-play experience for the guest
without disturbing normal phone service or requiring computer
reconfiguring by the guest. Our recently introduced IntelliPOP product
is designed to allow service providers to manage and guarantee bandwidth
and service performance across applications such as IP telephony, VPN
networking, videoconferencing, video-on-demand, file transfer and
Internet access and to efficiently configure the delivery of these
services according to the unique market requirements of multi-tenant
building owners and end-user subscribers on an individual or collective
basis.
. Our recently introduced IntelliPOP product is designed to allow service
providers to manage and guarantee bandwidth and service performance
across applications such as IP telephony, VPN networking,
videoconferencing, video-on-demand, file transfer and Internet access and
to efficiently configure the delivery of these services according to the
unique market requirements of multi-tenant building owners and end-user
subscribers on an individual or collective basis.
. Our products use industry-standard protocols for interoperability with
third-party systems and are based on industrial-grade computing platforms
for continuous industry-driven improvements in price and performance.
Strategy
Our objective is to be the dominant provider of advanced multi-service
broadband access systems that exploit the large existing infrastructure of
copper telephone wires within multi-tenant complexes, such as apartment
buildings, hotels, office buildings, business parks, university dormitories
and other buildings. Key elements of our business strategy are as follows:
Facilitate Rapid Growth in MDU Markets. We market our Expresso MDU and
related products to service providers that are focused on the residential MDU
market and can benefit from highly-scalable Internet access solutions with low
initial deployment costs. We actively work with our customers both to deploy
systems in additional properties as well as to facilitate the adoption of
broadband access services by tenants in buildings in which our systems are
already deployed. We intend to continue to focus our direct sales and
marketing efforts on establishing additional customer relationships with large
MDU service providers. In addition, we intend to reach smaller service
providers through our network of value added resellers, or VARs, and systems
integrators.
Accelerate Penetration in MCU Markets. We plan to accelerate our
penetration of the commercial MCU market with our IntelliPOP system that has
been designed to offer speeds greater than 10 Mbps over single-pair,
telephone-grade wire. Using a patent-pending Signature Switch architecture,
IntelliPOP is designed to allow service providers to quickly and cost-
effectively deliver multiple, high-performance broadband services
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through classification and prioritization of device and/or application-specific
network traffic. IntelliPOP is currently being evaluated by several potential
customers.
Enhance the Service Capabilities Provided by our Products and Systems. By
adding higher-level features and functions above the basic data transport
layer, such as subscriber management, network address translation, traffic
prioritization, bandwidth limiting, IP telephony and VPN networking support to
our product line, we enable our service provider customers to expand the range
of services that they can market and deploy to their customers. Service
providers, in turn, can leverage their sales and marketing efforts, reduce
customer turnover, and have a higher revenue-to-cost portfolio of services. We
intend to lower the total cost of system ownership for our customers by
reducing manufacturing costs, expanding the self-provisioning features of our
systems, and enhancing network management capabilities. In addition, we expect
to utilize technology obtained from our FreeGate, Xstreamis and ActiveTelco
acquisitions in the further development of our IntelliPOP product platform.
Expand International Presence. We believe that our Expresso and IntelliPOP
product lines, which have been developed in conformance with international
standards, can serve a substantial market for high-speed data access products
outside of the United States. We are adding personnel in several key
international markets and are actively seeking to add new international
distributors who focus on the MTU market.
Core Technologies and Products
We have developed a broad base of proprietary FastCopper technology to
address noise and distortion problems so that high-speed data access can be
achieved over a single pair of ordinary copper telephone wires used in
corporate and educational campuses, apartment buildings, hotels and single
family homes. Our FastCopper technology encompasses three main areas of
expertise to maximize transmission rates at minimum costs over existing copper
telephone wires: noise reduction, analog and digital signal processing to
reduce distortion, and digital modulation techniques. Our FastCopper expertise
is deployed in our HomeRun, LongRun and other transmission technologies.
HomeRun creates a cost-effective Ethernet LAN over the random topology of
home telephone wires, without disturbing existing telephone service and/or
G.lite asymmetrical DSL, or G.lite ADSL, service running simultaneously over
these same wires. With HomeRun, multiple devices can share peripherals and/or a
single high-speed Internet access connection on a 1 Mbps Ethernet LAN. HomeRun
supports Internet connections through integrated services digital network, or
ISDN, or xDSL wireline technologies, a wireless modem or a cable modem. LongRun
shares similar modulation techniques with HomeRun, but operates at lower
baseband frequencies to provide improved performance in the presence of intra-
system crosstalk and coverage of longer distances that may be found in many
apartment, hotel, and university dormitory complexes. HomeRun is designed to
operate at distances up to 500 feet, while LongRun is intended to operate at
distances up to 2,500 feet.
The following products are based in part on this FastCopper technology
foundation and are augmented by additional technologies that allow for enhanced
capabilities:
Expresso System Platforms
Our Expresso MDU products are designed to be used by ILECs, PTTs, CLECs and
other service providers to provide high-speed advanced data services to large
numbers of end users over private copper network infrastructures. Expresso MDU
is AC-powered and, when integrated with our HomeRun or LongRun technology,
provides owners of private copper networks with an easy to deploy and scalable
means to distribute high-speed data access to tenants over the copper telephone
wires found in MTUs. In addition, we offer our Expresso GS system, which is DC-
powered and intended for use by service providers to serve last mile
applications using xDSL technologies.
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An Expresso MDU or Expresso GS system consists of a compact, modular
central-site shelf with a simple network management protocol, or SNMP,
management card, optional switching, multiplexing and wide-area network, or
WAN, interface cards, and up to 17 xDSL, HomeRun or LongRun line cards. The 10
1/2 inch high system is available with two mounting options, either 19 inches
wide for data center and international installations or 23 inches wide for
telephone company installations.
Each Expresso MDU and Expresso GS shelf can support up to 136 line-side
subscriber connections, making the Expresso MDU and Expresso GS platforms among
the highest density xDSL platforms in the industry. Multiple Expresso MDU and
Expresso GS shelves can be interconnected via 10 or 100Base-T Ethernet
connections, allowing the systems to accommodate hundreds of subscribers on a
common WAN interface.
Expresso MDU
Expresso MDU integrates our HomeRun and LongRun technologies with our
flexible Expresso platform to provide owners of MDUs with easy to deploy,
scalable and cost-effective solutions to distribute high-speed data access to
multiple tenants over the private copper networks within MDUs. The Expresso MDU
platform has been designed for deployment in residential locations, such as in
the basement wiring room of an apartment building. Expresso MDU can be equipped
with HomeRun and/or LongRun line cards to provide a secure Ethernet LAN for
each living unit within an MDU. We have developed HomeRun and LongRun adapters
that convert HomeRun/LongRun signals to a standard 10Base-T Ethernet interface.
Consumer products, such as PCs, peripherals, Internet telephones and
television-based web browsers, that are compatible with either version 1.0 or
version 2.0 of HomePNA can directly connect to the Expresso MDU without the
need for any additional adapter or network interface card.
Expresso MDU Lite
To provide service to small apartment buildings spread across a garden-style
complex in which there is no central wiring point, we developed the Expresso
MDU Lite and the Expresso LongRun MDU Lite. The former is intended for domestic
and international markets, while the latter is primarily intended for
international markets. The Expresso MDU Lite contains either eight ports of
HomeRun or eight ports of LongRun. Multiple units may be connected together to
support more than eight subscribers and these units may be connected back to a
central point via LongRun copper-based products, coax-based cable modems, or
radio-based modems.
Expresso GS
For local loop applications, we offer the Expresso GS system, which consists
of xDSL line cards connected to MXL-2300 series routers. The MXL-2300 series
routers, when used with a synchronous DSL, or SDSL, 2.3 line card, will provide
access at 2.3 Mbps. Our dynamic SmartWire SDSL rate adaptation enables all
subscribers to be served at the highest attainable speeds over each loop.
Through Expresso's All-Rate DSL feature, a service provider can offer tiered
access services in increments of 64 Kbps to meet the varying bandwidth and
price requirements of each subscriber. Expresso's All-Rate DSL feature also
allows service providers to offer a low cost, low bandwidth, entry level
service that can expand to higher bandwidth capabilities as each subscriber's
need for bandwidth expands. Our MXL-2300 routers provide a standard 10Base-T
interface for connection to users' PCs or LANs.
Expresso SMS 2000
Our Expresso SMS 2000 and companion Expresso OCS system provide plug-and-
play functionality, subscriber management, network address translation, credit
card billing, and other functions for the MDU market. The compact 1 3/4 inch
high Expresso SMS 2000 system runs on a Red Hat Linux operating system, is
typically located on the premises of an MDU complex and supports up to 800
simultaneous user sessions per unit. The companion Expresso OCS operations
center software is intended to be located at a metro POP or
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central network operations center. The Expresso OCS system is a software
package that runs on a standard PC computing platform. Each Expresso OCS system
can manage up to 300 remote Expresso SMS systems, providing central credit card
billing interfaces, accounting records, and access to the accounting and policy
data bases most often used by CLECs and Internet Service Providers, or ISPs.
IntelliPOP System
The recently introduced IntelliPOP system, currently under evaluation by
potential customers, includes the 5212 12-port Service Gateway and the 5101
Service Access Unit. A comprehensive Tut Management System is under development
that will allow full utilization of the service management aspects of
IntelliPOP. The IntelliPOP 5212 Service Gateway is a small service platform,
less than two inches high, that combines the functionality of an edge router, a
high-speed switch, and an access multiplexer with powerful bandwidth management
tools to distribute multiple IP-based services to individual tenants throughout
a small or mid-sized commercial building. The IntelliPOP 5212 Service Gateway
incorporates 12 very high speed DSL-based, or VDSL-based, line-side ports, each
of which can deliver up to 15 Mbps of symmetric bandwidth to a 5101 customer
premises unit. The 5101 Service Access Unit includes two 10Base-T ports for
interfacing to a variety of end-user devices and/or networks.
Subsequent versions of IntelliPOP are under development that will
incorporate higher access speeds, higher port capacities, and features
specifically tailored for the apartment and hospitality markets.
XL Products
We use our FastCopper technology, along with commercially available
components, to build high-speed data access products. In the XL600 product
series, we applied our noise reduction and signal processing expertise to build
a 10Mbps, 600 foot Ethernet LAN extension product to operate over a single pair
of copper telephone wires. For other XL products, we pioneered the use of rate
adaptive SDSL technology in products that extend transmission distances up to
24,700 feet without the use of repeaters. For HomeRun, we developed a
proprietary modulation technique to transmit high-speed data signals over the
random tree and branch networks typically found in single family homes. In the
XL 4000 product, we applied our noise reduction and signal processing expertise
to enable a 10 Mbps Ethernet LAN extension at distances up to 4,000 feet over a
single copper pair.
Customers and Markets
We target our development, marketing and sales efforts to service providers
in both the MDU and MCU markets.
MDU Market
Service providers, including ILECs, PTTs, CLECs, ISPs and multiple system
operators for the cable industry, can recognize substantial economies of scale
by providing high-speed services to MDU tenants from a single point of service.
MDUs include apartment complexes, hotels, university dormitories and military
housing complexes. We believe that the potential international MDU market
represents a strategic opportunity for us.
Our potential customers in the MDU market include both service providers who
seek to sell services to MDU tenants and owners of MDU complexes who seek to
offer advanced amenities to their tenants, increase property value, and/or gain
additional revenue from the property. Our Expresso SMS 2000 system has been
designed with features to specifically address the needs of this market. Among
our Expresso MDU customers throughout most of the calendar year 2000 were CAIS,
Inc., Darwin Networks, Inc., I-Quest Corporation, Reflex Communications, Inc.,
and Velocity HSI, Inc. Abrupt changes in the capital markets have led each of
these companies to narrow the focus of their market activities and severely
curtail previous levels of operations including their deployment of our
product. In the case of Darwin Networks, Inc., in January 2001, they filed for
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Chapter 11 bankruptcy protection. In the case Reflex Communications, Inc., in
March 2001, they filed for Chapter 7 bankruptcy protection. We also saw a fall
off in sales to customers in the Korean market, including sales to TriGem
InfoComm, as a result of regulatory and other changes within that marketplace.
As a result, we are depending more heavily on the development of our
relationships with other international customers and the business divisions of
ILECs, CLECs and PTTs.
MCU Market
For some time there have been service providers focused on delivering voice
services to tenants in multi-tenant commercial buildings, but over the last few
years, a new class of service providers and business divisions of ILECs and
PTTs have emerged that plan to use broadband IP-based infrastructures to
provide a wide array of bundled services, including high-speed Internet access,
email, web hosting, firewall protection, local and long distance voice, and
business TV to tenants in multi-tenant commercial buildings. These MCU service
providers are demanding a low-cost, multi-service, broadband platform on which
to deliver this array of services to the small and medium size businesses that
tend to locate in MCUs. Among our current MCU customers are Cygcom Integrated
Technologies, Inc., Newcom Americas, Inc., Rikei Corporation and Rycom CCI,
Inc.
The initial version of our IntelliPOP system has been designed to
specifically address the needs of the MCU market in terms of performance, size,
and ease of installation. We believe that IntelliPOP incorporates the high-
speed access technologies, high-performance processing technologies, and
sophisticated bandwidth management techniques required by business end users.
At the same time, the IntelliPOP Service Gateway is designed to be an easy-to-
deploy rack-mountable or wall-mountable unit that is less than two inches high
allowing for easy and cost-effective deployment in the smallest of multi-tenant
buildings. Several existing and potential customers are currently evaluating
the IntelliPOP product.
For simple point-to-point applications, we market our XL products to
domestic and international end users for LAN extensions over existing copper
telephone wires. We have several hundred domestic and international customers
for our XL product line.
Home Networking
The growth in the demand for high-speed data access, the decreasing cost of
personal computers and the proliferation of Internet access devices in homes
are creating an emerging demand for home networking and access solutions. Home
networks must be designed to allow the sharing of files, the sharing of
peripherals, such as printers, the simultaneous, uninterrupted use of voice
service and, perhaps most importantly, the sharing of Internet and remote
corporate network access. Home network consumers desire a low cost, easy to
implement network solution that does not require new wires to be installed
throughout the home.
We are licensing our HomeRun technology to members of the HomePNA and
others. In 1998, the HomePNA selected HomeRun as the initial specification for
a home networking standard. The founding members of the HomePNA were 3Com
Corporation, Advanced Micro Devices, Inc., Agere Systems (assigned from Lucent
Technologies, Inc.), AT&T Wireless Services, Broadcom Corporation (purchased
Epigram Corporation), Compaq Computer Corporation, Conexant Systems, Inc.,
Hewlett-Packard Co., Intel Corporation, International Business Machines and Tut
Systems. The HomePNA currently includes over 200 members.
Marketing, Sales and Customer Support
Marketing
We seek to increase demand for our products, expand company and product
visibility in the market and establish cooperative marketing programs. In
addition to customer-specific sales efforts, our marketing activities include
attendance at major industry trade shows and conferences, such as NetWorld +
InterOp, DSLcon, HiTech, National Multihousing Conference, and SuperComm, the
distribution of sales and product literature,
8
operation of a web site, advertising in trade journals and catalogs, direct
marketing and ongoing communications with our customers, the press and industry
analysts. As appropriate, we enter into cooperative marketing and/or
development agreements with strategic partners that may include key customers,
semiconductor manufacturers, radio, fiber, or cable equipment manufacturers,
set-top box manufacturers, and others.
Sales
We sell our products through multiple sales channels in the United States,
including a select group of regional VARs, systems integrators and
distributors, data networking catalogs and directly to service providers.
Internationally, we sell and market our products through sales agents, systems
integrators and distributors. In 1999 and 2000, we established new sales
channels in Canada, Europe, South America, Australia and Asia. In 1999, we
opened a sales office in the United Kingdom. For the year ended December 31,
2000, we derived approximately 41% of our revenue from customers in
international markets. We believe that our products can serve a substantial
market for high-speed data access products outside of the United States.
Customer Support
We believe that consistent high-quality service and support is a key factor
in attracting and retaining customers. Service and technical support of our
products is coordinated by our customer support organization located in
Pleasanton, California. Telecommunications and Networking Systems Engineers
provide critical technical support to our customers. Our Systems Application
Engineers, located in each of our sales regions, support pre- and post-sales
activities. We also employ a nationwide third party support organization to
handle inquiries from a large number of customers and provide first level
telephone technical support and on-site installation and support services.
Customers can also access technical information and receive technical support
through the Internet.
Research and Development
Our research and development efforts are focused on enhancing our existing
products and developing new products. Our research and development organization
emphasizes early stage system engineering. The product development process
begins with a comprehensive functional product specification based on input
from the sales and marketing organizations. We incorporate feedback from end
users and distribution channels, and through participation in industry events,
industry organizations and standards development bodies. Key elements of our
research and development strategy include:
. Core Designs. We seek to develop platform architectures and core designs
that allow for cost-effective deployment and flexible upgrades that meet
the needs of multiple markets and applications. These designs emphasize
quick time to market and future cost reduction potential. The Expresso
GS/MDU and IntelliPOP platforms are a direct result of this strategy.
. Product Line Extensions. We seek to extend our existing product lines
through product modifications and enhancements in order to meet the needs
of particular customers and markets. Products resulting from our product
line extension efforts include the Expresso MDU Lite.
. Use of Industry Standard Components. Our design philosophy emphasizes the
use of industry standard hardware and software components whenever
possible to reduce time to market, decrease the cost of goods and lessen
the risks inherent in new design. We maximize the use of third party
software for operating systems and certain protocol stacks which allows
our software engineers to concentrate on hardware-specific drivers, user
interface software and advanced features.
. New Technologies. We seek to enhance our product lines by incorporating
additional xDSL technologies, such as VDSL, higher speed WAN interfaces
and new network management software features. Our IntelliPOP suite of
products currently under customer evaluation is designed to utilize
9
technology from our FreeGate, Xstreamis and ActiveTelco acquisitions and
to incorporate components of our existing products, technologies and
designs. We also seek to develop new product capabilities through software
upgrades to our Expresso SMS 2000 platform.
Manufacturing
We do not manufacture any of our own products. We rely on contract
manufacturers to assemble, test and package our products. We require ISO 9002
registration for these contract manufacturers as a condition of qualification.
We audit each contractor's manufacturing process performance through audits,
testing and inspections and monitor each contractor's quality through incoming
testing and inspection of packaged products received from each contractor. In
addition, we monitor the reliability of our products through in-house repair,
reliability audit testing and field data analysis.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. We and our contract manufacturers
have experienced difficulty in obtaining some components used in our products.
We forecast our product requirements to maintain sufficient product inventory
to allow us to meet the short delivery times demanded by our large and diverse
customer base, which is typically one to four days from receipt of order to
shipment to the customer. However, because of recent changes in the industry,
we have had to cancel certain finished goods and component orders which may
have a negative impact on our ability to diversify our product manufacturing
across a larger base of contract manufacturers. Our future success will depend
in significant part on our ability to obtain manufacturing on time, at low
costs and in sufficient quantities to meet demand.
Competition
The markets for our products are intensely competitive, continually
evolving and subject to rapid technological change. We believe that we and our
products face the following competitive factors:
. conformance to industry standards;
. breadth of product lines;
. implementation of additional product features and enhancements, including
improvements in product performance, reliability, size, and scalability;
. low cost and ease of deployment and use;
. sales and distribution capability;
. technical support; and
. service and general industry and economic conditions.
Although we believe that we currently compete favorably with respect to all
of these factors, there can be no assurance that we will have the financial
resources, technical expertise or marketing, manufacturing, distribution and
support capabilities to compete successfully in the future. We expect that
competition in each of our markets will increase in the future. Our principal
competitors include or are expected to include Cisco Systems, Inc., Copper
Mountain Networks, Inc., Elastic Networks, Inc., Paradyne Networks, Inc., and
a number of other public and private companies. Many of our competitors and
potential competitors have substantially greater name recognition and
technical, financial and marketing resources than us. These competitors may
undertake more extensive marketing campaigns, adopt more aggressive pricing
policies and devote substantially more resources to developing new products
than us. There can be no assurance that we will be able to compete
successfully against current or future competitors or that competitive
pressures faced will not harm our business, financial condition and results of
operations. In addition, some of our licensees may sell aspects of our
technology to our competitors or potential competitors. These competitors may
cause an erosion in the
10
potential market for our products. This competition could result in price
reductions, reduced profit margins and loss of market share, which would harm
our business, financial condition and results of operations.
We also compete with technologies using alternative transmission media such
as coaxial cable, wireless facilities and fiber optic cable. To the extent that
telecommunications service providers choose to install fiber optic cable or
other transmission media in the last mile, or to the extent that homeowners and
businesses install other transmission media within buildings, we expect that
demand for our copper telephone wire-based products will decline. These
competitive pressures from alternative transmission technologies may further
necessitate price reductions of our existing and future products.
Proprietary Rights
Our success and ability to compete is dependent in part upon our proprietary
technology. We rely on a combination of patent, copyright and trade secret laws
and non-disclosure agreements to protect our proprietary technology. We
currently hold 20 United States patents and have 24 United States patent
applications pending. There can be no assurance that patents will be issued
with respect to pending or future patent applications or that our patents will
be upheld as valid or will prevent the development of competitive products. We
seek to protect our intellectual property rights by limiting access to the
distribution of our software, documentation and other proprietary information.
In addition, we enter into confidentiality agreements with our employees and
certain customers, vendors and strategic partners. The steps taken by us in
this regard may be inadequate to prevent misappropriation of our technology and
our competitors may independently develop technologies that are substantially
equivalent or superior to our technologies. We are also subject to the risk of
adverse claims and litigation alleging infringement of the intellectual
property rights of others. In this regard, there can be no assurance that third
parties will not assert infringement claims in the future with respect to our
current or future products or that any of these claims will not require us to
enter into license arrangements or result in protracted and costly litigation,
regardless of the merits of those claims. No assurance can be given that any
necessary licenses will be available or that, if available, these licenses can
be obtained on commercially reasonable terms.
Employees
As of February 19, 2001, we employed 223 persons, including:
. 23 in operations;
. 75 in sales, marketing and customer support;
. 88 in research and development; and
. 37 in finance, administration, and information technology support.
We also employ a number of contract employees, especially for technical
publications and systems verification. None of our employees are represented by
a labor union and we have experienced no work stoppages to date.
ITEM 2. FACILITIES
Our principal administrative and engineering facilities are located in
facilities totaling approximately 89,000 square feet located in Pleasanton,
California. In addition, we lease sales and administrative facilities totaling
approximately 2,600 square feet in Beaverton, Oregon, and engineering and
administrative facilities totaling approximately 20,200 square feet in
Sunnyvale, California. We also lease engineering facilities in Ann Arbor,
Michigan. The lease for the Pleasanton facility expires in April 2007, with an
option to renew for five years, the lease for the Oregon facility expires in
March 2002, the lease for the Sunnyvale facility expires in August 2002 and the
lease for the Ann Arbor facility expires in December 2001. We recently vacated
offices in Pleasant Hill, California and Oakland, California. The lease for the
Pleasant Hill facility expires in May 2001 and the lease for the Oakland
facility expires in April 2001. We currently sublet certain of our facilities.
We
11
believe that our facilities will be adequate to meet our requirements for the
foreseeable future and that suitable additional or substitute space will be
available as needed.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material litigation and we are not aware of any
pending or threatened litigation that could have a material adverse effect upon
our business, operating results or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Our common stock has been quoted on the Nasdaq National Market under the
symbol "TUTS" since our initial public offering in January 1999. The following
table sets forth, for the periods indicated, the high and low closing sales
prices per share of the common stock, as reported on the Nasdaq National
Market.
High Low
------- -------
1999:
First Quarter (from January 29, 1999)........................ $ 76.13 $ 39.75
Second Quarter............................................... 70.19 38.00
Third Quarter................................................ 47.25 22.44
Fourth Quarter............................................... 56.50 24.94
2000:
First Quarter................................................ 72.38 39.00
Second Quarter............................................... 63.13 31.38
Third Quarter................................................ 115.50 55.44
Fourth Quarter............................................... 79.25 6.16
On March 19, 2001, the last reported sale price of our common stock on the
Nasdaq National Market was $3.81 per share. As of March 19, 2001, there were
16,241,973 shares of our common stock outstanding and approximately 276 holders
of record of our common stock.
We have not paid dividends in the past and we intend to retain earnings, if
any, and will not pay dividends in the foreseeable future. Any future
determination to pay dividends will be at the discretion of the board of
directors and will be dependent upon our financial condition, results of
operations, capital requirements, general business conditions and such other
factors as our Board of Directors may deem relevant.
Recent Sales of Unregistered Securities
On January 11, 2001, we issued 321,343 shares of our common stock and
options to purchase 18,657 shares of our common stock to finance in part our
acquisition of ActiveTelco, Inc. The issuance of the securities in this
transaction was exempt from registration under the Securities Act in reliance
upon Section 4(2) of the Securities Act or Regulation D promulgated thereunder.
13
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Our selected consolidated financial data set forth below as of December 31,
2000 and 1999, and for each of the three years ended December 31, 2000, are
derived from our consolidated financial statements that have been audited by
PricewaterhouseCoopers LLP, independent accountants, and are included elsewhere
in this report. Our selected consolidated financial data set forth below as of
December 31, 1998, 1997 and 1996 and for each of the two years ended December
31, 1998 are derived from our audited consolidated financial statements not
included elsewhere herein. The data set forth below should be read in
conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations and the consolidated financial statements and related
notes included elsewhere in this report.
Years Ended December 31,
------------------------------------------------
2000 1999 1998 1997 1996
--------- -------- -------- -------- -------
(in thousands, except per share data)
(unaudited)
Statement of Operations Data:
Total revenues............... $ 71,991 $ 27,807 $ 10,555 $ 6,221 $ 4,454
Total cost of goods sold..... 69,983 15,459 5,809 3,228 2,198
--------- -------- -------- -------- -------
Gross margin................. 2,008 12,348 4,746 2,993 2,256
--------- -------- -------- -------- -------
Operating expenses:
Sales and marketing........ 19,945 10,523 8,462 5,147 3,068
Research and development... 17,149 7,618 6,200 3,562 2,012
General and
administrative............ 11,503 4,194 2,703 2,362 1,746
In-process research and
development............... 800 2,600 -- -- --
Amortization of
intangibles............... 7,623 52 -- -- --
Noncash compensation
expense................... 438 455 1,233 1,260 --
Provision for doubtful
accounts.................. 22,546 235 104 13 37
--------- -------- -------- -------- -------
Total operating
expenses................ 80,004 25,677 18,702 12,344 6,863
--------- -------- -------- -------- -------
Loss from operations......... (77,996) (13,329) (13,956) (9,351) (4,607)
Other income (expense), net.. 3,899 1,596 210 195 181
--------- -------- -------- -------- -------
Loss before income taxes..... (74,097) (11,733) (13,746) (9,156) (4,426)
Income tax expense........... 1 1 1 1 1
--------- -------- -------- -------- -------
Net loss..................... (74,098) (11,734) (13,747) (9,157) (4,427)
Dividend accretion on
preferred stock............. -- 235 2,584 1,627 1,137
--------- -------- -------- -------- -------
Net loss attributable to
common stockholders......... $ (74,098) $(11,969) $(16,331) $(10,784) $(5,564)
========= ======== ======== ======== =======
Net loss per share
attributable to common
stockholders, basic and
diluted..................... $ (4.98) $ (1.12) $ (60.62) $ (59.36) $(37.51)
========= ======== ======== ======== =======
Shares used in computing net
loss per share attributable
to common stockholders,
basic and diluted........... 14,866 10,729 269 182 148
========= ======== ======== ======== =======
December 31,
------------------------------------------------
2000 1999 1998 1997 1996
--------- -------- -------- -------- -------
(in thousands)
(unaudited)
Balance Sheet Data:
Cash, cash equivalents and
short-term investments...... $ 102,614 $ 32,236 $ 4,452 $ 10,285 $ 8,950
Working capital.............. 110,920 44,416 7,173 11,066 8,357
Total assets................. 205,588 65,356 15,257 15,168 10,689
Redeemable convertible
preferred stock and
warrants.................... -- -- 45,995 38,871 24,684
Long-term debt, net of
current portion............. -- -- 4,262 140 190
Accumulated deficit.......... (130,585) (56,487) (44,434) (28,103) (17,319)
Total stockholders' equity
(deficit)................... 166,173 51,522 (41,839) (26,444) (15,694)
14
The following table presents certain unaudited consolidated quarterly
financial information for each of the eight quarters ended December 31, 2000.
In the opinion of management, this quarterly information has been prepared on
the same basis as the consolidated financial statements and includes all
adjustments necessary to present fairly the information for the periods
presented. The results of operations for any quarter are not necessarily
indicative of results for the full year or for any future period.
Quarter Ended
------------------------------------------------------------------------------------------------------
Dec. 31, Sep. 30, Jun. 30, Mar. 31, Dec. 31, Sep. 30, Jun. 30,
2000 2000 2000 2000 1999 1999 1999
-------- -------- -------- -------- -------- -------- --------
(in thousands, except per share data)
(unaudited)
Total revenues $ 5,936 $28,567 $21,014 $16,474 $10,642 $8,264 $5,010
Gross margin (28,612) 13,503 9,780 7,337 4,687 3,923 2,089
Net loss
attributable to
common
stockholders (68,071)(/1/) (611)(/2/) (1,180)(/3/) (4,236)(/4/) (4,161)(/5/) (1,566)(/6/) (2,695)(/6/)
Net loss per
share
attributable to
common
stockholders,
basic and
diluted $(4.28)(/1/) $ (0.04)(/2/) $ (0.08)(/3/) $ (0.34)(/4/) $ (0.35)(/5/) $(0.13)(/6/) $(0.23)(/6/)
Shares used in
computing net
loss per share
attributable to
common
stockholders,
basic and
diluted 15,900 15,751 15,302 12,435 11,822 11,670 11,498
Mar. 31,
1999
-------------
Total revenues $3,891
Gross margin 1,649
Net loss
attributable to
common
stockholders (3,547)(/7/)
Net loss per
share
attributable to
common
stockholders,
basic and
diluted $(0.45)(/7/)
Shares used in
computing net
loss per share
attributable to
common
stockholders,
basic and
diluted 7,872
- --------
(/1/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include
amortization of goodwill and purchased intangibles of $2,535. Alternative
measure of net loss attributable to common stockholders and net loss per
share attributable to common stockholders, basic and diluted excluding
these items were $(65,536) and $(4.12), respectively.
(/2/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include
amortization of goodwill and purchased intangibles of $2,528. Alternative
measure of net income attributable to common stockholders and net income
per share attributable to common stockholders, basic excluding these items
were $1,917 and $0.12, respectively. Alternative measure of net income per
share attributable to common stockholders, diluted excluding these items
was $0.11. Shares used in computing alternative measure net income per
share, diluted was 17,346.
(/3/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include
amortization of goodwill and purchased intangibles of $1,814. Alternative
measure of net income attributable to common stockholders and net income
per share attributable to common stockholders, basic and diluted excluding
these items were $634 and $0.04, respectively. Shares used in computing
alternative measure net income per share, diluted was 16,547.
(/4/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include in-process
research and development expenses of $800 and amortization of goodwill and
purchased intangibles of $746. Alternative measure of net loss
attributable to common stockholders and net loss per share attributable to
common stockholders, basic and diluted excluding these items were $(2,690)
and $(0.22), respectively.
(/5/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include in-process
research and development expenses of $2,600 and amortization of goodwill
and purchased intangibles of $52. Alternative measure of net loss
attributable to common stockholders and net loss per share attributable to
common stockholders, basic and diluted excluding these items were $(1,509)
and $(0.13), respectively.
(/6/)There were no items that would generate a difference between net loss
attributable to common stockholders and net loss per share attributable to
common stockholders, basic and diluted, and alternative measure of net
loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted.
(/7/)Net loss attributable to common stockholders and net loss per share
attributable to common stockholders, basic and diluted include dividend
accretion of preferred stock of $235. Alternative measure of net loss
attributable to common stockholders and net loss per share attributable to
common stockholders, basic and diluted excluding this item were $(3,312)
and $(0.32), respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and the related Notes included in this Annual Report on Form 10-K.
This discussion contains, in addition to historical information, forward-
looking statements that involve risks and uncertainties including but not
limited to statements regarding customer and geographic mix, gross margins and
operating costs and expenses. Our actual results could differ materially from
the results discussed in the forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed below, as well as those discussed in our Registration Statements on
Form S-1, as filed with the SEC on September 20, 2000, those discussed in our
other reports and filings with the SEC and
15
those discussed under "Additional Risk Factors That Could Affect Our Operating
Results and the Market Price of Our Stock" elsewhere in this Annual Report on
Form 10-K. We disclaim any obligation to update information contained in any
forward-looking statement.
Overview
We design, develop and market multi-service broadband access systems that
enable service providers to deliver high-speed data access to multi-tenant
buildings. We use our proprietary FastCopper technology to deliver cost-
effective, scalable and easy to deploy solutions that exploit the underutilized
bandwidth of copper telephone wires within these buildings. Our collection of
FastCopper technologies includes HomeRun, which was selected as the initial
specification for a home networking standard promoted by the HomePNA, and
LongRun, a proprietary extension of HomeRun providing superior performance at
longer distances. These technologies are deployed through our Expresso high-
bandwidth access multiplexers and associated routers. In addition to our
Expresso access multiplexers are our products that provide service providers
with enhanced capabilities such as subscriber management, bandwidth management,
IP address management, and network address translation. Recently, we introduced
our IntelliPOP product line with proprietary Signature Switch technology. Our
proprietary Signature Switch technology is designed to allow service providers
to manage and guarantee bandwidth and service performance across applications
such as IP telephony, VPN networking, videoconferencing, video-on-demand, file
transfer and Internet access, and to efficiently configure IntelliPOP for the
delivery of these services according to the unique market requirements of
multi-tenant building owners and end-user subscribers on an individual or
collective basis.
We commenced operations in August 1991. Through the third quarter of 1998,
substantially all of our revenue was derived from the sale of our XL Ethernet
LAN extension products to the corporate and university segments of the MCU
market. In early 1997, we introduced the first products in our Expresso product
line aimed at service provider markets. During the first quarter of 1998, we
began licensing our HomeRun technology to certain leading semiconductor,
computer hardware and consumer electronics manufacturers for incorporation into
integrated circuits and consumer products including PCs, peripherals, modems
and other Internet appliances. In the third and fourth quarters of 1998, we
commenced selling our Expresso GS products, which are configured for local loop
applications, and Expresso MDU products, which incorporate our HomeRun
technology to a broader range of service providers, primarily those serving
apartment complexes, hotels, university dormitories and military complexes in
the MDU market. In the first quarter of 1999, we commenced selling Expresso MDU
products incorporating our LongRun technology and Expresso MDU Lite into
additional segments of the MDU market. During the fourth quarter of 1999, we
commenced selling our Expresso SMS 2000 and companion Expresso OCS system
providing subscriber management, bandwidth management, credit card billing and
other functions to the MDU market. During the first quarter of 2000, we
commenced selling our OneGate Internet server appliances, acquired as a result
of our FreeGate acquisition, to the MCU market. During the last quarter of
2000, our new IntelliPOP product was under evaluation by several potential
customers.
We generate revenue primarily from the sale of hardware products and, to a
lesser extent, through the licensing of our HomeRun technology and the sale of
our software products. We generally recognize product revenue when persuasive
evidence of an arrangement exists, delivery has occurred, the fee is fixed or
determinable, and collectibility is probable. Revenue from service obligations
included in product revenues is deferred and generally recognized ratably over
the period of the obligation. We also maintain accruals and allowances for all
cooperative marketing and other programs. Estimated sales returns, and warranty
costs based on historical experience by product, are recorded at the time
revenue is recognized. Our products generally carry a one year to two year
warranty from the date of purchase. Estimated sales returns, and warranty costs
based on historical experience by product, are recorded at the time revenue is
recognized.
16
License and royalty revenue consists of nonrefundable up-front license fees,
some of which may offset initial royalty payments, and royalties. Currently,
the majority of our license and royalty revenue is comprised of non-refundable
license fees paid in advance. Such revenue is recognized ratably over the
period during which post-contract customer support is expected to be provided
or upon delivery and transfer of agreed upon technical specifications in
contracts where essentially no further support obligations exist. Future
license and royalty revenue is expected to consist primarily of royalties based
on products sold by our licensees. We do not expect that such license and
royalty revenue will constitute a substantial portion of our revenue in future
periods. With the introduction of our IntelliPOP product line, we expect that
revenue from the sale of software products and maintenance fees will constitute
a substantial portion of revenue in future periods.
We expect that sales price reductions on some of our products will be
necessary to remain competitive and to reduce relatively high levels of
inventory. Although we have historically been able to offset most price
declines with reductions in our manufacturing costs, there can be no assurance
that we will be able to offset further price declines with cost reductions. In
addition, some of our licensees may sell products based on our technology to
our competitors or potential competitors. There can be no assurance that our
HomeRun technology will be successfully deployed on a widespread basis or that
such licensing will not result in an erosion of the potential market for our
products.
Sales to customers outside of the United States accounted for approximately
41.0%, 32.3% and 18.5% of revenue for the years ended December 31, 2000, 1999
and 1998, respectively. On average, we expect international sales to represent
approximately one-half or less of our revenue. However, actual results, both
geographically and in absolute dollars, may vary from quarter to quarter
depending on the timing of orders placed by customers. To date, all
international sales have been denominated in U.S. dollars.
We expect to continue to evaluate product line expansion and new product
opportunities, engage in extensive research, development and engineering
activities and focus on cost-effective design of our products. Accordingly, we
will continue to make significant expenditures on sales and marketing, and
research and development activities.
In June 1999, we acquired PublicPort, Inc. in exchange for 168,679 shares of
our common stock. This transaction was treated as a pooling of interests for
accounting purposes. PublicPort was located in Ann Arbor, Michigan. PublicPort
designed and developed subscriber management systems that enabled businesses in
the MDU market to provide mobile computer users access to the public Internet
or private corporate networks without having to reconfigure their computer's
network access software.
In November 1999, we acquired Vintel Communications, Inc. ("Vintel") for
$4.8 million, consisting of $0.5 million cash, 116,370 shares of our common
stock and 40,500 options to acquire our common stock. This transaction was
treated as a purchase for accounting purposes. Vintel was located in Oakland,
California. Vintel designed and developed high-performance integrated service
routers that allowed service providers to offer bundles of services, including
voice-over-IP and high speed Internet services over a common IP infrastructure
to customers in the MTU market.
In February 2000, we acquired FreeGate Corporation ("FreeGate") for
approximately $25.5 million, consisting of 510,931 shares of our common stock,
19,707 options to acquire our common stock, and acquisition related expenses
consisting primarily of investment advisory, legal, other professional fees and
other assumed liabilities. This transaction was treated as a purchase for
accounting purposes. FreeGate was located in Sunnyvale, California. FreeGate
designed, developed and marketed Internet server appliances combining the
functions of IP routing, firewall security, network address translation, secure
remote access via VPN networking, and email and web servers on a compact, PC-
based platform.
In April 2000, we acquired certain assets of OneWorld Systems, Inc.
("OneWorld") for approximately $2.4 million in cash. This transaction was
treated as a purchase of assets for accounting purposes.
17
In May 2000, we acquired Xstreamis Limited ("Xstreamis"), formerly
Xstreamis, plc, for $19.6 million, consisting of 439,137 shares of our common
stock, 10,863 options to acquire our common stock, $0.1 million in cash and
$0.6 million in acquisition related expenses consisting primarily of legal and
other professional fees. This transaction was treated as a purchase for
accounting purposes. Xstreamis was located in the United Kingdom. Xstreamis
provided policy-driven traffic management for high-performance, multimedia
networking solutions including routing, switching and bridging functions.
In January 2001, we acquired ActiveTelco, Inc. ("ActiveTelco") for
approximately $4.9 million, consisting of an aggregate of 321,343 shares of the
Company's common stock and 18,657 options to purchase shares of the Company's
common stock and acquisition related expenses consisting primarily of legal,
other professional fees, assumed ActiveTelco convertible notes in the amount of
$0.7 million plus accrued interest and other assumed liabilities of
approximately $1.1 million. This transaction is being treated as a purchase for
accounting purposes. ActiveTelco was located in Fremont, California.
ActiveTelco provided an Internet telephony platform that enabled Internet and
telecommunications service providers to integrate and deliver Web-based
telephony applications such as unified messaging, long-distance service,
voicemail and fax delivery, call forwarding, call conferencing and callback
services.
While we expect to derive benefits from sales of product lines that are
designed, developed and marketed as a result of these acquisitions, there can
be no assurance that we will be able to complete the development and commercial
deployment of certain of these products or expand sales of those products which
have already been completed. In January 2001, we decided to abandon future
sales of the existing OneGate product that we acquired in the FreeGate
acquisition. The related OneGate and other intellectual property acquired from
FreeGate is being incorporated into the design of future products.
Through these completed transactions, we have added approximately 80 people
to our workforce. The costs associated with personnel including rent for
additional facilities and related general and administrative costs as well as
costs associated with research and development, and sales and marketing
activities substantially increased our operating costs in fiscal year 2000 when
compared to related costs expended in fiscal year 1999. In January 2001, we
reduced our total workforce by 10% in efforts to control overall operating
expenses in response to recent declines in and expected slowing of our sales
growth.
We have incurred net operating losses to date and, as of December 31, 2000,
had an accumulated deficit of $130.6 million. Our ability to generate income
from operations will be primarily dependent on increases in sales volume,
reductions in manufacturing costs and the growth of high-speed data access
solutions in the service provider and MTU markets. In view of our limited
history of product revenue from new markets, reliance on growth in deployment
of high-speed data access solutions and the unpredictability of orders and
subsequent revenue, we believe that period to period comparisons of our
financial results are not necessarily meaningful and should not be relied upon
as an indication of future performance. Failure to generate significant revenue
from new products, whether due to lack of market acceptance, competition,
technological change or otherwise, or the inability to reduce manufacturing
costs, will harm our business, financial condition and results of operations.
18
Results of Operations
The following table sets forth items from our statements of operations as a
percentage of total revenue for the periods indicated:
Year Ended December
31,
------------------------
2000 1999 1998
------- ------ -------
Total revenues..................................... 100.0% 100.0% 100.0%
Total cost of goods sold........................... 97.2 55.6 55.0
------- ------ -------
Gross margin..................................... 2.8 44.4 45.0
------- ------ -------
Operating expenses:
Sales and marketing.............................. 27.7 37.8 80.2
Research and development......................... 23.8 27.4 58.7
General administrative........................... 16.0 15.1 25.6
In-process research and development.............. 1.1 9.4 --
Amortization of intangibles...................... 10.6 0.2 --
Noncash compensation expenses.................... 0.6 1.6 11.7
Provision for doubtful accounts.................. 31.3 0.8 1.0
------- ------ -------
Total operating expenses....................... 111.1 92.3 177.2
------- ------ -------
Loss from operations............................... (108.3) (47.9) (132.2)
Impairment of certain equity investments........... (4.3) -- --
Interest expense................................... (0.5) (2.2) (1.1)
Interest income.................................... 10.2 7.9 3.1
Other income, net.................................. -- -- --
------- ------ -------
Loss before income taxes........................... (102.9) (42.2) (130.2)
Income tax expense................................. -- -- --
------- ------ -------
Net loss........................................... (102.9) (42.2) (130.2)
Dividend accretion on preferred stock.............. -- 0.8 24.5
------- ------ -------
Net loss attributable to common stockholders....... (102.9)% (43.0)% (154.7)%
======= ====== =======
Years Ended December 31, 2000, 1999 and 1998
Revenue. We generate revenue primarily from the sale of hardware products
and, to a lesser extent, through the licensing of our HomeRun technology and
from the sale of software products. Our total revenue increased to $72.0
million for the year ended December 31, 2000 from $27.8 million for the year
ended December 31, 1999, and from $10.6 million for the year ended December 31,
1998. Using a year-over-year comparison, the increases in 2000 and 1999 were
primarily due to increased sales of our Expresso MDU products. However, during
the fourth quarter of 2000, revenue growth slowed substantially due to several
key customers who, in the latter part of the fourth quarter experienced a rapid
deterioration in their ability to obtain additional capital and, as a result,
severely curtailed or halted their purchases of our product, and also due to a
fall-off in sales to the Korean market. This resulted in fourth quarter
revenues of $5.9 million compared with revenues of $66.1 million for the first
three quarters of 2000 in aggregate and $10.6 million for the fourth quarter of
1999. License and royalty revenue increased to $2.0 million for the year ended
December 31, 2000, from $1.5 million for the year ended December 31, 1999, and
from $0.8 million for the year ended December 31, 1998. The increase in 2000
was primarily due to increases in royalty payments. The increase in 1999 was
primarily due to increases in up-front license fees recognized during the year
and receipt of related royalty payments. There was one new license and royalty
agreement signed during fiscal year 2000.
19
Cost of Goods Sold/Gross Margin. Cost of goods sold consists of raw
materials, contract manufacturing, personnel costs, test and quality assurance
for products, and cost of licensed technology included in the products. Our
cost of goods sold before provision for loss on purchase commitments and
abandoned products increased to $42.8 million for the year ended December 31,
2000, from $15.5 million for the year ended December 31, 1999, and from $5.8
million for the year ended December 31, 1998. The increases in 2000 and 1999
were primarily due to increased production of our Expresso MDU products. Our
gross margin before provision for loss on purchase commitments and abandoned
products on an absolute basis increased to $29.2 million for the year ended
December 31, 2000, from $12.3 million for the year ended December 31, 1999, and
from $4.7 million for the year ended December 31, 1998. Gross margin before
provision for loss on purchase commitments and abandoned products as a
percentage of revenue decreased to 40.6% of revenue for the year ended December
31, 2000, from 44.4% of revenue for the year ended December 31, 1999, and from
45.0% of revenue for the year ended December 31, 1998. The decrease in gross
margin before such provisions as a percentage of revenue in 2000 was due
primarily to fourth quarter introductions of new products in the Expresso MDU
product line which had lower than average gross margins, increases in inventory
reserves related to estimated losses on custom built products and older product
versions that were not upgraded in light of fourth quarter industry slowdowns,
higher costs of scarce component parts which could not be offset by further
product cost reductions, and fixed manufacturing costs which could not be
reduced in correlation with the rapid decline of revenue in the fourth quarter.
During the fourth quarter of 2000, we recognized a charge related to provision
for loss on purchase commitments and abandoned product lines of $27.2 million.
The provision covers estimated costs for the cancellation of inventory purchase
commitments that resulted from industry slow downs of large scale deployments
in the MTU market and actual costs for inventory of abandoned product lines no
longer deemed essential to our core technologies in the future. The cost of
these abandoned products was $8.2 million and included OneGate products,
certain Expresso GS line cards and routers, and certain subscriber management
software. This charge was included in cost of goods sold resulting in an
overall gross margin of 2.8% for 2000. The decrease in gross margin as a
percent of revenue in 1999 from 1998 was primarily due to the change in product
mix, as we sold a larger percentage of Expresso products that had lower average
gross margins than the XL products.
Sales and Marketing. Sales and marketing expense primarily consists of
personnel costs, including commissions and costs related to customer support,
travel, trade shows, promotions, and outside services. Our sales and marketing
expenses increased to $19.9 million for the year ended December 31, 2000, from
$10.5 million for the year ended December 31, 1999, and from $8.5 million for
the year ended December 31, 1998. The increases in both 2000 and 1999 were
primarily due to increased hiring of sales and marketing personnel. These
increases were also due to travel, attendance at trade shows, as well as
increases in personnel related to customer support activities and expanded
efforts in international markets.
Research and Development. Research and development expense primarily
consists of personnel costs related to engineering and technical support,
contract consultants, outside testing services, equipment and supplies
associated with enhancing existing products and developing new products.
Research and development costs are expensed as incurred. Our research and
development expenses increased to $17.1 million for the year ended December 31,
2000, from $7.6 million for the year ended December 31, 1999, and from $6.2
million for the year ended December 31, 1998. The increase in 2000 was
primarily due to further development of the Expresso MDU products, development
of HomeRun-related products, continued development of the subscriber management
system portion of the Expresso MDU product line and initial development of our
IntelliPOP platform. The research and development expenses of FreeGate and
Xstreamis were consolidated with our expenses for the periods subsequent to the
respective February 2000 and May 2000 acquisitions. Additionally, in 2000 we
amortized $2.0 million of deferred compensation and notes receivable to
research and development related to restricted stock granted to certain
FreeGate and OneWorld employees. Approximately $1.3 million of the remaining
deferred compensation and notes receivable have been recorded as a reduction of
equity in the balance sheet. We intend to recognize the expense ratably over
the remaining period in which the restrictions lapse, currently estimated at
eight and ten months for each of FreeGate and OneWorld, respectively. The
increase in 1999 was primarily due to further development of the Expresso GS
and Expresso MDU products,
20
development of HomeRun-related products, enhancement of certain XL products,
and continued development of the subscriber management system portion of the
Expresso MDU product line. The research and development expenses of PublicPort
and Vintel were consolidated with our expenses for the periods subsequent to
the respective June 1999 and November 1999 acquisitions. We intend to increase
investment in research and development programs in future periods for the
purpose of enhancing current products to provide advanced Internet service
applications for both domestic and international markets, reducing the cost of
current products, and developing and acquiring new products.
General and Administrative. General and administrative expense primarily
consists of personnel costs for administrative officers and support personnel,
and legal, accounting and consulting fees. Our general and administrative
expenses increased to $11.5 million for the year ended December 31, 2000, from
$4.2 million for the year ended December 31, 1999, and from $2.7 million for
the year ended December 31, 1998. The increases in both 2000 and 1999 were
primarily due to additions of administrative personnel and increases in other
costs related to our growth. We intend to increase general and administrative
expenditures and infrastructure costs as we expand our business.
In-Process Research and Development. Amounts expensed as in-process research
and development were $0.8 million in 2000 and $2.6 million in 1999 and were
related to in-process research and development purchased from FreeGate and
Vintel, respectively. There were no such costs prior to 1999.
In-Process Research and Development, FreeGate. Amounts expensed as in-
process research and development were $0.8 million for the year ended December
31, 2000 and were related to in-process research and development purchased from
FreeGate. The purchased in-process technology was expensed upon acquisition,
because technological feasibility had not been established and no future
alternative uses existed. The in-process technology percentage of completion
was estimated to be 75%. The value of this in-process technology was determined
by estimating the costs to develop the purchased in-process technology into a
commercially viable product, estimating the resulting net cash flows from the
sale of the product resulting from the completion of the in-process technology
and discounting the net cash flows back to their present value using a risk-
weighted discount rate of 30%. Research and development costs to bring in-
process technology from FreeGate to technological feasibility are not expected
to have a material impact on the Company's future results of operations or cash
flows.
In-Process Research and Development, Vintel. Amounts expensed as in-process
research and development were $2.6 million for the year ended December 31, 1999
and were related to in-process research and development purchased from Vintel.
The purchased in-process technology was expensed upon acquisition, because
technological feasibility had not been established and no future alternative
uses existed. The in-process technology percentage of completion was estimated
to be 75%. The value of this in-process technology was determined by estimating
the costs to develop the purchased in-process technology into a commercially
viable product, estimating the resulting net cash flows from the sale of the
product resulting from the completion of the in-process technology and
discounting the net cash flows back to their present value using a risk-
weighted discount rate of 30%. Research and development costs to bring in-
process technology from Vintel to technological feasibility are not expected to
have a material impact on the Company's future results of operations or cash
flows.
Amortization of Intangibles. Amortization of intangibles consists of the
periodic amortization of intangible assets related to the purchase acquisitions
of Vintel, FreeGate, OneWorld and Xstreamis. These assets consist primarily of
assembled workforce, completed technology and patents, and goodwill, and each
are amortized over their estimated useful lives of three, five and five years,
respectively. Amortization of intangibles increased to $7.6 million for the
year ended December 31, 2000, from $0.1 million for the year ended December 31,
1999. There were no such costs in the year ended December 31, 1998. The
increase in 2000 relates to the acquisitions completed in the year for
FreeGate, OneWorld and Xstreamis and a full year of amortization of the Vintel
acquisition completed in November 1999. The increase in 1999 relates to the
Vintel acquisition.
21
Noncash Compensation Expense. Noncash compensation expense in 2000 and 1999
consisted of the recognition of expense related to certain employee stock
option grants, based on the difference between the deemed fair value of common
stock and the option exercise price at the date of grant. Noncash compensation
expense in 1998 primarily consisted of expenses related to the grant of a
warrant to purchase up to 666,836 shares of common stock in consideration for
technology endorsement, marketing and certain development support by Microsoft
with respect to our HomeRun technology and related products. Noncash
compensation expense in 1998 also consisted of the recognition of expense
related to certain employee stock option grants. Our noncash compensation
expense was $0.4 million, $0.5 million and $1.2 million for the years ended
December 31, 2000, 1999 and 1998, respectively. We intend to recognize $0.3
million in additional expenses related to employee stock options ratably over
the remaining vesting period of the related options. Such deferred expense has
been recorded as a reduction of equity in the balance sheet.
Provision for Doubtful Accounts. Provision for doubtful accounts consisted
of the recognition of bad debt expense related to past due accounts receivable
balances. The provision for doubtful accounts increased to $22.5 million for
the year ended December 31, 2000, from $0.2 million for the year ended December
31, 1999, and from $0.1 million for the year ended December 31, 1998. The
increase in 2000 was primarily due to provisions recorded on past due accounts
receivable from several key customers who, during the latter part of the fourth
quarter of 2000, experienced a rapid deterioration in their ability to obtain
additional capital to fund their business models, declared their inability to
make timely payments on their accounts, and, as of the date of this report,
have not been able to demonstrate wherewithal to pay their outstanding account
balances. In January 2001, one of these customers filed for Chapter 11
bankruptcy protection. In March 2001, another one of these customers filed for
Chapter 7 bankruptcy protection. The other customers may be forced to follow
similar protection options in the event capital funding does not materialize.
Impairment of Certain Equity Investments. Impairment of certain equity
investments consisted of the recognition of expense related to the write off of
$3.1 million invested in three nonpublicly traded companies. The value of these
investments was impaired due to uncertainty associated with the on-going
viability of each of the businesses in the current network infrastructure
industry. There was no such impairment of our equity investments in 1999 or
1998.
Interest Expense. Interest expense consisted of interest expense associated
with credit facilities. Our interest expense decreased to $0.4 million for the
year ended December 31, 2000, from $0.6 million for the year ended December 31,
1999, and increased from $0.1 million for the year ended December 31, 1998. The
decrease in 2000 was primarily due to our paying off the principal owed on our
credit facilities. The increase in 1999 was primarily due to higher average
principal owed on our credit facilities during fiscal 1999 as compared to
fiscal 1998.
Interest Income. Interest income consisted of interest income on our cash,
investments and notes receivable balances, offset by the amortization of
premiums paid on investments. Our interest income increased to $7.4 million for
the year ended December 31, 2000, from $2.2 million for the year ended December
31, 1999, and from $0.3 million for the year ended December 31, 1998. The
increases in 2000 and 1999 were primarily due to interest income on higher
average cash and investment balances.
Liquidity and Capital Resources
From our inception through January 1999, we have financed our operations
primarily through the sale of preferred equity securities for an aggregate of
$46.2 million net of offering costs. In January 1999, we completed our initial
public offering and issued 2,875,000 shares of our common stock at a price of
$18.00. We received approximately $46.9 million in cash, net of underwriting
discounts, commissions and other offering costs. We also received approximately
$6.7 million as a result of the exercise of a warrant to purchase 666,836
shares of Series G convertible preferred stock at a price of $10.00 per share.
In March 2000, we completed our secondary offering and issued 2,500,000 shares
of our common stock at a price of $60.00 and we received approximately $141.7
million in cash, net of underwriting discounts, commissions and other offering
costs.
22
As of December 31, 2000, we had cash, cash equivalents, and short-term
investments of $102.6 million compared to $32.2 million as of December 31,
1999.
The net increase in cash and cash equivalents of $33.9 million during the
year ended December 31, 2000 resulted primarily from net proceeds from our
secondary offering of $141.7 million and proceeds from the issuance of common
stock related to stock options and employee stock purchases of $4.9 million.
The increases in cash and cash equivalents from these sources were offset by
uses in operating activities of $63.8 million, the purchase of property and
equipment of $8.6 million, the purchase of investments and other assets, net of
maturities and sales of investments, of $36.6 million, the payoff of borrowings
under a credit facility of $1.5 million, the acquisition costs for FreeGate,
OneWorld and Xstreamis of $1.8 million and other financing activities of $0.4
million.
The net increase in cash and cash equivalents of $9.0 million during the
year ended December 31, 1999 resulted primarily from net proceeds from our
initial public offering of $46.9 million, net proceeds from the exercise of a
warrant for convertible preferred stock of $6.7 million, proceeds from the
issuance of common stock related to stock options and employee stock purchase
plan of $0.7 million, and proceeds from the acquisition of Vintel of $0.4
million. The increases in cash and cash equivalents from these sources were
offset by uses in operating activities of $19.8 million, the purchase of
investments net of proceeds from sales and maturities of investments of $20.7
million, the purchase of property and equipment of $2.5 million, the payoff of
borrowings under a credit facilities of $2.7 million.
The net decrease in cash and cash equivalents of $0.9 million during the
year ended December 31, 1998 resulted primarily from uses for operating
activities of $12.7 million and the purchase of property and equipment of $1.0
million. These decreases in cash and cash equivalents were offset by proceeds
from sales and maturities of short term investments net of purchases of short-
term investments of $5.1 million, proceeds from the sale of preferred
securities of $3.8 million and borrowings from credit facilities net of
repayments of $3.9 million.
In the first quarter of 2000, we entered into a lease for administrative and
engineering facilities. Under the terms of the lease, we were required to issue
a letter of credit in the amount of $1.8 million. The letter of credit is
collateralized by restricted funds in the amount of $3.2 million, which are
included in intangibles and other assets as of December 31, 2000. The letter of
credit is reduced annually by $0.25 million provided we are not in default
under the terms of the lease agreement.
For future periods, we generally anticipate moderate increases in working
capital on a period to period basis primarily as a result of higher relative
levels of inventory. In 2000, we leased and improved facility space for
administrative and engineering requirements to accommodate future growth needs
through 2001. We foresee limited increases for expenditures of property and
equipment related to the expansion of systems infrastructure, office equipment
and lab and test equipment through 2001.
We believe that our cash, cash equivalents and short-term investment
balances will be sufficient to satisfy our cash requirements for at least the
next 12 months.
Option Exchange Program
We are offering our employees the opportunity to cancel certain outstanding
stock options in return for new options to purchase shares of our common stock
equal to the number of options canceled on or about April 24, 2001. These new
options will be issued to participants in the exchange program six months and
two days from the day that the offer ends. The exercise price of the new
options will not be determined until the date of grant, and will be set at the
closing price reported on the Nasdaq National Market for our common stock on
the date that is six months and one day from the end of the option exchange
offer period.
23
All options held by eligible employees currently outstanding under our 1992
Stock Plan, 1998 Stock Plan and the 1999 Nonstatutory Stock Plan are included
in the option exchange program. If all eligible employees participate in the
program, options for a total of 1,711,963 shares of our common stock will be
exchanged for new options. Employees of Tut Systems UK Limited, members of the
Board of Directors, executive officers and vice-presidents will be excluded
from the option exchange program.
The primary purpose of the option exchange program is to provide our
employees who hold options that are currently "out-of-the-money" with an
opportunity, so long as they are employees on the date of the replacement
grant, to exchange those old options for new stock options to be granted on or
about October 26, 2001. Employees who choose to cancel options will receive
credit for past vesting as well as vesting during the waiting period before the
new options are issued. In addition, the vesting period for the new options
will be shortened by approximately six months. However, the replacement stock
options will not be exercisable prior to the grant date on or about October 26,
2001.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and measure those instruments
at fair value. The Company adopted SFAS No. 133 (as amended by SFAS No. 138) as
required by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement
No. 133," effective January 1, 2001. The Company, to date, has not engaged in
derivative and hedging activities, and accordingly does not believe that the
adoption of SFAS No. 133 will have a material impact on the financial reporting
and related disclosures of the Company.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements," which provides guidance on the recognition,
presentation, and disclosure of revenue in financial statements filed with the
SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue
and provides guidance for disclosures related to revenue recognition policies.
Management evaluated the guidance in SAB 101 and the current interpretations
and believes that it has complied with the guidance contained therein.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions Involving
Stock Compensation, an Interpretation of APB Opinion No. 25." FIN 44 clarifies
the application of Opinion No. 25 for (a) the definition of employee for
purposes of applying Opinion No. 25, (b) the criteria for determining whether a
plan qualifies as a noncompensatory plan, (c) the accounting consequences of
various modifications to the terms of a previously fixed stock option or award,
and (d) the accounting for an exchange of stock compensation awards in a
business combination. FIN 44 was effective July 1, 2000, but certain
conclusions covered specific events that occurred after either December 15,
1998, or January 12, 2000. The adoption of FIN 44 did not have a material
effect on the financial statements.
Additional Risk Factors That Could Affect Our Operating Results and the Market
Price Of Our Stock
We have a history of losses and expect future losses.
We have incurred substantial net losses and experienced negative cash flow
each quarter since our inception. We incurred net losses attributable to common
stockholders of $74.1 million for the fiscal year ended December 31, 2000 and
$12.0 million for the fiscal year ended December 31, 1999. As of December 31,
2000,
24
we had an accumulated deficit of $130.6 million. We expect that we will
continue to incur losses in 2001 and we may incur losses in future periods as
well.
To achieve or sustain profitability, we must increase sales of our Expresso
products, successfully launch our IntelliPOP product, reduce manufacturing
costs, sell excess component parts obtained as a result of canceled purchase
commitments and successfully introduce enhanced versions of our existing and
new products.
We may never achieve or sustain profitability. We have spent substantial
amounts of money on the development of our Expresso products, HomeRun
technology, IntelliPOP product and software products. We intend to continue
increasing certain of our operating expenditures, including our sales and
marketing, research and development and general and administrative
expenditures. We cannot assure you that we will generate a sufficient level of
revenue to offset these expenditures, or that we will be able to adjust
spending in a timely manner to respond to any unanticipated decline in revenue
due to the fact that our expenditures for sales and marketing, research and
development, and general administrative functions are, in the short term,
relatively fixed. Our ability to increase revenue or achieve profitability in
the future will primarily depend on our ability to increase sales of our
Expresso products, successfully launch our IntelliPOP product, reduce
manufacturing costs, sell excess component parts obtained as a result of
canceled purchase commitments and successfully introduce and sell enhanced
versions of our existing products and new products.
A number of factors could cause our quarterly and annual financial results
to be worse than expected, which could result in a decline in our stock price.
Our annual and quarterly operating results have fluctuated in the past and
may fluctuate significantly in the future as a result of numerous factors, some
of which are outside of our control. These factors include:
. availability of capital in the network infrastructure industry;
. market acceptance of our products;
. competitive pressures, including pricing pressures from our partners and
competitors;
. the timing or cancellation of orders from, or shipments to, existing and
new customers;
. the timing of new product and service introductions by us, our customers,
our partners or our competitors;
. variations in our sales or distribution channels;
. variations in the mix of products offered by us;
. changes in the pricing policies of our suppliers;
. the availability and cost of key components; and
. the timing of personnel hiring.
We anticipate that average selling prices for our products will decrease in
the near future due to volume pricing agreements and the need to reduce
relatively high levels of inventory. In addition, we may also experience
substantial period to period fluctuations in future operating results and
declines in gross margin as a result of the erosion of average selling prices
for high-speed data access products and services due to a number of factors,
including competition and rapid technological change. Decreasing average
selling prices could cause us to experience decreased revenue despite an
increase in the number of units sold. We cannot assure you that we will be able
to sustain our gross margins even at the anticipated reduced levels, improve
our gross margins by offering new products or increased product functionality,
or offset future price declines with cost reductions.
As a result of these and other factors, it is possible that in some future
period our operating results will be below the expectations of securities
analysts and investors. In that event, the trading price of our common stock
would likely decline.
25
Purchases by past customers have decreased dramatically and we must establish a
new base of customers.
Many of our past customers have been unable to continue to access capital
and are experiencing significant financial difficulties, including bankruptcy.
Our 10 largest customers accounted for 72.2% of net sales for the year ended
December 31, 2000 and 62% of net sales for the year ended December 31, 1999.
Trigem Infocomm, Inc., Reflex Communications, Inc. and Darwin Networks, Inc.
accounted for 18%, 12% and 11%, respectively, of our net sales for the year
ended December 31, 2000. CAIS, Inc. and Rycom CCI, Inc. accounted for 12% and
10%, respectively, of our net sales in 1999. We do not expect to see similar
levels of sales, if any, from the majority of these particular customers in
2001. In order to meet our revenue targets, we must establish a new customer
base and increase sales to existing customers who have not been our lead
customers in the past. Our strategy of targeting larger, more established
customers may result in longer sales cycles and delayed revenue. Sales into
larger accounts could also result in increased competition from larger and
better established competitors.
We face substantial risk in launching our new IntelliPOP product.
We are in the process of launching our new IntelliPOP product. Risks
associated with the launch include delays in shipping including software bugs,
delays in product hardware and software testing, and delays in production build
of the product. The complexity of the product will require additional customer
support resources. Since the product will include major software components, we
plan to sell software maintenance agreements. Accordingly, revenue associated
with such maintenance agreements will be deferred and recognized over the life
of the underlying support. The launch of our IntelliPOP product may also cause
customers to delay purchases of our existing products. In addition, the
introduction of a new, more complex product, coupled with a search for larger,
more established customers may result in longer sales cycles and delayed
revenue.
We must reduce our inventory and future purchase commitments.
Changes in our business have resulted in the accumulation of a substantial
inventory of finished goods and components. We have provided for losses related
to the cancellation of purchase commitments. However, we must sell existing
finished goods inventory and delay or sell finished goods inventory from future
purchase commitments as well as sell component inventory resulting from
deliveries on already canceled purchase commitments. Failure to decrease
current and future inventory and/or to sell component parts may require that we
take additional charges related to slow moving or obsolete inventory and
components. If we are unable to sell a substantial amount of both the finished
goods and the component inventories, our expected cash position throughout the
year 2001 will be negatively impacted.
Our ability to attract and retain our personnel may be negatively impacted by
the drop in our stock price.
The drop in our stock price has resulted in most of our outstanding employee
stock options being "underwater" or priced substantially above current market
price. While we currently have an offer out to the majority of our employees to
cancel their existing options and have such options reissued at a date at least
six months and two days later than the date of cancellation, the effectiveness
of such a plan cannot be predicted. Accounting and other regulatory concerns
will prevent or limit our ability to issue additional stock options to these
employees during the period between cancellation and reissuance. If certain
market conditions persist, the attractiveness of our stock option offerings and
the success of our employee stock plans may be negatively impacted and as a
result diminish our ability to attract and retain qualified personnel.
Changes in capital markets may negatively impact our business.
Due to recent changes in the capital markets including increased volatility
in equity markets and tightening of lending in the credit markets, we believe
that we are exposed to a greater risk that customers will alter their
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payment practices to conserve capital. These changes may lead to increases in
outstanding accounts receivable, longer payback periods and increased risk of
default. For example, we increased our provisions recorded on past due accounts
receivable from several key customers who, during the latter part of the fourth
quarter of 2000, experienced a rapid deterioration in their ability to obtain
additional capital to fund their business models, declared their inability to
make timely payments on their accounts, and, as of the date of this report,
have not been able to demonstrate wherewithal to pay their existing account
balances. Two of these customers have filed bankruptcy proceedings. These
increased risks will be considered when assessing our customers' wherewithal to
pay and will likely result in longer revenue deferrals than previously
experienced. We also believe that certain of our customers will alter their
deployment plans to meet the constraints imposed by changes in the capital
markets. If we are not able to increase sales to other customer segments and/or
sales are otherwise delayed, we may experience volatility in expected sales
growth patterns which would increase the risk of declining sales growth in any
particular quarter.
Difficulties in forecasting product sales could negatively impact our business.
We base our expense levels in part upon our expectations concerning future
revenue and these expense levels are relatively fixed in the short-term. Orders
for our products, however, may vary from quarter to quarter. In some
circumstances, customers may delay purchasing our current products in favor of
next-generation products. In addition, our new products are generally subject
to technical evaluations that typically last 60 to 90 days, in the case of
IntelliPOP, those evaluations may increase to six months. If orders forecasted
for a specific customer for a particular quarter do not occur in that quarter,
our revenue for that quarter would be reduced. If we have lower revenue in a
quarter than expected, we may not be able to reduce our spending in the short-
term in response to this shortfall and reduced revenue would have a direct
impact on our results of operations for that quarter. Further, we purchase
components and contract manufacture our products based on forecasts of sales.
If orders for products exceed our forecasts, we may have difficulty meeting
customers orders in a timely manner, which could damage our reputation or
result in lost sales. Conversely, if orders are less than our forecasts, we may
have difficulty in canceling future purchase commitments in a timely manner
which may result in greater than expected inventory levels and exposure to
losses related to slow moving and obsolete inventory.
We depend on contract manufacturers to manufacture all of our products and rely
upon them to deliver high-quality products in a timely manner.
We do not manufacture our products. We rely on contract manufacturers to
assemble, test and package our products. We cannot assure you that these
contract manufacturers and suppliers will be able to meet our future
requirements for manufactured products, components and subassemblies. Any
interruption in the operations of one or more of these contract manufacturers
would harm our ability to meet our scheduled product deliveries to customers.
We also intend to regularly introduce new products and product enhancements,
which will require that we rapidly achieve volume production by coordinating
our efforts with those of our suppliers and contract manufacturers. The
inability of our contract manufacturers to provide us with adequate supplies of
high-quality products or the loss of a current contract manufacturer would
cause a delay in our ability to fulfill customer orders while we obtain a
replacement manufacturer and would harm our business, operating results and
financial condition. In addition, we have canceled certain finished goods and
component orders which may have a negative impact on our ability to diversify
our product manufacturing across a larger base of contract manufactures. In
addition, our inability to accurately forecast the actual demand for our
products could result in supply, manufacturing or testing capacity constraints.
These constraints could result in delays in the delivery of our products or the
loss of existing or potential customers, either of which could harm our
business, operating results or financial condition.
We currently purchase all of our raw materials and components used in our
products through our contract manufacturers. Components are purchased pursuant
to purchase orders based on forecasts, but neither we nor our contract
manufacturers have any guaranteed supply arrangements with these suppliers. The
availability of many of these