-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HSSfEqAHHJJgj6nq2oYGJlwkZAja0iKmvjhQDxPh9rDG/wHvL2+wCHhbDcP+HZ/l /VVE0EwR0afwRC941rME5w== 0001012870-00-000932.txt : 20000224 0001012870-00-000932.hdr.sgml : 20000224 ACCESSION NUMBER: 0001012870-00-000932 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000223 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TUT SYSTEMS INC CENTRAL INDEX KEY: 0000878436 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 942958543 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-25291 FILM NUMBER: 551723 BUSINESS ADDRESS: STREET 1: 2495 ESTAND WAY CITY: PLEASANT HILL STATE: CA ZIP: 94523 BUSINESS PHONE: 9256826510 MAIL ADDRESS: STREET 1: 2495 ESTAND WAY CITY: PLEASANT HILL STATE: CA ZIP: 94523 10-K405 1 FORM 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-K (Mark One) [X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1999 [_] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number: 000-25291 --------------- TUT SYSTEMS, INC. (Exact name of Registrant as specified in its charter) Delaware 94-2958543 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.)
2495 Estand Way Pleasant Hill, California 94523 94523 (address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (925) 682-6510 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value (Title of Class) --------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the Registrant was approximately $552,185,000 as of December 31, 1999 based on the closing price of the Common Stock as reported on The Nasdaq Stock Market for that date. There were 11,940,610 shares of the Registrant's Common Stock issued and outstanding on December 31, 1999. DOCUMENTS INCORPORATED BY REFERENCE The Registrant has not incorporated any documents by reference in this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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. We disclaim any obligation to update information contained in any forward-looking statement. ITEM 1. BUSINESS 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 a cost- effective, scalable and easy to deploy solution to exploit the underutilized bandwidth of copper telephone wires within these buildings. Our products also provide service providers with enhanced capabilities such as subscriber management, firewall protection, virtual private networking, and small business email and web servers. 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 rapidly increase over the next several years. The Yankee Group projects that the U.S. market for residential high- speed Internet services will grow from 1.4 million subscribers in 1999 to approximately 16 million subscribers by 2004. In addition, Forrester Research projects that the U.S. market for commercial broadband Internet access will grow from $2.4 billion in 1998 to $28.7 billion in 2003. 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, to offer DSL- based services. All of these new networks offer speeds more than 20 times as fast as 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 1 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 segmented 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 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 are 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 As 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 now have an opportunity to share the service revenue generated from their buildings, and to offer new Internet-enabled services. These services enable on-line reservation of building amenities, community message boards, e-commerce and payment of rent. A set of specialized service providers has recently emerged 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 key to meeting future customer needs and driving service provider profitability through bundled service offerings. The MTU market is attractive to these emerging service providers because of the efficiency of delivering multiple services, often on an exclusive basis, to a geographically concentrated and demographically similar customer base. Infrastructure Requirements for MTU Service Providers Service providers marketing to MTU owners and tenants typically concentrate their networks and marketing and sales efforts within major metropolitan areas. In each local service area, a service provider will then 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 email, 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. 2 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 multiple services such as voice, video, firewall security and virtual private 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, firewall protection, virtual private networking, and small business email and web servers. 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 HPNA, and is licensed to leading semiconductor, computer hardware and consumer 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. 3 . 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. We recently acquired our OneGate Internet appliance to enable MCU and other business-focused service providers to provide the key Internet access functions required by small businesses, including routing between LAN and WAN domains, firewall protection, virtual private networking, email server, and web servers. These 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 enhanced service capabilities for this market. The acquisition of FreeGate, whose OneGate Internet appliance is specifically designed to serve the growing data communications needs of small to medium businesses, was our initial step in addressing the value-added needs of this market. OneGate enables service providers to address the growing needs of small businesses for Internet access and security, intranet corporate networking and electronic commerce solutions. We believe that the capabilities of OneGate products in combination with our broadband access systems provide us with a significant competitive advantage. We intend to use our direct sales force to target large service providers in the MCU market and develop relationships with key VARs and systems integrators in this market. 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, web, and email servers, firewall protection, and virtual private 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 churn, and have a higher revenue-to-cost portfolio of services. We intend to use our product development capabilities and our FastCopper technology to enable higher data speeds over longer distances. We plan to enhance our Expresso SMS 2000 and OneGate platforms by adding new software features to support voice, video, and enhanced data capabilities. 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. Continue to Leverage HomeRun Technology and Partnerships. In June 1998, our HomeRun technology was selected as the initial specification for a home networking standard to be promoted by the Home PNA. We have licensed HomeRun to leading semiconductor, computer hardware, and consumer electronics 4 manufacturers, including 3Com, AMD, AT&T Wireless, Broadcom, Compaq, Conexant Systems, Davicom, Intel, Lucent, Motorola, National Semiconductor, STMicroelectronics and TDK. These licensees embed HomeRun technology into integrated circuits and consumer products, including PCs, network interface cards, network adaptors, and modems. We believe that the availability of these devices will reduce the total cost of deploying services based on HomeRun enabled versions of Expresso MDU. We plan to continue to leverage our relationships with these licensees to give us better access to technologies that are supportive of our proprietary LongRun technology and related systems. Expand International Presence. We believe that our Expresso 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. In addition, we believe that our Expresso SMS 2000 and OneGate product lines can meet the needs of established as well as emerging service providers in international markets such as Europe, the Middle East, and Asia. We have added 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 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 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 specified to operate over distances as long as 500 feet, while LongRun is intended to operate at distances up to 2500 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, 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. An Expresso MDU or Expresso GS system consists of a compact, modular central- site shelf with an SNMP management card, optional switching, multiplexing and 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. 5 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 systems to accommodate hundreds of subscribers onto 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 later is primarily intended for international markets. MDU Lites contain either eight ports of HomeRun or eight ports of LongRun. Multiple units may be connected together to support more than eight subscribers and they 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 remote M-1100 or MXL-2300 series routers. The M-1100 series routers connect users' PCs or LANs to the Expresso GS system over a local loop that may extend up to 24,700 feet using our current 1.1 Mbps SDSL line technology. The MXL-2300 series routers, when used with a new line card being developed, 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. All-Rate DSL allows service providers to offer a low cost, low bandwidth, entry level service that can expand to higher bandwidth capabilities as a subscriber's need for bandwidth expands. Our M-1100 and 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" 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 central network operations center. Expresso OCS is a software package that runs on a standard PC computing platform. Each Expresso OCS 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 ISPs. 6 OneGate 1000 Our OneGate 1000 Internet server appliances combine the functions of IP routing, firewall security, network address translation, secure remote access via virtual private networking, email, and web servers on one compact PC-based platform. Redundant mirrored hard drives provide fault tolerance for critical functions as well as storage for email and web pages. Built-in WAN interfaces support T1, DSL, and ISDN links. The OneGate 1000 is designed for larger offices and supports workgroups of 25 to 250 users. For business enterprises with more than a single office location, multiple OneGate units interoperate with each other to provide a secure virtual private network using the worldwide reach of the public Internet. For service providers, the OneGate service platform provides an all-in-one single box solution to locate on a customer's premises. Although located on a customer's premises, the OneGate systems facilitate outsourced management and control by the service provider. Software upgrades and any maintenance fixes can be enabled from the service provider's central network operations center without having to involve the end customer. XL Products We use our FastCopper technology, along with commercially available components, to build high-speed data access products. In the XL1500 product series, we applied our noise reduction and signal processing expertise to build a 10Mbps, 1,500 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 synchronous digital subscriber line, or SDSL, technology products that extend to 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 random tree and branch networks typically found in single family homes. Customers and Markets We target our development, marketing and sales efforts to service providers in both the MDU market and MCU market. MDU Market Service providers, including ILECs, 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. Among our Expresso MDU customers are BRE Properties, Darwin Networks and Reflex Communications. Our Expresso SMS 2000 system has been designed with features to specifically address the needs of this market. MCU Market For some time there have been service providers focused on delivering voice services to tenants in multi-tenant commercial buildings, but recently a new class of service providers and CLECs have emerged that plan to use a broadband IP-based infrastructure to provide a wide array of 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. 7 Our Expresso-based transport systems, when coupled with our OneGate products, enable service providers to offer services on an "as-needed" basis, all remotely controlled and managed. Access bandwidth, firewall, email, web server, and virtual private networking services are managed by the service provider obviating the need for a small business to hire on-site IT staff. Among our MCU customers are Darwin Networks, Rycom Inc. and 2nd Century Communications. 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 more than 500 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 Home PNA and others. In 1998, the Home PNA selected HomeRun as the initial specification for a home networking standard. The founding members of the Home PNA were 3Com, AMD, AT&T Wireless, Compaq, Epigram, Hewlett-Packard, IBM, Intel, Lucent, Rockwell and Tut Systems. The Home PNA currently includes over 120 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 Interop, Hitech, National Multihousing Conference, and SuperComm, the distribution of sales and product literature, 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 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 1998 and 1999, we established new sales channels in Canada, Europe, South America, Australia and Asia. In 1999, we opened a sales office in the United Kingdom. In 1999, we derived approximately 32% 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 the customer support organization located in Pleasant Hill, California. Telecommunications and Networking Systems Engineers provide critical technical support to our customers. Our Systems Application Engineers, located in each of our sales regions, 8 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 such as the Home PNA. 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 platform is 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 routing software, allowing our software engineers to concentrate on hardware-specific drivers, user interface software and advanced features. . New Technologies. We seek to enhance our Expresso platform by incorporating additional xDSL technologies, such as VDSL, higher speed WAN interfaces and new network management software features. We also seek to develop new product capabilities through software upgrades to our Expresso SMS 2000 and OneGate platforms. Manufacturing We do not manufacture any of our own products, but instead 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 the contractor's manufacturing process performance through audits, testing and inspections and monitor contractor quality through incoming testing and inspection of packaged products. 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. For example, we are experiencing, and may continue experiencing in the future, difficulty obtaining flash memory. 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, typically one to four days between receipt of order and shipment to the customer. 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; 9 . 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, Copper Mountain, Nortel and Paradyne, 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 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 17 United States patents and have 18 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. 10 Employees As of February 14, 2000, we employed 163 persons, including: . 17 in operations; . 57 in marketing, sales and customer support; ITEM 2. FACILITIES Our principal administrative and engineering facilities are located in one leased building totaling approximately 23,000 square feet located in Pleasant Hill, California. In addition, we lease sales and administrative facilities totaling approximately 2,600 square feet in Beaverton, Oregon, engineering and administrative facilities totaling approximately 20,200 square feet in Sunnyvale, California. We also lease engineering facilities in Oakland, California, and Ann Arbor, Michigan. The current lease for the Pleasant Hill facility expires in May 2001, with an option to renew for two years, the lease for the Oregon facility expires in March 2002, the lease for the Sunnyvale facility expires in August 2002, the lease for the Oakland facility expires in April 2000, and the lease for the Ann Arbor facility expires in December 2001. We also have sales offices in the vicinity of New York, Washington D.C., Chicago, Dallas and Denver. We intend to relocate our principal administrative and engineering facilities from Pleasant Hill to Pleasanton, California during 2000 and intend to lease facilities totaling approximately 90,000 square feet in Pleasanton. We believe that with this additional space, 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. 11 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 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 (through February 18, 2000)...................... $53.50 $39.38
On February 18, 2000, the last reported sale price of our common stock on the Nasdaq National Market was $39.88 per share. As of December 31, 1999, there were approximately 314 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 cash dividends in the foreseeable future. Our loan and security agreement with a commercial bank prohibits the payment of dividends. Any future determination to pay cash 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 the board of directors may deem relevant. 12 ITEM 6. SELECTED FINANCIAL DATA
Years Ended December 31, -------------------------------------------------- Actual -------------------------------------------------- 1995 1996 1997 1998 1999 -------- -------- --------- --------- -------- (in thousands, except per share data) Statement of Operations Data: Total revenues............. $ 3,445 $ 4,454 $ 6,221 $ 10,555 $ 27,807 Total cost of goods sold... 1,688 2,198 3,228 5,809 15,459 -------- -------- --------- --------- -------- Gross margin............. 1,757 2,256 2,993 4,746 12,348 -------- -------- --------- --------- -------- Operating expenses: Sales and marketing...... 2,645 3,068 5,147 8,462 10,523 Research and development............. 993 2,012 3,562 6,200 7,618 General and administrative.......... 1,562 1,783 2,375 2,807 4,429 In-process research and development............. -- -- -- -- 2,600 Amortization of intangibles............. -- -- -- -- 52 Noncash compensation expense................. -- -- 1,260 1,233 455 -------- -------- --------- --------- -------- Total operating expenses................ 5,200 6,863 12,344 18,702 25,677 -------- -------- --------- --------- -------- Loss from operations..... (3,443) (4,607) (9,351) (13,956) (13,329) Other income (expense), net....................... 54 181 195 210 1,596 -------- -------- --------- --------- -------- Loss before income taxes................... (3,389) (4,426) (9,156) (13,746) (11,733) Income tax expense......... 1 1 1 1 1 -------- -------- --------- --------- -------- Net loss................. (3,390) (4,427) (9,157) (13,747) (11,734) Dividend accretion on preferred stock........... 694 1,137 1,627 2,584 235 -------- -------- --------- --------- -------- Net loss attributable to common stockholders....... $ (4,084) $ (5,564) $ (10,784) $ (16,331) $(11,969) ======== ======== ========= ========= ======== Net loss per share attributable to common stockholders, basic and diluted................... $ (32.56) $ (37.51) $ (59.36) $ (60.62) $ (1.12) ======== ======== ========= ========= ======== Shares used in computing net loss per share attributable to common stockholders, basic and diluted................... 125 148 182 269 10,729 ======== ======== ========= ========= ========
December 31, ------------------------------------------------ Actual ------------------------------------------------ 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- (in thousands) Balance Sheet Data: Cash, cash equivalents and short-term investments..... $ 1,531 $ 8,950 $ 10,285 $ 4,452 $ 32,236 Working capital............. 1,771 8,357 11,066 7,173 44,416 Total assets................ 3,198 10,689 15,168 15,257 65,356 Redeemable convertible preferred stock and warrant.................... 12,381 24,684 38,871 45,995 -- Long-term debt, net of current portion............ 55 190 140 4,262 -- Accumulated deficit......... (11,755) (17,319) (28,103) (44,434) (56,487) Total stockholders' equity (deficit).................. (10,137) (15,694) (26,444) (41,839) 51,522
13 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. 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. We disclaim any obligation to update information contained in any forward-looking statement. Overview We design, develop and market multi-service broadband access systems that enable service providers to deliver high-speed data access over the existing copper telephone infrastructure found in multi-tenant unit, or MTU, complexes, such as apartment buildings, hotels, business parks and commercial office buildings. Our systems enable service providers to deliver high speed Internet access, as well as enhanced capabilities, such as subscriber management, community based web pages, firewall protection, virtual private networking, as well as small business email and web servers. We commenced operations in August 1991. Through the third quarter of 1998, substantially all of our revenue was derived from the sale of our XL Ethernet LAN extension products to the corporate and university segments of the multi- commercial unit, or MCU, market. In early 1997, we introduced the first products in our Expresso product line aimed at service provider markets. During the first quarter of 1998, we began licensing our HomeRun technology to certain leading semiconductor, computer hardware and consumer electronics manufacturers for incorporation into integrated circuits and consumer products including PCs, peripherals, modems and other Internet appliances. In the third and fourth quarters of 1998, we commenced selling our Expresso GS products, which are configured for local loop applications, and Expresso MDU products, which incorporate our HomeRun technology to a broader range of service providers, primarily those serving apartment complexes, hotels, university dormitories and military complexes in the multi-dwelling unit, or MDU, market. In the first quarter of 1999, we commenced selling Expresso MDU products incorporating our LongRun technology and Expresso MDU Lite to additional segments of the MDU market. During the fourth quarter of 1999, we commenced selling our Expresso SMS 2000 and companion Expresso OCS system providing subscriber management, bandwidth management, credit card billing and other functions to the MDU market. We generate revenue primarily from the sale of products and, to a lesser extent, through the licensing of our HomeRun technology. We recognize revenue from product sales upon shipment. Estimated sales returns and warranty costs, based on historical experience by product, are recorded at the time revenue is recognized. License and royalty revenue consists of non-refundable up-front license fees, some of which may offset initial royalty payments, and royalties. Currently, the majority of our license and royalty revenue is comprised of non- refundable license fees paid in advance. Such revenue is recognized ratably over the period during which post-contract customer support is expected to be provided or upon delivery and transfer of agreed upon technical specifications in contracts where essentially no further support obligations exist. Future license and royalty revenue is expected to consist primarily of royalties based on products sold by our licensees. We do not expect that such license and royalty revenue will constitute a substantial portion of our revenue in future periods. Sales price reductions on some of our products may be necessary to remain competitive. Although we have been historically able to offset most price declines with reductions in our manufacturing costs, there can be no assurance that we will be able to offset further price declines with cost reductions. In addition, some of our licensees may sell products based on our technology to our competitors or potential competitors. There can be no assurance that our HomeRun technology will be successfully deployed on a widespread basis or that such licensing will not result in an erosion of the potential market for our products. 14 Sales to customers outside of the United States accounted for approximately 15.8%, 18.5% and 32.3% of revenue in 1997, 1998 and 1999, respectively. We expect international sales to increase in absolute dollars in the future but to represent approximately one third or less of our revenue, but they may decrease as a percentage of total sales in the future. To date, substantially all international sales have been denominated in U.S. dollars. We expect to continue to evaluate product line expansion and new product opportunities, engage in extensive research, development and engineering activities and focus on cost-effective design of our products. Accordingly, we will continue to make significant expenditures on sales and marketing and research and development activities. In June 1999, we acquired PublicPort, Inc. in exchange for 168,679 shares of common stock. This transaction was treated as a pooling of interests for accounting purposes. PublicPort was located in Ann Arbor, Michigan. PublicPort designed and developed subscriber management systems that enabled businesses in the MDU market to provide mobile computer users access to the public Internet or private corporate networks without having to reconfigure their computer's network access software. In November 1999, we acquired Vintel Communications, Inc. for $4.8 million, consisting of $500,000 cash, 116,370 shares of common stock and approximately 40,000 options to acquire common stock. This transaction was treated as a purchase for accounting purposes. Vintel was located in Oakland, California. Vintel designed and developed high-performance integrated service routers that allowed service providers to offer bundles of services, including voice-over-IP and high speed Internet services over a common IP infrastructure to customers in the MTU market. In February 2000, we acquired FreeGate Corporation for approximately $24.7 million, consisting of 510,931 shares of common stock, approximately 19,600 options to acquire common stock and acquisition related expenses, consisting primarily of investment advisory, legal and other professional fees. This transaction was treated as a purchase for accounting purposes. FreeGate was located in Sunnyvale, California. FreeGate designed, developed and marketed Internet server appliances combining the functions of IP routing, firewall security, network address translation, secure remote access via virtual private networking, and email and web servers on a compact, PC-based platform. In February 2000, we signed a definitive agreement to acquire certain assets of OneWorld Systems, Inc. for approximately $2.3 million in cash. This transaction will be treated as a purchase for accounting purposes. OneWorld was located in Sunnyvale, California. OneWorld designed and developed network communication appliances and network modems. While we expect to derive benefit from sales of product lines acquired through some of these acquisitions and designed, developed and marketed as a result of these acquisitions, there can be no assurance that we will be able to sustain or expand sales of those products or complete the development and commercial deployment of products expected as a result of these acquisitions. Through these completed and anticipated transactions, we have added approximately 55 people to our workforce. The costs associated with personnel including rent for additional facilities and related general and administrative costs as well as costs associated with research and development, and sales and marketing activities will substantially increase our operating costs when compared to related costs expended in 1999. We have incurred net operating losses to date and, as of December 31, 1999, had an accumulated deficit of $56.5 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 15 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. Results of Operations The following table sets forth items from our statements of operations as a percentage of total revenue for the periods indicated:
Years ended December 31, ----------------------- 1997 1998 1999 ------ ------ ----- Total revenue............... 100.0% 100.0% 100.0% Total cost of goods sold.... 51.9 55.0 55.6 ------ ------ ----- Gross margin.............. 48.1 45.0 44.4 Operating expenses: Sales and marketing....... 82.7 80.2 37.8 Research and development.. 57.3 58.7 27.4 General administrative.... 38.2 26.6 15.9 In-process research and development.............. -- -- 9.4 Amortization of intangibles.............. -- -- -- Noncash compensation expenses................. 20.3 11.7 1.6 ------ ------ ----- Total operating expenses............... 198.4 177.2 92.3 ------ ------ ----- Loss from operations...... (150.3) (132.2) (47.9) Other income (expense), net........................ 3.1 2.0 5.7 ------ ------ ----- Loss before income taxes.. (147.2) (130.2) (42.0) Income tax expense.......... -- -- -- ------ ------ ----- Net loss.................. (147.2)% (130.2)% (42.0)% ====== ====== =====
Years Ended December 31, 1997, 1998 and 1999 Revenue. We generate revenue primarily from the sale of products and, to a lesser extent, through the licensing of our HomeRun technology. Our total revenue increased to $27.8 million for the year ended December 31, 1999, from $10.6 million for the year ended December 31, 1998, and from $6.2 million for the year ended December 31, 1997. The increase in 1999 was primarily due to an increase in sales of Expresso products. The increase in 1998 was primarily due to an increase in sales of XL products and initial sales of Expresso GS and Expresso MDU products. License and royalty revenue increased to $1.5 million for the year ended December 31, 1999; from $0.8 million for the year ended December 31, 1998. 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 no license and royalty revenue in periods prior to 1998. Cost of Goods Sold/Gross Margin. Cost of goods sold consists of raw materials, contract manufacturing, personnel costs, test and quality assurance for products, and cost of licensed technology included in the products. Our cost of goods sold increased to $15.5 million for the year ended December 31, 1999, from $5.8 million for the year ended December 31, 1998, and from $3.2 million for the year ended December 31, 1997. The increase in 1999 was primarily due to increased production of our Expresso products. The increase in 1998 was primarily due to increased production of our XL and Expresso products and initial production of our Expresso GS and Expresso MDU products. Our gross margin on an absolute basis increased to $12.3 million for the year ended December 31, 1999, from $4.7 million for the year ended December 31, 1998, and from $3.0 million for the year ended December 31, 1997. Gross margin as a percentage of revenue decreased to 44.4% of revenue for the year ended December 31, 1999, from 45.0% of revenue for the year 16 ended December 31, 1998, and from 48.1% of revenue for the year ended December 31, 1997. The decrease in gross margin as a percent of revenue in 1999 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. Volume price discounts to certain customers with substantial volume commitments and increased costs of raw materials and contract manufacturing associated with initial introductions of new products in the Expresso MDU product lines also contributed to this decrease in gross margin. The decrease in gross margin as a percentage of revenue in 1998 was primarily due to the change in product mix to include Expresso products which have lower average gross margins than the XL products, combined with the increased costs of raw materials and contract manufacturing associated with initial Expresso GS and Expresso MDU product introductions. 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 $10.5 million for the year ended December 31, 1999, from $8.5 million for the year ended December 31, 1998, and from $5.1 million for the year ended December 31, 1997. The increases in both 1999 and 1998 were primarily due to increased hiring of sales and marketing personnel, travel, attendance at trade shows, as well as increases in personnel related to customer support activities and expanded efforts in international markets. Research and Development. Research and development expense primarily consists of personnel costs related to engineering and technical support, contract consultants, outside testing services, equipment and supplies associated with enhancing existing products and developing new products. Research and development costs are expensed as incurred. Our research and development expenses increased to $7.6 million for the year ended December 31, 1999, from $6.2 million for the year ended December 31, 1998, and from $3.6 million for the year ended December 31, 1997. The increase in 1999 was primarily due to further development of the Expresso GS and Expresso MDU products, 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 and November acquisitions. The increase in 1998 was primarily due to further development of the Expresso GS and Expresso MDU products, development of HomeRun-related products, preparation of HomeRun technology for licensing and potential standardization and enhancement of certain XL products. 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 $4.4 million for the year ended December 31, 1999, from $2.8 million for the year ended December 31, 1998, and from $2.4 million for the year ended December 31, 1997. The increases in both 1999 and 1998 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. Amortization of Intangibles. Amortization of intangibles consists of the periodic amortization of intangible assets related to purchase acquisitions. These assets consist primarily of acquired workforce and goodwill and are amortized over their estimated useful lives of 3 and 5 years, respectively. Amortization of intangibles in 1999 of $0.1 million relates to intangible assets acquired from Vintel. There were no such costs prior to 1999. In-process research and development. Amounts expensed as in-process research and development were $2.6 million in 1999 and were related to in-process research and development purchased from Vintel. There were no such costs prior to 1999. The fair value of such technology currently under development was determined by using the income approach, which discounts expected future cash flows to present value. The 17 discount rates used in the present value calculations were typically derived from a weighted average cost of capital analysis, adjusted upward to reflect additional risks inherent in the development life cycle. These risk factors are reflected in the discount rate used of 30%. We expect that the pricing model for products and intellectual property licenses related to our acquisition of Vintel will be considered standard within the high-technology communications industry. We do not expect, however, to achieve expense reductions as a result of integrating the acquired in-process technology. Therefore, the valuation assumptions do not include any anticipated cost savings. Our estimated cost to complete the technology at the time of acquisition was approximately $2.0 million. To date, those costs are approximately $0.1 million. We expect that products incorporating the acquired technology from this acquisition will be completed and begin to generate cash flows over a six to nine month period after integration. Development of these technologies, however, remains a significant risk due to the remaining effort to achieve technical viability, rapidly changing customer markets, uncertain standards for new products and significant competitive threats from numerous companies. Efforts to develop the acquired technology into commercially viable products consists principally of planning, designing and testing activities necessary to determine that the product can meet market expectations, including functionality and technical requirements. Failure to bring these products to market in a timely manner could result in a loss of market share, or a lost opportunity to capitalize on emerging markets, and could harm our business and operating results. Regarding our purchase of Vintel, actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisition as they relate to the value of purchased in-process research and development. The assumptions primarily consist of an expected completion date for the in-process projects, estimated costs to complete the projects and revenue and expense projections once the products have entered the market. There have been no product shipments to date from acquired technologies, therefore, it is difficult to determine the accuracy of overall revenue projections early in the technology or product lifecycle. Failure to achieve the expected levels of revenue and net income from these products may negatively impact the return on investment expected at the time that the acquisition was completed. Noncash Compensation Expense. Noncash compensation expense in 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 and 1997 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 both years also consisted of the recognition of expense related to certain employee stock option grants. Our noncash compensation expense was $0.5 million, $1.2 million, and $1.3 million for the years ended December 31, 1999, 1998 and 1997, respectively. We intend to recognize $1.0 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. Other Income (Expense), Net. Other income (expense), net consists of interest income on cash balances, offset by interest expense associated with credit facilities. Our other income (expense), net was $1.6 million, $0.2 million, and $0.2 million for the years ended December 31, 1999, 1998 and 1997, respectively. Liquidity and Capital Resources Since our inception, 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. As of December 31, 1999, we had cash, cash equivalents and short-term investments of $32.2 million. 18 Net increase in cash and cash equivalents in 1999 of $9.0 million resulted primarily from net proceeds from our initial public offering and exercise of a warrant for convertible preferred stock, and net proceeds of maturities of short term investments, offset by a net loss of $11.7 million, a net decrease in working capital of $12.2 million due to the increase in our sales activity for the year, purchases of short term investments, purchases of property and equipment and repayment of credit facilities. Net decrease in cash and cash equivalents in 1998 of $0.9 million resulted primarily from a net loss of $13.7 million, net changes in working capital, and purchase of property and equipment offset by net proceeds from maturities of short term investments, net proceeds from the sale of preferred securities and net borrowings from credit facilities. Net increase in cash and cash equivalents in 1997 of $4.0 million resulted primarily from net proceeds from the sale of preferred securities, and net proceeds from maturities of short term investments, offset by a net loss of $9.2 million, net changes in working capital, and the purchase of property and equipment. We have a credit facility to borrow up to $7.5 million. The credit facility is composed of two revolvers: a formula revolver of up to the lesser of $3.0 million or 85% of qualified accounts receivable bearing interest at prime plus 2.0% per annum; and a non-formula revolver of up to $4.5 million bearing interest at prime plus 3.5% per annum. The credit facility requires a minimum monthly interest payment of $10,000. The term of the credit facility is 18 months ending on June 30, 2000 and is automatically renewed for additional terms of one year unless 60 days' written notice is given by either party. We have approximately $1.5 million borrowed against the credit facility as of December 31, 1999. For future periods, we generally anticipate significant increases in working capital on a period to period basis primarily as a result of planned increased product sales and higher relative levels of inventory. We will also continue to expend significant amounts on property and equipment related to the expansion of systems infrastructure and office equipment and our anticipated move to expanded headquarter facilities to support our growth. We also expect to continue to expend significant amounts on lab and test equipment to support on- going research and development efforts. We believe that our cash, cash equivalents and short-term investment balances and funds available under our credit facility will be sufficient to satisfy our cash requirements for at least the next 12 months. 19 During the years ended December 31, 1999, 1998 and 1997, we incurred non-cash expenses related to purchase acquisition and dividend accretion. The table below sets forth supplemental information concerning the impact of certain non- cash items on losses from operations. The accompanying supplemental financial information is presented for informational purposes only and should not be considered as a substitute for the historical financial information presented in accordance with generally accepted accounting principles. The Statements of Operations data has been derived from our audited financial statements.
Years Ended December 31, ---------------------------- 1997 1998 1999 -------- -------- -------- Computation of pro forma net loss per share: Net loss attributable to common stockholders.. $(10,784) $(16,331) $(11,969) Adjustments for certain noncash expenses related to purchase acquisition and dividend accretion: Amortization of intangibles................. -- -- 52 In-process research and development......... -- -- 2,600 Dividend accretion on preferred stock....... 1,627 2,584 235 -------- -------- -------- Pro forma net loss.............................. $ (9,157) $(13,747) $ (9,082) ======== ======== ======== Pro forma net loss per share.................... $ (1.21) $ (1.64) $ (0.80) ======== ======== ======== Shares used in computing pro forma net loss per share, basic and diluted (1)................... 7,568 8,389 11,321 ======== ======== ======== - -------- (1) Calculation of pro forma shares, basic and diluted: Shares used in computing net loss attributable to common stockholders, basic and diluted...... 182 269 10,729 Adjustment to reflect the assumed conversion of preferred stock................................ 7,386 8,120 592 -------- -------- -------- Shares used in computing pro forma net loss per share, basic and diluted....................... 7,568 8,389 11,321 ======== ======== ========
Year 2000 Compliance We have addressed computer networks year 2000 compliance in our systems, accounting software, computer hardware and existing products, and have communicated with our significant third party vendors with respect to their respective states of readiness. In order to assess year 2000 compliance of our products and systems, we identified those systems critical to our operations and the operations of our technologies and, based upon tests to such products and systems, believed that all of our systems and technologies, to the extent developed, were materially compliant. We expended approximately $70,000 to assess and address the year 2000 problem. Although it is now past January 1, 2000, and we have not experienced any adverse impact from the transition to the Year 2000, we cannot assure you that we or our suppliers and customers have not been affected in a manner that is not yet apparent. In addition, some computer programs that were date sensitive to the Year 2000 may not have been programmed to process the Year 2000 as a leap year, and any negative consequential effects remain unknown. As a result, we will continue to monitor our Year 2000 compliance and the Year 2000 compliance of our suppliers and customers. 20 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 $12.0 million for 1999 and $16.3 million for 1998. As of December 31, 1999, we had an accumulated deficit of $56.5 million. We expect that we will continue to incur losses in 2000. We may incur losses in future periods as well. To achieve or sustain profitability, we must increase sales of our Expresso products, reduce manufacturing costs and successfully introduce enhanced versions of our existing and new products. We may never achieve or sustain profitability. We have spent substantial amounts of money on the development of our Expresso products, HomeRun technology and software products. We intend to continue increasing certain of our operating expenditures, including our sales and marketing, research and development and general and administrative expenditures. We cannot assure you that we will generate a sufficient level of revenue to offset these expenditures, or that we will be able to adjust spending in a timely manner to respond to any unanticipated decline in revenue due to the fact that our expenditures for sales and marketing, research and development, and general administrative functions are, in the short term, relatively fixed. Our ability to increase revenue or achieve profitability in the future will primarily depend on our ability to increase sales of our Expresso products, reduce manufacturing costs, and successfully introduce and sell enhanced versions of our existing products and new products. A number of factors could cause our quarterly and annual financial results to be worse than expected, which could result in a decline in our stock price. Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future as a result of numerous factors, some of which are outside of our control. These factors include: . market acceptance of our products; . competitive pressures, including pricing pressures from our partners and competitors; . the timing or cancellation of orders from, or shipments to, existing and new customers; . the timing of new product and service introductions by us, our customers, our partners or our competitors; . variations in our sales or distribution channels; . variations in the mix of products offered by us; . changes in the pricing policies of our suppliers; . the availability and cost of key components; and . the timing of personnel hiring. We may also experience substantial period to period fluctuations in future operating results and declines in gross margin as a result of the erosion of average selling prices for high-speed data access products and services due to a number of factors, including competition and rapid technological change. We anticipate that average selling prices for our products will decrease over time due to competitive pressures and volume pricing agreements. Decreasing average selling prices could cause us to experience decreased revenue despite an increase in the number of units sold. We cannot assure you that we will be able to sustain our gross margins in the future, improve our gross margins by offering new products or increased product functionality, or offset future price declines with cost reductions. 21 As a result of these and other factors, it is possible that in some future period our operating results will be below the expectations of securities analysts and investors. In that event, the trading price of our common stock would likely decline. Difficulties in forecasting product sales could negatively impact our business. We base our expense levels in part upon our expectations concerning future revenue and these expense levels are relatively fixed in the short-term. Orders for our products, however, may vary from quarter to quarter. In some circumstances, customers may delay purchasing our current products in favor of next-generation products. In addition, our new products are generally subject to technical evaluations that typically last 60 to 90 days. If orders forecasted for a specific customer for a particular quarter do not occur in that quarter, our revenue for that quarter would be reduced. If we have lower revenue in a quarter than expected, we may not be able to reduce our spending in the short-term in response to this shortfall and reduced revenue would have a direct impact on our results of operations for that quarter. Further, we purchase components and contract manufacture our products based on forecasts of sales. If orders for products exceed our forecasts, we may have difficulty meeting customers orders in a timely manner, which could damage our reputation or result in lost sales. Our market is subject to rapid technological change, and if we do not address these changes, our products will become obsolete, harming our business and ability to compete. The markets for high-speed data access products are characterized by rapid technological developments, frequent enhancements to existing products and new product introductions, changes in end user requirements and evolving industry standards. In addition, the market for high-speed data access products is dependent in large part on the increased use of the Internet. Issues concerning the use of the Internet, including security, lost or delayed packets, and quality of service, may negatively affect the development of the market for our products. We cannot assure you that we will be able to respond quickly and effectively to technological change. If we do not address these technological changes and challenges by regularly introducing new products, our product line will become obsolete, which would harm our business, financial condition and results of operations. Our success depends on our ability to continually introduce new products that achieve broad market acceptance. We must also continually improve the performance, features and reliability of our products, particularly in response to competitive product offerings. To remain competitive we need to introduce products in a timely manner that incorporate or are compatible with these new technologies as they emerge. We may have only a limited amount of time to penetrate certain markets, and we cannot assure you that we will be successful in achieving widespread acceptance of our products before competitors offer products and services similar or superior to our products. Any delay in product introduction could adversely affect our ability to compete and cause our operating results to be below our expectations or the expectations of public market analysts or investors. In addition, when we announce new products or product enhancements that have the potential to replace or shorten the life cycle of our existing products, customers may defer purchasing our existing products. These actions could harm our operating results by unexpectedly decreasing sales, increasing our inventory levels of older products and exposing us to greater risk of product obsolescence. Our success depends on continued market acceptance of our Expresso products. We must devote a substantial amount of human and capital resources in order to maintain commercial acceptance of our Expresso products and to expand offerings of the Expresso product line in the MDU and MCU markets and to further penetrate these markets. Historically, the majority of our Expresso products have been sold into the MDU market. Our future success depends on the ability to continue to penetrate this market and to expand our penetration into the MCU market. Our success also depends on our ability to educate existing and potential customers and end users about the benefits of our Fast Copper technology, including 22 HomeRun and LongRun, and the development of new products to meet changing and expanding demands of service providers, MTU owners and corporate customers. The continued success of our Expresso products will also depend on the ability of our service provider customers to market and sell high-speed data services to end users. We cannot assure you that our Expresso products will achieve or maintain broad commercial acceptance within the MDU market, MCU market, or in any other market we enter. The market in which we operate is highly competitive, and we may not be able to compete effectively. The market for multi-service broadband access systems is intensely competitive, and we expect that this market will become increasingly competitive in the future. Our most immediate competitors include Cisco, Copper Mountain, Nortel and Paradyne, and a number of other public and private companies. Many of these competitors are offering, or may offer, technologies and services that directly compete with some or all of our high-speed access products and related software products. In addition, the market in which we compete is characterized by increasing consolidation, and we cannot predict with certainty how industry consolidation will affect us or our competitors. Many of our competitors and potential competitors have substantially greater name recognition and technical, financial and marketing resources than we do, and we can give you no assurance that we will be able to compete effectively in our target markets. These competitors may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products than we can. In addition, our HomeRun licensees may sell products based on our HomeRun technology to our competitors or potential competitors. This licensing may cause an erosion in the potential market for our products. We cannot assure you that we will have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete successfully. This competition could result in price reductions, reduced profit margins and loss of market share, which could harm our business, financial condition and results of operations. Our copper-wire based solutions face severe competition from other technologies and the commercial acceptance of any competing solutions could harm our business and ability to compete. The market for high-speed data access products and services is characterized by several competing technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. These competing solutions provide fast access, high reliability and are cost-effective for some users. Because many of our products are based on the use of copper telephone wire, and because there are physical limits to the speed and distance over which data can be transmitted over this wire, our products may not be a viable solution for customers requiring service at performance levels beyond the current limits of copper telephone wire. To the extent that telecommunications service providers choose to install fiber optic cable or other transmission media in the last mile, or to the extent that homes and businesses install other transmission media within buildings, we expect that demand for our products that are based on copper telephone wires will decline. Commercial acceptance of any one of these competing solutions or any technological advancement or product introduction that provides faster access, greater reliability, increased cost- effectiveness or other advantages over technologies that utilize existing telephone copper wires could decrease the demand for our products and reduce average selling prices and gross margins associated with our products. The occurrence of any one or more of these events could harm our business, financial condition and results of operations. Manufacturing or design defects in our products could harm our reputation and business. Any defect or deficiency in our products could reduce the functionality, effectiveness or marketability of our products. These defects or deficiencies could cause orders for our products to be canceled or delayed, reduce revenue, or render our product designs obsolete. In that event, we would be required to devote substantial financial and other resources for a significant period of time in order to develop new product designs. We cannot assure you that we would be successful in addressing any manufacturing or design defects in our products or in developing new product designs in a timely manner, if at all. Any of these events, individually or in the aggregate, could harm our business, financial condition and results of operations. 23 We must maintain and develop strategic partnerships with third parties to increase market penetration of our HomeRun technology. We have established relationships with several strategic partners, including our collaborative arrangement through the Home Phoneline Network Alliance, or the Home PNA, with leading semiconductor, computer hardware and consumer electronics manufacturers. We have also licensed our HomeRun technology to members of the Home PNA and others. In this regard, the widespread market acceptance of our HomeRun technology for home networking applications is dependent on the development and marketing of HomeRun-enabled integrated circuits and consumer products by our licensees and their customers. We cannot assure you that our HomeRun technology will continue to be deployed on a widespread basis and future sales of products containing our HomeRun technology cannot be predicted. The amount and timing of resources that our licensees devote to developing and marketing HomeRun-enabled products is not within our control. We cannot assure you that these licensees will continue to develop and market products as expected or that significant license and royalty revenue will be forthcoming in the future. If any of our licensees fails to commercialize or market products incorporating HomeRun technology, our revenue may not grow as expected and we may be required to undertake unforeseen additional responsibilities or to devote additional resources to development, commercialization or marketing of HomeRun, all of which could harm our business, financial condition and results of operations. Changing industry standards may reduce the demand for our products, which will harm our business. We will not be competitive unless we continually introduce new products and product enhancements that address changing industry standards. The emergence of new industry standards, whether through adoption by official standards committees or widespread use by telephone companies or other service providers, could require redesign of our products. If these standards become widespread and our products are not in compliance, our customers and potential customers may not purchase our products, which would harm our business, financial condition and results of operations. The rapid development of new standards increases the risk that competitors could develop products that make our products obsolete. Any failure by us to develop and introduce new products or enhancements directed at new industry standards could harm our business, financial condition and results of operations. In addition, selection of competing technologies as standards by standards setting bodies such as the Home PNA could negatively affect our reputation in the market regardless of whether our products are standard compliant or demand for our products does not decline. This selection could be interpreted by the press and others as having a negative impact on our business which could negatively impact the market price of our stock. A majority of our sales comes from a small number of customers; if we lose any of these customers, our sales could decline significantly. The majority of our annual sales comes from a small number of our customers. Our 10 largest customers accounted for 62% of net sales in 1999. Because we are dependent upon continued revenue from our 10 largest customers, any material delay, cancellation or reduction of orders from these or other major customers could cause our sales to decline significantly. Some of these customers individually accounted for more than 10% of our annual net sales in 1999. CAIS, Inc. and Rycom CCI, Inc. accounted for 12% and 10%, respectively, of our annual net sales in 1999. There is no guarantee that we will be able to retain any of our 10 largest customers or any other accounts. In addition, our customers may materially reduce the levels of services ordered from us at any time. This could cause a significant decline in our net sales and we may not be able to reduce the accompanying expenses at the same time. We depend on contract manufacturers to manufacture all of our products, and rely upon them to deliver high-quality products in a timely manner. We do not manufacture any of our products, but instead rely on contract manufacturers to assemble, test and package our products. We cannot assure you that these contract manufacturers and suppliers will be able to 24 meet our future requirements for manufactured products, components and subassemblies. Any interruption in the operations of one or more of these contract manufacturers would harm our ability to meet our scheduled product deliveries to customers. We also intend to regularly introduce new products and product enhancements, which will require that we rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturers to provide us with adequate supplies of high-quality products or the loss of a current contract manufacturer would cause a delay in our ability to fulfill customer orders while we obtain a replacement manufacturer and would harm our business, operating results and financial condition. In addition, our inability to accurately forecast the actual demand for our products could result in supply, manufacturing or testing capacity constraints. These constraints could result in delays in the delivery of our products or the loss of existing or potential customers, either of which could harm our business, operating results or financial condition. We currently purchase all of our raw materials and components used in our products through our contract manufacturers. Components are purchased pursuant to purchase orders based on forecasts, but we or our contract manufacturers have no guaranteed supply arrangements with these suppliers. The availability of many of these components is dependent in part on our ability to provide our contract manufacturers and their suppliers with accurate forecasts of our future needs. If we or our manufacturers were unable to obtain a sufficient supply of components from current sources, we could experience difficulties in obtaining alternative sources or in altering product designs to use alternative components. For example, we are experiencing, and may continue experiencing in the future, difficulty obtaining flash memory. Resulting delays, reductions in product shipments could damage customer relationships and could harm our business, financial condition or results of operations. In addition, any increases in component costs that are passed on to our customers could reduce demand for our products. We rely on third parties to test all of our products and a failure to adequately control quality could harm our business. Substantially all of our products are assembled and tested by our contract manufacturers. Although we perform random spot testing on manufactured products, we rely on our contract manufacturers for assembly and primary testing of our products. Any quality assurance problems could increase the costs of manufacturing, assembling or testing of our products and could harm our business, financial condition and results of operation. Moreover, defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or liability claims, each of which could harm our business, financial condition and results of operations. We purchase several key components from single or limited sources and could lose sales if these sources fail to fill our needs. We currently purchase all of our raw materials and components used in our products through our contract manufacturers. In procuring components, our contract manufacturers rely on some suppliers that are the sole source of those components, and we are dependent upon supply from these sources to meet our needs. For example, all of the field programmable gate array supplies used in our products are purchased from Xilinx. Our products are also dependent on various sole source offerings from Dallas Semiconductor, Intel, Metalink US, Motorola, Oki Semiconductor, Osicom Technologies, SaRonix, Siemens and Wind River Systems. If there is any interruption in the supply of any of the key components currently obtained from a single or limited source, obtaining these components from other sources could take a substantial period of time, could cause us to redesign our products and could disrupt our operations and harm our business in any given period. We may not be able to effectively integrate our recent acquisitions into our existing business. In June 1999, we acquired PublicPort, Inc., in November 1999, we acquired Vintel Communications, Inc., and in February 2000, we acquired FreeGate Corporation. In addition, in February 2000, we signed a definitive agreement to acquire certain assets of OneWorld Systems, Inc. We will need to overcome significant issues in order to realize any benefits from these transactions. These issues include: . integrating the operations of the geographically dispersed businesses acquired into our own operations; 25 . incorporating acquired technology, rights and products into our products and services; . developing new products and services that utilize the assets of all entities; . the potential disruption of our ongoing business and the distraction of our management; and . the potential impairment of relationships with employees, suppliers and customers. We may engage in future acquisitions of companies, technologies or products and the failure to integrate any future acquisitions could harm our business. As a part of our business strategy, we expect to make additional acquisitions of, or significant investments in, complementary companies, products or technologies. Any future acquisitions would be accompanied by the risks commonly encountered in acquisitions of companies. These risks include: . difficulties in assimilating the operations and personnel of the acquired companies; . diversion of management's attention from ongoing business concerns; . our potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services; . additional expense associated with amortization of acquired intangible assets; . maintenance of uniform standards, controls, procedures and policies; and . impairment of existing relationships with employees, suppliers and customers as a result of the integration of new personnel. We cannot assure you that we will be able to successfully integrate any business, products, technologies or personnel that we may acquire in the future, and our failure to do so could harm our business, operating results and financial condition. If we fail to manage our growth effectively, our business could be harmed. Our growth has placed, and in the future may continue to place, a significant strain on our engineering, managerial, administrative, operational, financial and marketing resources, and increased demands on our systems and controls. To exploit the market for our products, we must develop new and enhanced products while managing anticipated growth in sales by implementing effective planning and operating processes. To manage our anticipated growth, we must, among other things, continue to implement and improve our operational, financial and management information systems, hire and train additional qualified personnel, continue to expand and upgrade core technologies and effectively manage multiple relationships with various customers, suppliers and other third parties. We cannot assure you that our systems, procedures or controls will be adequate to support our operations or that our management will be able to achieve the rapid execution necessary to exploit fully the market for our products or systems. If we are unable to manage our growth effectively, our business, financial condition and results of operations could be harmed. We depend on international sales for a significant portion of our revenue, which could subject our business to a number of risks. Sales to customers outside of the United States accounted for approximately 32.3% and 18.5% of revenue for the years ended December 31, 1999 and 1998, respectively. There are a number of risks arising from our international business, including: . longer receivables collection periods; . increased exposure to bad debt write-offs; . risk of political and economic instability; 26 . difficulties in enforcing agreements through foreign legal systems; . unexpected changes in regulatory requirements; . import or export licensing requirements; . reduced protection for intellectual property rights in some countries; and . currency fluctuations. We expect sales to customers outside of the United States to continue to account for a significant portion of our revenue. We can give you no assurance that foreign markets for our products will not develop more slowly than currently anticipated. Any failure to increase sales to customers outside of the United States could harm our business, financial condition and results of operations. We also expend product development and other resources in order to meet regulatory and technical requirements of foreign countries. We are depending on sales of our products in these foreign markets in order to recoup the costs associated with developing products for these markets. Fluctuations in currency exchange rates may harm our business. All of our foreign sales are invoiced in U.S. dollars. As a result, fluctuations in currency exchange rates could cause our products to become relatively more expensive for international customers and reduce demand for our products. We anticipate that foreign sales will generally continue to be invoiced in U.S. dollars. Accordingly, we do not currently engage in foreign currency hedging transactions. As we expand our current international operations, however, we may allow payment in foreign currencies and exposure to losses in foreign currency transactions may increase. To reduce this exposure we may purchase forward foreign exchange contracts or use other hedging strategies. However, we cannot assure you that any currency hedging strategy would be successful in avoiding exchange related losses. If we fail to protect our intellectual property, or if others use our proprietary technology without authorization, our competitive position may suffer. Our future success and ability to compete is dependent in part upon our proprietary technology. We rely on a combination of copyright, patent, trademark and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. We currently hold 17 United States patents and have 18 United States patent applications pending. However, we cannot assure you that patents will be issued with respect to pending or future patent applications or that our patents will be upheld as valid or will prevent the development of competitive products or that any actions we have taken will adequately protect our intellectual property rights. We generally enter into confidentiality agreements with our employees, consultants, resellers, customers and potential customers, strictly limit access to and distribution of our software, and further limit the disclosure and use of other of our proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use our products or technology. We also cannot assure you that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. We may be subject to intellectual property infringement claims that are costly to defend and could harm our business and ability to compete. We are also subject to the risk of adverse claims and litigation alleging infringement of the intellectual property rights of others. We cannot assure you that third parties will not assert infringement claims in the future with respect to our current or future products. Any such assertion, regardless of its merit, could require 27 us to pay damages or settlement amounts and could require us to develop non- infringing technology or acquire licenses to the technology that is the subject of asserted infringement. This litigation or potential litigation could result in product delays, increased costs or both. In addition, the cost of any litigation and the resulting distraction of our management resources could harm our business, results of operations or financial condition. We also cannot assure you that any licenses of technology necessary for our business will be available or that, if available, these licenses can be obtained on commercially reasonable terms. Our failure to obtain these licenses could harm our business, results of operations and financial condition. If our products do not comply with complex government regulations, our products may not be sold, preventing us from increasing our revenue or achieving profitability. We and our customers are subject to varying degrees of federal, state and local regulation. Our products must comply with various regulations and standards defined by the Federal Communications Commission. The FCC has issued regulations that set installation and equipment standards for communications systems. Our products are also required to meet certain safety requirements. For example, certain of our products must be certified by Underwriters Laboratories in order to meet federal safety requirements relating to electrical appliances to be used inside the home. In addition, certain products must be Network Equipment Building Standard certified before they may be deployed by certain of our customers. Any delay in or failure to obtain these approvals could harm our business, financial condition or results of operations. Outside of the United States, our products are subject to the regulatory requirements of each country in which our products are manufactured or sold. These requirements are likely to vary widely. If we do not obtain timely domestic or foreign regulatory approvals or certificates we would not be able to sell our products where these regulations apply, which may prevent us from sustaining our revenue or achieving profitability. In addition, regulation of our customers may adversely impact our business, operating results and financial condition. For example, FCC regulatory policies affecting the availability of data and Internet services and other terms on which telecommunications companies conduct their business may impede our penetration of certain markets. In addition, the increasing demand for communications systems has exerted pressure on regulatory bodies worldwide to adopt new standards, generally following extensive investigation of competing technologies. The delays inherent in this governmental approval process may cause the cancellation, postponement or rescheduling of the installation of communications systems by our customers, which in turn may harm the sale of products by us to these customers. Our success is dependent on our ability to provide adequate customer support. Our ability to achieve our planned sales growth and retain current and future customers will depend in part upon the quality of our customer support operations. Our customers generally require significant support and training with respect to our products, particularly in the initial deployment and implementation stage. As our systems and products become more complex, we believe our ability to provide adequate customer support will be increasingly important to our success. We have limited experience with widespread deployment of our products to a diverse customer base, and we cannot assure you that we will have adequate personnel to provide the levels of support that our customers may require during initial product deployment or on an ongoing basis. In addition, we rely on a third party for a substantial portion of our customer support functions. Our failure to provide sufficient support to our customers could delay or prevent the successful deployment of our products. Failure to provide adequate support could also have an adverse impact on our reputation and relationship with our customers, could prevent us from gaining new customers and could harm our business, financial condition or results of operations. If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to successfully manage our business. We depend on the performance of Matthew Taylor, our Chief Technical Officer, and Salvatore D'Auria, our President, Chief Executive Officer and Chairman of the Board, and on other senior management and 28 technical personnel with experience in the data communications, telecommunications and high-speed data access industries. The loss of any one of them could harm our ability to execute our business strategy. Additionally, we do not have employment contracts with any of our executive officers and we only maintain a "key person" life insurance policy on Matthew Taylor. We believe that our future success will depend in large part upon our continued ability to identify, hire, retain and motivate highly skilled employees, who are in great demand. We cannot assure you that we will be able to do so. Our stock price has fluctuated and is likely to continue to fluctuate, and you may not be able to resell your shares at or above the offering price. The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price could fluctuate widely in response to factors such as the following: . actual or anticipated variations in operating results; . announcements of technological innovations, new products or new services by us or by our partners, competitors or customers; . changes in financial estimates or recommendations by stock market analysts regarding us or our competitors; . conditions or trends in the telecommunications industry, including regulatory developments; . growth of the Internet; . announcements by us of significant acquisitions, strategic partnerships, joint ventures or capital commitments; . additions or departures of key personnel; . future equity or debt offerings or our announcements of these offerings; and . general market and general economic conditions. In addition, in recent years, the stock market in general, and the Nasdaq National Market and the securities of Internet and technology companies in particular, have experienced extreme price and volume fluctuations. These fluctuations have often been unrelated or disproportionate to the operating performance of these technology companies. These market and industry factors may harm our stock price, regardless of our operating results. In addition, trading prices of the stocks of many technology companies are at or near historic highs and reflect price-earnings ratios substantially above historic levels. These trading prices and price-earnings ratios may not be sustained. Our charter and bylaws and Delaware law contain provisions that could delay or prevent a change in control. Certain provisions of our charter and bylaws may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions could limit the price that certain investors may be willing to pay in the future for shares of our common stock. Our charter and bylaws provide for a classified board of directors, eliminate cumulative voting in the election of directors, restrict our stockholders from acting by written consent and calling special meetings, and provide for procedures for advance notification of stockholder nominations and proposals. In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. These provisions, as well as Section 203 of the Delaware General Corporation Law, to which we are subject, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management. 29 Future sales of our common stock could depress our stock price. Sales of a substantial number of shares of our common stock in the public market, or the appearance that these shares are available for sale, could harm the market price of our common stock. These sales also may make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we deem appropriate. As of December 31, 1999, we had 11,940,610 shares outstanding. Of these shares, 11,655,561 shares of common stock are currently available for sale in the public market, some of which are subject to volume and other limitations under securities laws. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We place our investments with high credit issuers in short-term securities with maturities of three to twelve months. Our portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. We have no investments denominated in foreign country currencies and therefore are not subject to foreign exchange risk. 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TUT SYSTEMS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Accountants........................................ 32 Consolidated Balance Sheets as of December 31, 1998 and 1999............. 33 Consolidated Statements of Operations for the years ended December 31, 1997, 1998, and 1999.................................................... 34 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1998, and 1999....................................... 35 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998, and 1999.................................................... 36 Notes to Consolidated Financial Statements............................... 37
31 REPORT OF INDEPENDENT ACCOUNTANTS To the Stockholders and Board of Directors of Tut Systems, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 59 present fairly, in all material respects, the financial position of Tut Systems, Inc. at December 31, 1998 and December 31, 1999 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the index appearing under item 14(a)(2) on page 59 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP San Jose, California January 20, 2000 except as to Note 14 which is as of February 14, 2000 32 TUT SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
December 31, ------------------ 1998 1999 -------- -------- ASSETS Current assets: Cash and cash equivalents................................ $ 4,452 $ 13,405 Short-term investments................................... -- 18,831 Accounts receivable, net of allowance for doubtful accounts of $115 and $335 in 1998 and 1999, respectively............................................ 2,738 11,742 Inventories.............................................. 3,787 8,401 Prepaid expenses and other current assets................ 955 3,746 -------- -------- Total current assets................................... 11,932 56,125 Property and equipment, net................................ 1,790 3,476 Deferred offering costs.................................... 955 -- Other assets............................................... 580 5,755 -------- -------- Total assets........................................... $ 15,257 $ 65,356 ======== ======== LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND WARRANT AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable......................................... $ 2,421 $ 5,859 Accrued liabilities...................................... 1,758 3,551 Lines of credit.......................................... -- 1,529 Deferred revenue......................................... 580 770 -------- -------- Total current liabilities.............................. 4,759 11,709 Lines of credit, net of current portion.................... 4,262 -- Deferred revenue, net of current portion................... 2,080 2,125 -------- -------- Total liabilities...................................... 11,101 13,834 -------- -------- Redeemable convertible preferred stock; $0.001 par value; 7,531 shares authorized; 6,355 shares issued and outstanding in 1998 and none in 1999 (liquidation value: $43,895 at December 31, 1998)............................. 43,895 -- Redeemable convertible preferred stock warrant............. 2,100 -- -------- -------- 45,995 -- -------- -------- Commitments and Contingencies (Note 9) Stockholders' equity (deficit): Convertible preferred stock; $0.001 par value; 1,339 shares authorized; 1,098 shares issued and outstanding in 1998 and none in 1999 (liquidation value: $1,567 at December 31, 1998)...................................... 1,567 -- Common stock; $0.001 par value; 100,000 shares authorized; 347 and 11,941 shares issued and outstanding in 1998 and 1999, respectively.......................... -- 12 Additional paid-in capital................................. 2,455 108,969 Deferred compensation...................................... (1,427) (972) Accumulated deficit........................................ (44,434) (56,487) -------- -------- Total stockholders' equity (deficit)................... (41,839) 51,522 -------- -------- Total liabilities, redeemable convertible preferred stock and warrant and stockholders' equity (deficit)........................................... $ 15,257 $ 65,356 ======== ========
The accompanying notes are an integral part of these financial statements. 33 TUT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Years Ended December 31, ---------------------------- 1997 1998 1999 -------- -------- -------- Revenues: Product....................................... $ 6,221 $ 9,790 $ 26,266 License and royalty........................... -- 765 1,541 -------- -------- -------- Total revenues.............................. 6,221 10,555 27,807 -------- -------- -------- Costs of goods sold: Product....................................... 3,228 5,733 15,454 License and royalty........................... -- 76 5 -------- -------- -------- Total cost of goods sold.................... 3,228 5,809 15,459 -------- -------- -------- Gross margin.................................... 2,993 4,746 12,348 -------- -------- -------- Operating expenses: Sales and marketing........................... 5,147 8,462 10,523 Research and development...................... 3,562 6,200 7,618 General and administrative.................... 2,375 2,807 4,429 In-process research and development........... -- -- 2,600 Amortization of intangibles................... -- -- 52 Noncash compensation expense.................. 1,260 1,233 455 -------- -------- -------- Total operating expenses.................... 12,344 18,702 25,677 -------- -------- -------- Loss from operations............................ (9,351) (13,956) (13,329) Interest expense................................ (61) (117) (608) Interest income................................. 256 327 2,203 Other income, net............................... -- -- 1 -------- -------- -------- Loss before income taxes........................ (9,156) (13,746) (11,733) Income tax expense.............................. 1 1 1 -------- -------- -------- Net loss........................................ (9,157) (13,747) (11,734) Dividend accretion on preferred stock........... 1,627 2,584 235 -------- -------- -------- Net loss attributable to common stockholders.... $(10,784) $(16,331) $(11,969) ======== ======== ======== Net loss per share attributable to common stockholders, basic and diluted................ $ (59.36) $ (60.62) $ (1.12) ======== ======== ======== Shares used in computing net loss attributable to common stockholders, basic and diluted...... 182 269 10,729 ======== ======== ========
The accompanying notes are an integral part of these financial statements. 34 TUT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (in thousands)
Convertible Preferred Stock Series A-G Common Stock Additional -------------- ------------- Paid-in Deferred Accumulated Shares Amount Shares Amount Capital Compensation Deficit Total ------ ------ ------ ------ ---------- ------------ ----------- -------- Balance, January 1, 1997................... 1,098 $1,567 156 $ -- $ 58 $ -- $(17,319) $(15,694) Common stock issued for cash upon exercise of options................ -- -- 62 -- 34 -- -- 34 Dividend accretion...... -- -- -- -- -- -- (1,627) (1,627) Net loss................ -- -- -- -- -- -- (9,157) (9,157) ------ ------ ------ ----- -------- ------- -------- -------- Balance, December 31, 1997................... 1,098 1,567 218 -- 92 -- (28,103) (26,444) Common stock issued for cash upon exercise of options................ -- -- 129 -- 63 -- -- 63 Unearned compensation related to stock options................ -- -- -- -- 1,820 (1,820) -- -- Amortization related to unearned compensation.. -- -- -- -- -- 393 -- 393 Common stock warrant issued................. -- -- -- -- 480 -- -- 480 Dividend accretion...... -- -- -- -- -- -- (2,584) (2,584) Net loss................ -- -- -- -- -- -- (13,747) (13,747) ------ ------ ------ ----- -------- ------- -------- -------- Balance, December 31, 1998................... 1,098 1,567 347 -- 2,455 (1,427) (44,434) (41,839) Common stock issued in initial public offering, net.......... -- -- 2,875 3 46,864 -- -- 46,867 Conversion of Series A-C convertible preferred stock and Series D-G redeemable convertible preferred stock to common stock in conjunction with initial public offering............... (1,098) (1,567) 8,120 8 54,464 -- -- 52,905 Common stock issued for cash upon exercise of options................ -- -- 268 1 507 -- -- 508 Common stock issued in conjunction with Public Port pooling of interest acquisition... -- -- 169 -- 160 -- (84) 76 Common stock issued in conjunction with Vintel Corporation purchase acquisition............ -- -- 116 -- 4,254 -- -- 4,254 Common stock issued under employee stock purchase plan.......... -- -- 8 -- 239 -- -- 239 Exercise of common stock warrant................ -- -- 37 -- -- -- -- -- Common stock issued for consulting services.... -- -- 1 -- 26 -- -- 26 Amortization related to unearned compensation.. -- -- -- -- -- 455 -- 455 Dividend accretion...... -- -- -- -- -- -- (235) (235) Net loss................ -- -- -- -- -- -- (11,734) (11,734) ------ ------ ------ ----- -------- ------- -------- -------- Balance, December 31, 1999................... -- $ -- 11,941 $ 12 $108,969 $ (972) $(56,487) $ 51,522 ====== ====== ====== ===== ======== ======= ======== ========
The accompanying notes are an integral part of these financial statements. 35 TUT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Years Ended December 31, --------------------------- 1997 1998 1999 ------- -------- -------- Cash flows from operating activities: Net loss......................................... $(9,157) $(13,747) $(11,734) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization................... 398 606 894 Non cash interest income........................ -- -- (162) Common stock issued for services................ -- -- 26 Provision for doubtful accounts................. 14 104 235 Provision for excess and obsolete inventory..... 72 203 340 Amortization of discounts on investments........ (152) (204) (322) Noncash compensation expense.................... 1,260 1,233 455 Amortization of goodwill and intangible assets.. -- -- 52 Write-off of in-process research & development.. -- -- 2,600 Change in assets and liabilities: Accounts receivable............................ (1,036) (1,672) (9,239) Inventories.................................... (1,241) (2,566) (4,954) Prepaid expenses and other assets.............. (382) (1,066) (3,373) Accounts payable............................... 753 781 3,400 Deferred revenue............................... -- 2,660 235 Accrued liabilities............................ 331 1,011 1,768 ------- -------- -------- Net cash used in operating activities......... (9,140) (12,657) (19,779) ------- -------- -------- Cash flows from investing activities: Purchase of property and equipment............... (969) (1,051) (2,524) Purchase of short-term investments............... (6,543) (3,906) (32,663) Purchase of long-term investments................ -- -- (2,192) Proceeds from maturities of short-term investments..................................... 9,346 9,000 14,154 Cash acquired in business combination............ -- -- 406 ------- -------- -------- Net cash provided by (used in) investing activities................................... 1,834 4,043 (22,819) ------- -------- -------- Cash flows from financing activities: Payment on lines of credit....................... (1,130) (1,754) (2,733) Proceeds from lines of credit.................... 1,088 5,662 -- Proceeds from issuance of common and preferred stock, net...................................... 11,334 3,763 54,284 ------- -------- -------- Net cash provided by financing activities..... 11,292 7,671 51,551 ------- -------- -------- Net increase (decrease) in cash and cash equivalents...................................... 3,986 (943) 8,953 Cash and cash equivalents, beginning of period.... 1,409 5,395 4,452 ------- -------- -------- Cash and cash equivalents, end of period.......... $ 5,395 $ 4,452 $ 13,405 ======= ======== ======== Supplemental disclosure of cash flow information: Interest paid during the period.................. $ 61 $ 68 $ -- ======= ======== ======== Income taxes paid during the period.............. $ 1 $ 1 $ 1 ======= ======== ======== Noncash financing activities: Common stock warrants issued..................... $ -- $ 480 $ -- ======= ======== ======== Common stock issued in connection with Public Port............................................ $ -- $ -- $ 160 ======= ======== ======== Common stock issued for services................. $ -- $ -- $ 26 ======= ======== ======== Accretion of preferred stock..................... $ 1,627 $ 2,584 $ 235 ======= ======== ======== Conversion of preferred stock to common stock.... $ -- $ -- $ 47,802 ======= ======== ======== Unearned compensation related to stock option grants.......................................... $ 1,260 $ 1,233 $ 455 ======= ======== ======== Interest income from warrant..................... $ -- $ -- $ 162 ======= ======== ======== Liabilities assumed in connection with acquisition of Vintel Inc.: Fair value of tangible assets acquired........... $ 61 In-process research and development.............. 2,600 Goodwill and intangible assets................... 1,826 Common stock issued.............................. (4,254) Net cash paid.................................... (170) -------- Liabilities assumed.............................. $ 63 ========
The accompanying notes are an integral part of these financial statements. 36 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts) NOTE 1--THE COMPANY: Tut Systems, Inc. (the "Company"), was founded in 1983 and began operations in August 1991. The Company designs, develops and markets advanced communications products which enable high-speed data access over the copper infrastructure of telephone companies, as well as the copper telephone wires in homes, businesses and other buildings. The Company's products incorporate high- bandwidth access multiplexers, associated modems and routers, Ethernet extension products and integrated network management software. NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Principles of consolidation These consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Use of estimates The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair value of financial instruments The fair value of the Company's cash and cash equivalents, short-term investments, accounts receivable, accounts payable and lines of credit approximate their carrying value due to the short maturity or market rate structure of those instruments. Cash, cash equivalents and short-term investments Cash, cash equivalents, and short-term investments are stated at cost or amortized cost, which approximates fair value, and consist primarily of money market funds, certificates of deposits, corporate securities and debt securities. The Company includes in cash and cash equivalents all highly liquid investments which mature within three months of their purchase date. Investments maturing between three and twelve months from the date of purchase are classified as short-term investments. Management determines the appropriate classification of debt securities at the time of purchase and reevaluates that designation as of each balance sheet date. As of December 31, 1999, debt securities were classified as held-to- maturity as the Company intended to, and had the ability to hold these securities to maturity. Held-to-maturity securities are stated at amortized cost, which approximates fair market value. The estimated fair values of cash equivalents and short-term investments are based on quoted market prices. Inventories Inventories are stated at the lower of cost, using the average cost method, or market. Property and equipment Property and equipment are carried at cost. The Company provides for depreciation by charges to expense which are sufficient to write off the cost of the assets over their estimated useful lives on the straight-line basis. 37 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) Leasehold improvements are amortized over the lesser of the lease term or the estimated useful life of the improvement. Useful lives by principal classifications are as follows: Office equipment............................................... 5 years Computers and software......................................... 3-5 years Test equipment................................................. 5 years Leasehold improvements......................................... 1-5 years
When assets are sold or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from the asset and allowance for depreciation and amortization accounts respectively, and any gain or loss on that sale or disposal is credited or charged to income. Maintenance, repairs, and minor renewals are charged to expense as incurred. Expenditures which substantially increase an asset's useful life are capitalized. Intangible assets Intangible assets consist of goodwill and acquired workforce and are amortized on a straight line basis over five and three years, respectively. See Note 4, Business Combinations. Accounting for long-lived assets The Company evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Revenue recognition Product revenues The Company recognizes revenue from product sales upon shipment if collection of the resulting receivable is probable and product returns are reasonably estimated. Revenue on products shipped on a trial basis is recognized upon customer acceptance. Service revenue relating to customer maintenance fees for ongoing customer support is recognized ratably over the period of the contract. The Company's 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 the product revenue is recognized. License and royalty revenues The Company has entered into nonexclusive technology agreements with various licensees. These agreements provide the licensees the right to use the Company's proprietary technology to manufacture or have products manufactured using the proprietary technology and to receive customer support for specified periods and any changes or improvement to the technology over the term of the agreement. Contract fees for the services provided under these licensing agreements are generally comprised of license fees and nonrefundable, prepaid royalties which are recognized when the proprietary technology is 38 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) delivered if there are no significant vendor obligations. If the licensing agreements contain post-contract customer support, the Company recognizes the contract fees ratably over the five year period during which the post-contract customer support is expected to be provided. This period represents the estimated life of the technology. The Company begins to recognize revenue under the contract, once it has delivered the implementation package which contains all information needed to use the Company's proprietary technology in the licensee's process. The remaining obligations are primarily to provide the licensee with any changes or improvements to the technology and technical advice on specifications, testing, debugging and enhancements. The Company recognizes royalties upon notification of sale by its licensees. The terms of the royalty agreements generally require licensees to give notification to the Company and to pay royalties within 60 days of the end of the quarter during which the sales take place. Advertising expenses The Company accounts for advertising costs as expense in the period in which they are incurred. Advertising expense for the years ended December 31, 1997, 1998 and 1999 was $94, $127 and $86, respectively. Research and development Research and development expenditures are charged to expense as incurred. Income taxes Deferred income taxes result primarily from temporary differences between financial and tax reporting. Deferred tax assets and liabilities are determined based on the difference between the financial statement bases and the tax bases of assets and liabilities using enacted tax rates. A valuation allowance is established to reduce a deferred tax asset to the amount that is expected more likely than not to be realized. Net loss per share Basic and diluted net loss per share are computed using the weighted average number of common shares outstanding. Options, warrants and preferred stock were not included in the computation of diluted net loss per share because the effect would be antidilutive. The calculation of net loss per share attributable to common stockholders follows:
Years Ended December 31, ---------------------------- 1997 1998 1999 -------- -------- -------- Net loss per share attributable to common stockholders, basic and diluted: Net loss attributable to common stockholders... $(10,784) $(16,331) $(11,969) ======== ======== ======== Shares used in computing net loss attributable to common stockholders, basic and diluted..... 182 269 10,729 ======== ======== ======== Net loss per share attributable to common stockholders, basic and diluted............... $ (59.36) $ (60.62) $ (1.12) ======== ======== ======== Antidilutive securities including options, warrants, and preferred stock not included in net loss per share attributable to common stockholders calculation...................... 8,537 9,180 1,446 ======== ======== ========
39 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) Comprehensive income (loss) The Company has adopted the provisions of SFAS No. 130, or SFAS 130, "Reporting Comprehensive Income." SFAS 130 establishes standards for reporting comprehensive income (loss) and its components in financial statements. Comprehensive income (loss), as defined, includes all changes in equity during a period from non-owner sources. There has been no difference between the Company's net loss and its total comprehensive loss through December 31, 1999. 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 that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The Company, to date, has not engaged in derivative and hedging activities, and accordingly does not believe that the adoption of SFAS No. 133 will have a material impact on the financial reporting and related disclosures of the Company. The Company will adopt SFAS No. 133 as required by SFAS No. 137, "Deferral of the Effective Date of the FASB Statement No. 133," beginning with the third quarter of fiscal 2000. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements," which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. Management believes that the impact of SAB 101 will not have a material effect on the financial position or results of the operations of the Company. NOTE 3--CONCENTRATIONS OF CREDIT RISK: The Company operates in one business segment, designing, developing and marketing advanced communications products which enable high-speed data access in homes, businesses and other buildings. The markets for high-speed data access products are characterized by rapid technological developments, frequent new product introductions, changes in end user requirements and evolving industry standards. The Company's future success will depend on its ability to develop, introduce and market enhancements to its existing products, to introduce new products in a timely manner which meet customer requirements and to respond to competitive pressures and technological advances. Further, the emergence of new industry standards, whether through adoption by official standards committees or widespread use by telephone companies or other service providers, could require the Company to redesign its products. The Company performs ongoing credit evaluations of its customers and generally requires no collateral. The Company had no customers with accounts receivable balances greater than 10% at December 31, 1998. The Company had significant accounts receivable balances due from two customers, individually representing 28% and 18% of total accounts receivable, at December 31, 1999. Currently, the Company relies on contract manufacturers and some single source suppliers of materials for certain product components. As a result, should the Company's current manufacturers or suppliers not produce and deliver inventory for the Company to sell on a timely basis, operating results could be adversely impacted. The Company from time to time maintains a substantial portion of its cash and cash equivalents in money market accounts with one financial institution. The Company invests its excess cash in debt instruments of the 40 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) U.S. Treasury, governmental agencies and corporations with strong credit ratings. The Company has established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. The Company has not experienced any significant losses on its cash equivalents or short-term investments. NOTE 4--BUSINESS COMBINATIONS: Pooling of interests combination In June 1999, the Company acquired Public Port, Inc. ("Public Port"), a company that designs and develops subscriber management systems. Under the terms of the agreement, the Company issued 169 shares of its common stock for all of the outstanding stock of Public Port. The transaction was accounted for as a pooling of interests. The historical results of operations and financial position of Public Port have not been significant in relation to the Company. As such, historical results of the Company have not been restated for this acquisition. Purchase combination In November 1999, the Company acquired all of the outstanding options to purchase common stock and common stock of Vintel Communications, Inc. ("Vintel") for a total purchase price of $4,780, which consisted of $500 cash, 41 options to purchase shares of the Company's common stock and 116 shares of the Company's common stock and related expenses. Vintel was incorporated in March 1999 and is a networking company that specialized in developing high- performance integrated service routers. The acquisition was accounted for as a purchase and the results of operations of Vintel have been included in the consolidated financial statements from the date of acquisition. The allocation of the purchase price was based on the estimated fair value of the assets less liabilities at the date of the acquisition of $354, goodwill and acquired workforce of $1,446 and $380, respectively, and in-process research and development of $2,600. The amount allocated to the purchased in- process technology was determined based on an appraisal completed by an independent third party using established valuation techniques and was expensed upon acquisition, because technological feasibility had not been established and no future alternative uses existed. The product percentage of completion was estimated to be 75%. The value of this in-process technology was determined by estimating the costs to develop the purchased in-process technology into a commercially viable product, estimating the resulting net cash flows from the sale of the product resulting from the completion of the in-process technology and discounting the net cash flows back to their present value. Research and development costs to bring in-process product from Vintel to technological feasibility are not expected to have a material impact on the Company's future results of operations or cash flows. The following unaudited pro forma financial information reflects the results of operations for the year ended December 31, 1999, as if the acquisition of Vintel had occurred on January 1, 1999. The pro forma results exclude the $2,600 nonrecurring write-off of in-process research and development. Revenue....................................................... $ 27,807 Net loss attributable to common stockholders.................. $ (9,546) Net loss per share attributable to common stockholders, basic and diluted.................................................. $ (0.88)
41 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) NOTE 5--INVESTMENTS: The Company had no investments at December 31, 1998. The cost of short-term investments approximated the fair value and the amount of unrealized gains or losses was not significant at December 31, 1999. Short-term investments consist of the following:
December 31, ---------------- 1998 1999 ------- ------- Certificate of deposits................................ $ -- $ 3,095 Corporate bonds........................................ -- 15,736 ------- ------- $ -- $18,831 ======= ======= NOTE 6--BALANCE SHEET COMPONENTS: December 31, ---------------- 1998 1999 ------- ------- Inventories Finished goods....................................... $ 1,856 $ 6,731 Work in process...................................... 1,616 -- Raw material......................................... 315 1,670 ------- ------- $ 3,787 $ 8,401 ======= ======= December 31, ---------------- 1998 1999 ------- ------- Property and equipment Office equipment..................................... $ 519 $ 631 Computers and software............................... 1,143 2,661 Test equipment....................................... 860 1,795 Leasehold improvements............................... 454 469 ------- ------- 2,976 5,556 Less: accumulated depreciation and amortization...... (1,186) (2,080) ------- ------- $ 1,790 $ 3,476 ======= ======= December 31, ---------------- 1998 1999 ------- ------- Accrued liabilities Compensation......................................... $ 936 $ 1,488 Accrued offering costs............................... 340 -- Customer deposit..................................... -- 1,000 Other................................................ 482 1,063 ------- ------- $ 1,758 $ 3,551 ======= =======
42 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) NOTE 7--LINES OF CREDIT: The Company entered into a credit facility for up to $7,500 with a lending institution in December 1998. The credit facility is composed of two revolvers: a formula revolver of up to the lesser of $3,000 or 85% of qualifying accounts receivable and a non-formula revolver up to $4,500. The credit facility requires a minimum monthly interest payment of $10. The term of the credit facility is eighteen months and is renewable for additional terms of one year unless 60 days' written notice is given by either party. The loans under this credit facility are collateralized by substantially all assets of the Company. This agreement prohibits the payment of dividends. The Company granted the lending institution a warrant to purchase 55 shares of the Company's common stock at an exercise price of $14.00 per share on December 21, 1998. The warrant is exercisable for 5 years from the date of issuance and has been valued using the Black-Scholes method. On December 18, 1999, the lending institution completed a cashless exercise of its warrant to purchase the Company's common stock, resulting in the issuance of 37 shares of common stock. Amounts outstanding under lines of credit are as follows:
December 31, -------------- 1998 1999 ------- ------ Lending institution credit facility; non-formula revolver of $4,500, interest at prime plus 3.5% (12% at December 31, 1999)..................................... $ 4,262 $1,529 Lending institution credit facility; the lower of $3,000 or 85% of qualifying accounts receivable; interest at prime plus 2%.......................................... -- -- ------- ------ $ 4,262 $1,529 ======= ======
NOTE 8--INCOME TAXES: The income tax provision for each of 1997, 1998 and 1999 of $1 relates to the state franchise tax fee. The components of the net deferred tax assets as of December 31, 1998 and 1999 are as follows:
December 31, ------------------ 1998 1999 -------- -------- Deferred tax assets: Net operating loss carryforwards.................... $ 11,171 $ 14,937 Research and development credit..................... 977 1,599 Deferred research and development costs............. 402 635 Deferred revenue.................................... 1,035 1,152 Accruals and reserves............................... -- 1,195 Other............................................... 686 378 -------- -------- 14,271 19,896 Less: valuation allowance........................... (14,271) (19,896) -------- -------- Net deferred tax assets............................... $ -- $ -- ======== ========
Due to the uncertainty surrounding the realization of the tax attributes in tax returns, the Company has placed a full valuation allowance against its otherwise recognizable net deferred tax assets. 43 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) At December 31, 1999, the Company has approximately $39,530 in federal and $8,900 in state net operating losses, or NOL carryforwards to reduce future taxable income. At December 31, 1999, the Company also has research and experimentation tax credit carryforwards of approximately $923 and $676 for federal and state income tax purposes, respectively. The NOL and credit carryforwards expire in 2000 to 2019. NOL carryforwards of $7,000 and $2,000 for federal and state income tax purposes, respectively, are subject to annual limitations due to a change in ownership as defined under the Tax Reform Act of 1986. NOTE 9--COMMITMENTS AND CONTINGENCIES: Lease obligations The Company leases office, manufacturing and warehouse space under noncancelable operating leases that expire through 2002. On March 3, 1998, the Company extended its existing lease for its headquarters location for three years beginning June 1, 1998 to May 31, 2001. During December 1998, the Company leased additional space under the same terms. The additional lease contains an option to extend for an additional two years at a rate to be determined. In connection with the business combinations in 1999, the Company assumed operating leases which expire in April and December 2001. Minimum future lease payments under operating leases at December 31, 1999 are as follows: 2000................................................................. $399 2001................................................................. 219 2002................................................................. 14 ---- $632 ====
Rent expense for the years ended December 31, 1997, 1998 and 1999 was $267, $314 and $369, respectively. Royalty obligation The Company has acquired the rights, title, and interests in two patents from a founder and stockholder of the Company. These two patents give the Company exclusive control of the Balun technology required in the Company's products. Under the previous agreement, the Company was required to pay on-going royalties based on the net sales price of products sold utilizing the patented technology. In February 1999, the Company paid the founder $2.5 million as a lump sum payment for all its future royalty obligations. This payment is included in other assets at December 31, 1999. The Company is amortizing the amount ratably over five years. This period represents the estimated useful life of the patented technology. Amortization expense for the year ended December 31, 1999 was $458. For 1998, the royalty fees based on 1% of net sales were approximately $100. Contingencies The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of business. The Company's management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company's financial position, results of operations, or cash flows. 44 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) NOTE 10--PREFERRED STOCK: Convertible preferred stock and redeemable convertible preferred stock at December 31, 1998 was composed of the following, (in thousands):
Shares ---------------------- Liquidation Redemption Authorized Outstanding Amount Amount ---------- ----------- ----------- ---------- Convertible preferred stock Series A...................... 500 500 $ 2 $ 2 Series B...................... 89 89 199 199 Series C...................... 750 509 1,366 1,366 Redeemable convertible preferred stock Series D...................... 1,718 1,493 7,160 7,160 Series E...................... 1,313 1,306 7,591 7,591 Series F...................... 2,500 2,306 13,121 13,121 Series G...................... 2,000 1,250 16,023 16,023 Undesignated.................. 380 -- -- -- ----- ----- ------- ------- 9,250 7,453 $45,462 $45,462 ===== ===== ======= =======
On January 29, 1999, the Company completed its initial public offering of common stock. Simultaneously with the closing of the initial public offering, all issued and outstanding shares of the Company's convertible preferred stock and redeemable convertible preferred shares were automatically converted into shares of common stock. Warrants for Series G Mandatorily Redeemable Convertible Preferred Stock In connection with the issuance of Series G, in 1998 the Company issued warrants to purchase 667 shares of Series G with an exercise price of $10.00 per share. In January 1999, prior to the public offering, these warrants were exercised, resulting in the issuance of 667 shares of Series G in exchange for cash proceeds totaling $6.7 million. NOTE 11--STOCKHOLDERS' EQUITY Stock split In September 1998, in connection with the Company's reincorporation from California to Delaware, the Company effected a four for one reverse split of its common and preferred stock. All share data and stock option plan information have been restated to reflect the reverse split and the reincorporation. Stock option plans In November 1993, the Company adopted the 1992 Stock Plan (the "1992 Plan"), under which the Company may grant both incentive stock options and nonstatutory stock options to employees, consultants and directors. Options issued under the 1992 Plan can have an exercise price of no less than 85% of the fair market value, as defined under the 1992 Plan, of the stock at the date of grant. The 1992 Plan allows for the issuance of a maximum of 750 shares of the Company's common stock. In January 1997, the 1992 Plan was amended to increase the maximum number of shares that may be issued to 1,250. In March 1998, the 1992 Plan was amended to increase the maximum number of shares that may be issued to 1,438. This number of shares of 45 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) common stock has been reserved for issuance under the 1992 Plan. Generally, stock options are granted with vesting periods of four years and have an expiration date of ten years from the date of grant. The Company's 1998 Stock Plan (the "1998 Plan") was adopted by the Board of Directors in July 1998 and was approved by the stockholders in September 1998 and has rights and privileges similar to the 1992 Plan. The 1998 Plan allows for issuance of 1,000 shares of common stock with annual increases starting in 2000, subject to certain limitations. The Company's 1999 Nonstatutory Stock Option Plan (the "1999 Plan") was adopted by the Board of Directors in December 1999. The 1999 Plan allows for the issuance of 1,000 shares of common stock. The 1999 Plan has rights and privileges similar to the 1998 Plan. Activity under the 1992, 1998 and 1999 Plans are summarized as follows:
Outstanding Options ----------------------------------------- Weighted Shares Average Available Options Number of Price Aggregate Exercise For Grant Exercised Shares Per Share Price Price --------- --------- --------- ------------ --------- -------- Balance, January 1, 1997................... 147 152 451 $0.28-$ 0.52 $ 179 $ 0.40 Options authorized...... 500 -- -- -- -- -- Options granted......... (389) -- 389 0.52- 2.00 254 0.65 Options exercised....... -- 56 (56) 0.36- 0.48 (21) 0.38 Options terminated...... 59 -- (59) 0.36- 0.52 (27) 0.46 ----- --- ----- ------- Balance, December 31, 1997................... 317 208 725 0.28- 2.00 385 0.53 Options authorized...... 188 -- -- -- -- -- Options authorized...... 1,000 -- -- -- -- -- Options granted......... (414) -- 414 2.00- 15.00 2,822 6.82 Options exercised....... -- 129 (129) 0.36- 2.40 (63) 0.49 Options terminated...... 5 -- (5) 0.52 (3) 0.52 ----- --- ----- ------- Balance, December 31, 1998................... 1,096 337 1,005 0.28- 15.00 3,141 3.13 Options authorized...... 1,000 -- -- -- -- -- Options granted......... (849) -- 849 1.85- 53.63 22,346 26.35 Options exercised....... -- 268 (268) 0.36- 15.00 (508) 1.89 Options terminated...... 30 -- (139) 0.48- 46.63 (1,957) 14.09 Available options cancelled from 1992 Plan................... (10) -- -- -- -- -- ----- --- ----- ------- Balance, December 31, 1999................... 1,267 605 1,447 $0.28-$46.63 $23,022 $15.92 ===== === ===== =======
46 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) The following table summarizes information about stock options outstanding at December 31, 1999:
Options Outstanding Options Exercisable - ---------------------------------------------------- ----------------------- Weighted Average Remaining Weighted Weighted Range of Contractual Average Average Exercise Number Life Exercise Number Exercise Prices Outstanding (years) Price Exercisable Price -------- ----------- ----------- -------- ----------- -------- $ 0.36-$ 0.52 340 6.00 $ 0.45 230 $ 0.41 $ 1.85-$ 2.40 214 8.50 $ 2.24 108 $ 2.18 $ 3.60-$ 3.60 18 8.10 $ 3.60 7 $ 3.60 $ 8.00-$12.00 76 8.40 $10.44 24 $10.15 $15.00-$15.00 106 9.00 $15.00 10 $15.00 $22.94-$27.06 507 9.60 $23.59 -- $ -- $38.88-$45.00 170 9.50 $43.77 -- $ -- $46.63-$51.38 15 9.50 $48.75 -- $ --
In addition to the 1992, 1998 and 1999 Plans, the Company granted an option to purchase 6 shares at $2.24. These options were exercised in 1997. In connection with the grant of options for the purchase of 356 shares of common stock to employees during the period from December 1997 through June 1998, the Company recorded aggregate deferred compensation of $1,820 representing the difference between the deemed fair value of the common stock and the option exercise price at date of grant. This deferred compensation will be amortized over the vesting period relating to these options. Accordingly, the Company amortized $393 and $455 for the years ended December 31, 1998 and 1999, respectively. The Company uses the Black-Scholes method to value options granted to consultants. The total estimated fair value of these grants during the periods presented was not significant and was expensed over the applicable vesting periods. At December 31, 1997, 1998 and 1999, vested options to purchase 288, 385 and 379 shares of common stock, respectively were unexercised. The weighted average exercise price of these options was $0.36, $0.65 and $1.96 per share for 1997, 1998 and 1999, respectively. Employee Stock Purchase Plan The Company's 1998 Employee Stock Purchase Plan (the "1998 Purchase Plan") was adopted by the Board of Directors in July 1998 and was approved by the stockholders in September 1998. Under the 1998 Purchase Plan, an eligible employee may purchase shares of common stock from the Company through payroll deductions of up to 15% of his or her compensation, at a price per share equal to 85% of the lesser of the fair market value of the Company's common stock as of the first or last trading day on or after May 1 and November 1 and end on the last trading day of the period six (6) months later. At December 31, 1998, the Company has reserved 250 shares of common stock for issuance under the 1998 Purchase Plan. The 1998 Purchase Plan is subject to annual increases, subject to certain limitations. 47 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) Pro forma stock-based compensation The following information concerning the Company's stock option plan is provided in accordance with SFAS 123. The Company accounts for the Plan in accordance with APB No. 25 and related Interpretations. Had compensation expense for the stock option plans and the employee stock purchase plan been determined based on the fair value at the grant date for awards granted in 1997, 1998 and 1999, consistent with the provisions of SFAS 123, the pro forma net loss would have been reported as follows:
1997 1998 1999 -------- -------- -------- Net loss attributable to common stockholders--as reported....................................... $(10,784) $(16,331) $(11,969) Net loss attributable to common stockholders-- pro forma...................................... (10,798) (16,496) (13,602) Net loss per share attributable to common stockholders--as reported...................... (59.36) (60.62) (1.12) Net loss per share attributable to common stockholders--pro forma........................ (59.44) (61.24) (1.27)
Prior to the Company's initial public offering, the fair value for each option grant was determined using the minimum value method. Subsequent to the offering, the fair value was determined using the Black-Scholes method. Weighted average assumptions used in determining the fair value for grants in 1997, 1998 and 1999 include risk-free interest rates of 6.7%, 5.4% and 5.6%, respectively, and an expected life of 4 years each. Volatility and dividend yields are not factors in the Company's minimum value calculation. Using the Black-Scholes method, volatility was 90% and no dividend yield was assumed as the Company has not paid dividends and has no intention to do so. The weighted average fair value of options granted in 1997, 1998 and 1999 was $0.12, $2.13 and $17.74 per share, respectively. The Company has also estimated the fair value for the purchase rights issued in 1999 under the 1998 Purchase Plan, using the Black-Scholes method with the following weighted average assumptions: risk free interest rate of 4.7%, an expected life of 0.5 years, volatility of 90% and no dividend yield. NOTE 12--401(k) PLAN: In April 1995, the Company adopted the Tut Systems' Inc. 401(k) Plan (the "401(k) Plan") covering all eligible employees. Contributions are limited to 15% of each employee's annual compensation. Contributions to the 401(k) Plan by the Company are discretionary. The Company did not make any contributions for the years ended December 31, 1997, 1998 and 1999. NOTE 13--SEGMENT INFORMATION: The Company currently targets its sales efforts to both public and private network providers and users across four related market segments. The Company currently operates in a single business segment as there is only one measurement of profitability for its operations. Revenues are attributed to the following countries based on the location of customers:
1997 1998 1999 ------- ------- ------- United States........................................... $ 5,236 $ 8,601 $18,825 Canada.................................................. -- -- 2,779 All other countries..................................... 985 1,954 6,203 ------- ------- ------- $ 6,221 $10,555 $27,807 ======= ======= =======
48 TUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (in thousands, except per share amounts) The Company was able to determine revenue by country in 1999. In prior years, the Company was only able to determine revenue breakdown between the United States and all other countries. It is impracticable for the Company to compute product revenues by product type for the years ended December 31, 1997, 1998 and 1999. Two customers accounted for 14% and 12%, respectively, of the Company's revenue for the year ended December 31, 1997. One customer accounted for 10% of the Company's revenue for the year ended December 31, 1998. Two customers accounted for 12% and 10%, respectively, of the Company's revenue for the year ended December 31, 1999. NOTE 14--SUBSEQUENT EVENTS: (a) In November 1999, the Company entered into a definitive merger agreement with FreeGate Corporation, in which the stockholders of FreeGate Corporation receive common stock of the Company in exchange for all outstanding shares of preferred stock, common stock, shares issuable under common stock options, and shares issuable under warrants for common stock and preferred stock. The acquisition was consummated on February 14, 2000 and will be accounted for as a purchase business combination. The total purchase price of $24.7 million consisted of 511 shares of common stock, approximately 20 options to acquire common stock and acquisition related expenses, consisting primarily of investment advisory, legal and other professional fees. (b) One World. In February 2000, the Company signed a definitive agreement to acquire certain assets of OneWorld for approximately $2.3 million in cash. This transaction will be treated as a purchase for accounting purposes. 49 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 50 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT MANAGEMENT Directors and Executive Officers Our directors and executive officers as of February 22, 2000 are as follows:
Name Age Position - ---- --- -------- Salvatore D'Auria....... 44 President, Chief Executive Officer and Chairman of the Board Sanford Benett.......... 51 Chief Operating Officer Matthew Taylor.......... 40 Chief Technical Officer and Director Nelson Caldwell......... 43 Vice President of Finance, Chief Financial Officer and Secretary Allen Purdy............. 50 Vice President of Sales Thomas Warner........... 43 Vice President of Engineering Craig Bender............ 57 Vice President of Market Development Avi Caspi............... 48 Vice President of Operations Clifford H. Higgerson... 60 Director Saul Rosenzweig(1)...... 74 Director David Spreng(1)......... 38 Director George M. Middlemas..... 53 Director Brion Applegate(2)...... 46 Director Roger Moore(2).......... 58 Director Neal Douglas(2)......... 41 Director
- -------- (1) Member of the audit committee. (2)Member of the compensation committee. Salvatore D'Auria has served as President, Chief Executive Officer and a director since August 1994. Since January 2000, Mr. D'Auria has served as Chairman of the Board of Directors. He served as our Chief Operating Officer from May 1994 to August 1994. From August 1993 to May 1994, Mr. D'Auria performed various consulting services for networking software companies. Mr. D'Auria joined Central Point Software in October 1989 as Director of Product Marketing and was appointed as Vice President of Marketing in April 1990, and held various Vice President positions until August 1993. From 1980 to 1989, Mr. D'Auria served in various marketing and management positions at Hewlett- Packard. Mr. D'Auria holds a B.S. in Physics from Clarkson University. Sanford Benett has served as our Chief Operating Officer since February 2000. Mr. Benett served as President and Chief Operating Officer of FreeGate Corporation from June 1999 until February 2000. He also served as Vice President of Engineering of FreeGate from December 1998 until June 1999. From December 1997 to December 1998, Mr. Benett worked as an independent consultant. Mr. Benett also served as Vice President and General Manager of the Newton Business Division of Apple Computer from June 1995 until December 1997. He also served as Director of Software Engineering in the Newton Business Division from January 1994 until June 1995. Prior to that time he held various positions at GO Corporation, Datacopy/Xerox, TransImage Corporation, Tandem Computers and the Mitre Corporation. Mr. Benett holds a B.S. in Mathematics and an M.S. in Computer Science from the University of Maryland. Matthew Taylor is a co-founder of Tut Systems and has served as our Chief Technical Officer since August 1994 and as one of our directors since July 1993. From August 1994 to January 2000, Mr. Taylor was Chairman of the Board of Directors and Secretary. From April 1989 to August 1994, Mr. Taylor was President and Chief Executive Officer of Tut Systems. Prior to that time, Mr. Taylor was the Vice President of Engineering and a co-founder of Alameda Instruments, Inc., a semiconductor equipment company, from 1987 to 1989. Mr. Taylor holds a B.S. in Biology and an M.S. in Engineering Science from the University of California at Berkeley. 51 Nelson Caldwell has served as our Vice President of Finance and Chief Financial Officer since June 1997. Since January 2000, Mr. Caldwell has served as Secretary. From May 1995 to May 1997, Mr. Caldwell served as Chief Financial Officer and Secretary of Telechips Corporation, a computer telephony device company. Mr. Caldwell also served as the interim President and Chief Executive Officer and a director of Telechips from February 1997 to May 1997. Telechips filed for bankruptcy under Chapter 7 of the Federal Bankruptcy Code on June 30, 1997. Prior to that time, Mr. Caldwell held various positions at Coopers & Lybrand L.L.P. from June 1989 through April 1995, most recently as Manager in the Business Assurance practice. Mr. Caldwell holds a B.S. in Business Administration from California State University, Chico, and is a Certified Public Accountant. Allen Purdy has served as our Vice President of Sales since January 1997. From November 1992 to January 1997, Mr. Purdy was Regional Sales Manager and, most recently, Director of Sales of Applied Digital Access, Inc., a provider of network management and testing equipment for the telecommunications industry, and was a Regional Sales Manager with TeleSciences, Inc. from June 1989 to November 1992. Mr. Purdy holds a B.S. in Industrial Engineering from Rutgers University and an M.B.A. from Rider College. Thomas Warner has served as our Vice President of Engineering since February 1997. Prior to that time, Mr. Warner served in various positions at Ericsson Fiber Access, a division of Ericsson Inc. from March 1990 through February 1997, most recently as Vice President of Systems Management. Mr. Warner holds a B.S.E.E. from the University of Illinois at Champaign-Urbana. Craig Bender has served as our Vice President of Market Development since June 1997. Prior to that time, Mr. Bender was with Integrated Network Corporation where he served as Vice President of Marketing from 1988 to 1992, as Vice President of International Business Development from 1992 to 1996 and as Vice President of INC's DAGAZ division until 1997. Mr. Bender holds a B.S.E.E. from Syracuse University, an M.S.E.E. from the University of California at Los Angeles and an AT&T-sponsored Executive M.B.A. from Pace University. Avi Caspi has served as our Vice President of Operations since November 1999. From June 1999 until November 1999, Mr. Caspi worked as an independent consultant, and from February 1998 to June 1999, he was Vice President of Operations for Netro Corporation, a wireless equipment company. From November 1997 to February 1998, he worked as an independent consultant. Mr. Caspi was Vice President of Quality and Director of Manufacturing Operations for Packard Bell NEC from November 1991 to November 1997. Prior to that time, he held various positions with Alps Electrics, Allegretti & Company and Rain Bird Corporation. Mr. Caspi holds an M.B.A. from Pepperdine University, an M.S. in Industrial and Systems Engineering from the University of Southern California, a B.S. in Industrial Engineering from California State Polytechnic University and a B.S. in Practical Mechanical Engineering from ORT Tel-Aviv Technical Institute in Israel. Clifford H. Higgerson has served as one of our directors since July 1993. Since 1991, Mr. Higgerson has been a general partner of Vanguard Venture Partners, a venture capital firm specializing in high technology start-ups. Since 1987, Mr. Higgerson has also been a partner of Communications Ventures, Inc. Mr. Higgerson also is a director of Advanced Fibre Communications, Ciena Corporation, a manufacturer of multiplexing systems, and Digital Microwave Corporation. Mr. Higgerson earned his B.S. in Electrical Engineering from the University of Illinois and an M.B.A. in Finance from the University of California at Berkeley. Saul Rosenzweig has served as one of our directors since July 1993. Mr. Rosenzweig has been a general partner of Rosetree Partners, a venture investing group, since 1982. He has also served as President and Chief Executive Officer of Snap Software from 1994 to 1996, and as President of RZGroup, Inc., a communications management firm, since 1981. Mr. Rosenzweig holds B.S. degrees in Naval Science and in Industrial Management from Georgia Institute of Technology. David Spreng has served as one of our directors since February 1994. Mr. Spreng has served as the Managing General Partner of Crescendo Venture Management, LLC since September 1998. Mr. Spreng served as President of IAI Ventures, Inc. from March 1996 to September 1998 and served in various capacities at Investment Advisers, Inc. since 1989. Mr. Spreng is also a director of GalaGen, Inc., a pharmaceutical company, and PACE Health Management. Mr. Spreng holds a B.S. in Finance and Accounting from the University of Minnesota. 52 George M. Middlemas has served as one of our directors since April 1995. Mr. Middlemas has been Managing General Partner of Apex Partners, a venture capital firm, since 1991. Prior to that time, Mr. Middlemas served as Vice President and principal with Inco Venture Capital Management, and a vice president and member of the investment committee of Citicorp Venture Capital. Mr. Middlemas also serves on the Boards of Directors of Pure Cycle Corporation, a water and water recycling technology company, Online Resources & Communications Corporation, a provider of electronic commerce solutions, Data Critical Corporation, a provider of wireless communication and information systems which allow access to critical health information, and Qorus.com, Inc., a provider of value-added Internet protocol-based communications solutions. Mr. Middlemas holds an M.B.A from Harvard University, an M.A. in Political Science from the University of Pittsburgh and a B.A. in History and Political Science from The Pennsylvania State University. Brion Applegate has served as one of our directors since August 1996. Mr. Applegate was a co-founder of Spectrum Equity Investors and has served as a Managing General Partner since February 1993. Prior to that time, he was a General Partner of funds managed by Burr, Egan, Deleage & Co., a venture capital firm, from 1982 to 1993. Since August 1998, Mr. Applegate has been a director of Network Access Solutions, a provider of digital subscriber line- enabled networking solutions for businesses. Mr. Applegate holds a B.A. in Liberal Arts from Colgate University and an M.B.A. from Harvard University. Roger Moore has served as one of our directors since March 1997. Mr. Moore has served as President and Chief Executive Officer of Illuminet, Inc., a provider of network, database and billing services to the communications industry, since October 1998, and as a director of Illuminet since July 1998. Mr. Moore also served as President and Chief Executive Officer of Illuminet from January 1996 to August 1998. From September 1998 to October 1998, Mr. Moore served as President, Chief Executive Officer and a director of VINA Technologies, Inc., a telecommunications equipment company. From November 1985 to December 1995, Mr. Moore served in various executive capacities at Northern Telecom Ltd., including Vice President, Major Accounts and President, Northern Telecom Japan. Mr. Moore holds a B.S. in General Science from Virginia Polytechnic Institute and State University. Neal Douglas has served as one of our directors since December 1997. Since December 1999, he has been a Managing General Partner of Spectrum Equity Investors, and since January 1993, he has been a General Partner of AT&T Ventures, a venture capital firm. From May 1989 to January 1993, Mr. Douglas was a partner of New Enterprise Associates, a venture capital firm. Additionally, he was a Member of the Technical Staff at Bell Laboratories. He also serves as a director of Cellnet Data Systems, Inc., a provider of fixed network wireless information services, FVC.COM, Inc., an Internet video applications company, Netro Corporation, a provider of wireless networking equipment, Software.com, a provider of Internet messaging services, and several privately held companies. Mr. Douglas holds a B.S. in Electrical Engineering from Cornell University, an M.S. in Electrical Engineering from Stanford University, and an M.B.A from the University of California at Los Angeles. Our executive officers are appointed by the board of directors and serve until their successors are elected or appointed. There are no family relationships among any of our directors or executive officers. 53 ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table. The following table sets forth the compensation earned by our Chief Executive Officer and our four other most highly compensated executive officers for services to us in all capacities during each of the years ended December 31, 1999, 1998, and 1997: Summary Compensation Table
Long Term Compensation Awards ------------ Annual Compensation Securities ---------------------------- Underlying All other Year Salary Bonus Other(/1/) Options Compensation ---- -------- -------- ---------- ------------ ------------ Salvatore D'Auria....... 1999 $224,230 $286,721 -- $125,000 -- 1998 187,500 110,000 -- 75,000 $18,230(/2/) 1997 138,803 12,500 -- -- 31,250(/2/) Matthew Taylor.......... 1999 151,891 37,625 -- 5,000 -- 1998 149,808 35,100 -- 12,500 -- 1997 145,986 16,875 -- -- -- Allen Purdy............. 1999 142,308 96,668 -- 15,000 -- 1998 138,962 71,875 -- 12,500 -- 1997 113,096 70,837 -- 56,250 -- Nelson Caldwell......... 1999 142,846 46,188 -- 30,000 -- 1998 118,442 31,625 -- 12,500 -- 1997 52,489 14,771 -- 37,500 -- Thomas Warner........... 1999 140,000 35,438 -- 2,000 -- 1998 140,000 25,875 -- 13,750 -- 1997 111,211 22,563 -- 70,000 -- Nicholas Berberi........ 1999 141,037 19,750 -- -- -- 1998 129,600 16,900 -- 5,000 -- 1997 115,943 16,715 -- 6,250 --
- -------- (1) Other annual compensation in the form of perquisite and other personal benefits, securities or property has been omitted in those cases where the aggregate amount of such compensation is the lesser of either $50,000 or 10% of the total of annual salary and bonus for the executive officer. (2) Represents the principal portion of certain indebtedness between the Company and Mr. D'Auria which was forgiven during each of 1998 and 1997 pursuant to a loan agreement and secured promissory note for an aggregate of $125,000. The loan did not bear interest. Pursuant to the loan agreement, we forgave 25% of the principal amount of the loan each year.The loan has been discharged in full. 54 Stock Option Information. The following table sets forth certain information for the year ended December 31, 1999 with respect to each grant of stock options to our Chief Executive Officer and our four other most highly compensated executive officers: Option Grants During Year Ended December 31, 1999
Potential Realizable Percent of Value at Assumed Number of Total Annual Rates of Stock Securities Options Price Appreciation Underlying Granted to Exercise for Option Term(4) Options Employees Price per Expiration --------------------- Granted(1) in 1999(2) Share(3) Date 5% 10% ---------- ---------- --------- ---------- ---------- ---------- Salvatore D'Auria....... 125,000 14.7% $22.94 8/10/09 $1,803,355 $4,570,057 Matthew Taylor.......... 5,000 0.6% 15.00 1/26/09 47,167 119,531 Allen Purdy............. 5,000 0.6% 15.00 1/26/09 47,167 119,531 10,000 1.2% 22.94 8/10/09 144,268 365,605 Nelson Caldwell......... 5,000 0.6% 15.00 1/26/09 47,167 119,531 25,000 2.9% 22.94 8/10/09 360,671 914,011 Thomas Warner........... 2,000 0.2% 15.00 1/26/09 18,867 47,812
- -------- (1) The options granted to Messrs. D'Auria, Taylor, Warner, Purdy and Caldwell vest as to one-fourth of the shares after one year and thereafter as to 1/48th of the shares for each month which expires from the date of grant. (2) In 1999 the Company granted employees, consultants and directors options to purchase an aggregate of 848,900 shares of our common stock. (3) The exercise price per share of each option was equal to the fair value of our common stock based on the closing price per share of our common stock as quoted on the Nasdaq National Market on the trading day prior to the date of grant. (4) In accordance with the rules of the Securities and Exchange Commission, shown are the gains or "options spreads" that would exist for the respective options granted. These gains are based on the assumed rates of annual compound stock price appreciation of 5% and 10% from the date the option was granted over the full option term. These assumed annual compound rates of stock price appreciation are mandated by the rules of the SEC and do not represent our estimate or projection of future prices of our common stock. Aggregate Option Exercises and Option Values. The following table sets forth information with respect to our Chief Executive Officer and our four other most highly compensated executive officers concerning option exercises for the fiscal year ended December 31, 1999 and exercisable and unexercisable options held as of December 31, 1999: Aggregate Option Exercises in 1999 and Year-End Option Values
Number of Securities Underlying Value of Unexercised Number of Unexercised Options at In-the-Money Options at Shares December 31, 1999 December 31, 1999 Acquired Value ------------------------- ------------------------- on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable ----------- -------- ----------- ------------- ----------- ------------- Salvatore D'Auria....... 33,750 $776,189 $178,576 $165,625 $9,576,138 $8,881,641 Matthew Taylor.......... -- -- 5,729 11,771 307,218 631,220 Allen Purdy............. 31,300 998,648 15,444 37,006 828,185 1,984,447 Nelson Caldwell......... 6,477 119,586 10,969 51,356 588,213 2,753,966 Thomas Warner........... 22,968 597,624 6,693 29,865 358,912 1,601,511
- -------- (1) The fair market value of our common stock based on the closing price of our common stock as quoted on the Nasdaq National Market on December 31, 1999 was $53.63 per share. 55 Employee Contracts and Change in Control We currently have employment and non-competition agreements with Sandy Benett, our Chief Operating Officer, which became effective February 14, 2000. Pursuant to this employment agreement, and actions of the Compensation Committee of the Board of Directors, Mr. Benett is employed by us as our Chief Operating Officer, upon the closing of our acquisition of FreeGate Corporation on February 14, 2000, at an annual salary of $175,000 per year and in addition, is entitled to bonus compensation in the amount of up to $87,500 per year and other bonus or incentive compensation payments as our Board of Directors may determine from time to time, as well as employee benefits we generally provide to our employees. Mr. Benett was also granted options to purchase 200,000 shares of our common stock. Pursuant to the non-competition agreement, Mr. Benett shall not compete with us or solicit away any of our employees from the effective date of the agreement until 18 months following the closing of the FreeGate acquisition on February 14, 2000. We currently have no "change-of-control" agreements with any of our officers. Director Compensation Our directors currently receive no cash fees for services provided in that capacity but are reimbursed for out-of-pocket expenses they incur in connection with their attendance at meetings of our Board of Directors. In addition, in the past, we have granted certain of our directors stock options for their service on our Board. We do not intend to pay cash fees for the services of our Board members in the immediate future, nor to provide for the automatic grant of stock options to our directors. However, our directors are eligible to receive discretionary option grants pursuant to our 1998 Stock Plan and our employee directors are also eligible to participate in our 1998 Employee Stock Purchase Plan. Compensation Committee Interlocks and Insider Participation The members of our Compensation Committee of our Board of Directors are Messrs. Applegate, Douglas and Moore. None of the members of our Compensation Committee is currently or has been, at any time since our formation as a company, one of our officers or employees. During 1999, none of our executive officers (i) served as a member of the compensation committee (or other board committee performing similar functions or, in the absence of any such committee, the board of directors) of another entity, one of whose executive officers served on our Compensation Committee, (ii) served as a director of another entity, one of whose executive officers served on our Compensation Committee, or (iii) served as a member of the compensation committee (or other board committee performing similar functions or, in the absence of any such committee, the board of directors) of another entity, one of whose executive officers served as one of our directors. 56 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as of December 31, 1999 certain information with respect to the beneficial ownership of our common stock as to: . each person known by us to own beneficially more than 5% of the outstanding shares of our common stock; . our President and each of our four other most highly compensated executive officers; . each of our directors; and . all of our directors and executive officers as a group. Except as otherwise indicated, and subject to applicable community property laws, the persons named below have sole voting and investment power with respect to all shares of common stock held by them. Applicable percentage ownership in the table is based on 11,940,610 shares of common stock outstanding as of December 31, 1999. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Shares of common stock subject to options that are presently exercisable or exercisable within 60 days of December 31, 1999 are deemed outstanding for the purpose of computing the percentage ownership of the person or entity holding options or warrants, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person or entity. If any shares are issued upon exercise of options, warrants or other rights to acquire our capital stock that are presently outstanding or granted in the future or reserved for future issuance under our stock plans, there will be further dilution to new public investors. Unless otherwise indicated below, each person or entity named below has an address in care of our principal executive offices.
Shares Beneficially Owned Prior to the Offering --------------------- Beneficial Owner Number Percent - ---------------- ------ ------- 5% Beneficial Owners Microsoft Corporation (1)............................ 1,083,503 9.1% Vanguard IV, L.P. (2)................................ 658,591 5.5% Officers and Directors Clifford H. Higgerson (3)............................ 658,591 5.5% George Middlemas (4)................................. 313,826 2.6% Neal Douglas (5)..................................... 312,500 2.6% Salvatore D'Auria (6)................................ 207,583 1.7% Matthew Taylor (7)................................... 188,612 1.6% Saul Rosenzweig (8).................................. 79,913 * Thomas Warner (9).................................... 47,416 * Nelson Caldwell (10)................................. 25,683 * Allen Purdy (11)..................................... 20,686 * Roger Moore (12)..................................... 8,083 * Brion Applegate...................................... 955 * David Spreng......................................... -- -- All officers and directors as a group (15 persons) (13)................................................ 1,893,941 15.5%
- -------- * Less than 1%. (1) The address of record for Microsoft Corporation is One Microsoft Way, Building 8, Redmond, WA 98502-6399. (2) The address of record for Vanguard IV, L.P. is 555 University Avenue, Palo Alto, CA 94301. 57 (3) Consists of 658,591 shares held by Vanguard IV, L.P. Mr. Higgerson is a general partner of Vanguard IV, L.P. Mr. Higgerson disclaims beneficial ownership of these shares except to the extent of his proportional partnership interest therein. (4) Includes of 301,731 shares held by Apex Investment Funds. Mr. Middlemas is the Managing General Partner of Apex Investment Funds. Mr. Middlemas disclaims beneficial ownership of these shares except to the extent of his proportional partnership interest therein. (5) Consists of 312,500 shares held by AT&T Ventures. Mr. Douglas is a general partner of AT&T Ventures. Mr. Douglas disclaims beneficial ownership of these shares except to the extent of his proportional partnership interest therein. (6) Includes 181,701 shares issuable pursuant to options or rights exercisable within 60 days of December 31, 1999. (7) Includes 7,604 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. (8) Consists of 79,913 shares held by Rosetree Partners General Partnership. Mr. Rosenzweig is a general partner of Rosetree Partners General Partnership. Mr. Rosenzweig disclaims beneficial ownership of these shares except to the extent of his proportional partnership interest therein. (9) Includes 10,724 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. (10) Includes 14,408 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. (11) Includes 19,662 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. (12) Includes 7,083 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. (13) Includes an aggregate of 250,485 shares issuable pursuant to options exercisable within 60 days of December 31, 1999. Also includes an aggregate of 301,731 shares held by Apex Investment Funds, of which George Middlemas, our director, is Managing General Partner, 658,591 shares held by Vanguard IV, L.P. and 312,500 shares held by AT&T Ventures, of which Neal Douglas, our director, is a general partner. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS As part of our acquisition of FreeGate Corporation, completed on February 14, 2000, we assumed a note receivable from Sanford Benett, our Chief Operating Officer, in the amount of $143,453, bearing interest at 7% per annum and due upon the earlier of the sale of our common stock received by Mr. Benett as part of the acquisition or December 2003. During 1999, we granted options to certain of our executive officers. We intend to grant options to our executive officers and directors in the future. We have entered into indemnification agreements with our executive officers, directors and certain significant employees containing provisions that are in some respects broader than the specific indemnification provisions contained in the General Corporation Law of Delaware. These agreements provide, among other things, for indemnification of the executive officers, directors and certain significant employees in proceedings brought by third parties and in stockholder derivative suits. Each agreement also provides for advancement of expenses to the indemnified party. 58 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The following documents are filed as part of this Annual Report on Form 10-K:
Page ---- Report of Independent Accountants........................................ 32 Consolidated Balance Sheets as of December 31, 1998 and 1999............. 33 Consolidated Statements of Operations for the years ended December 31, 1997, 1998, and 1999.................................................... 34 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1998, and 1999....................................... 35 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1998 and 1999..................................................... 36 Notes to Consolidated Financial Statements............................... 37
2. Financial Statements Schedules The following financial statement schedule is filed as part of this Annual Report on Form 10-K: Schedule II--Valuation and Qualifying Accounts and Reserves All other schedules have been omitted as they are not required, not applicable, or the required information is otherwise included. 3. Exhibits The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Annual Report on Form 10-K. (b) Reports on Form 8-K We did not file any Reports of Form 8-K during the fourth quarter ended December 31, 1999. (c) Exhibits See item 14(a)(3) above. (d) Financial Statement Schedules See Item 14(a)(2) above. 59 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Pleasant Hill, State of California, on the 22nd day of February, 2000. TUT SYSTEMS, INC. /s/ Nelson Caldwell By: _________________________________ Nelson Caldwell Vice President, Finance, Chief Financial Officer and Secratary POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Salvatore D'Auria and Nelson Caldwell, and each of them, jointly and severally, his true and lawful attorneys-in-fact, each with full power of substitution and resubstitution, for him in any and all capacities, to sign any or all amendments to this Annual Report on Form 10-K, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do if personally present, hereby ratifying and confirming all that each said attorney-in-fact and agent, or his or her substitute or substitutes or any of them, may lawfully do or cause to be done by virtue hereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS ANNUAL REPORT ON FORM 10-K HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
Signature Title Date --------- ----- ---- /s/ Salvatore D'Auria Chairman of the Board, February 22, 2000 ____________________________________ President, and Chief Salvatore D'Auria Executive Officer (Principal Executive Officer) /s/ Nelson Caldwell Vice President, Finance, February 22, 2000 ____________________________________ Chief Financial Officer and Nelson Caldwell Secretary (Principal Financial and Accounting Officer) /s/ Matthew Taylor Chief Technical Officer and February 22, 2000 ____________________________________ Director Matthew Taylor /s/ Saul Rosenzweig Director February 22, 2000 ____________________________________ Saul Rosenzweig
60
Signature Title Date --------- ----- ---- /s/ George Middlemas Director February 22, 2000 ____________________________________ George Middlemas /s/ Roger Moore Director February 22, 2000 ____________________________________ Roger Moore
61 TUT SYSTEMS, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Addition Balance at (reductions) Balance at Beginning to Costs and End of of Period Expenses Write-offs Period ---------- ------------ ---------- ---------- Allowance for doubtful accounts Year ended December 31, 1997.. $ 20 $ 14 $ (5) $ 29 Year ended December 31, 1998.. 29 104 (18) 115 Year ended December 31, 1999.. 115 235 (15) 335 Valuation allowance for deferred tax assets: Year ended December 31, 1997.. 5,642 3,339 -- 8,981 Year ended December 31, 1998.. 8,981 5,290 -- 14,271 Year ended December 31, 1999.. 14,271 5,625 -- 19,896 Allowance for excess and obsolete inventory Year ended December 31, 1997.. -- 72 (65) 7 Year ended December 31, 1998.. 7 203 (95) 115 Year ended December 31, 1999.. 115 340 (37) 418
62 INDEX TO EXHIBITS
Exhibit Number Description ------- ----------- 1.1 Form of Underwriting Agreement. (1) 2.1 Agreement and Plan of Reorganization dated as of October 15, 1999, by and among Tut Systems, Inc., Vintel Acquisition Corp., and Vintel Communications, Inc. (4) 2.2 Agreement and Plan of Reorganization dated as of June 8, 1999, by and among Tut Systems, Inc., Public Port Acquisition Corporation, and Public Port, Inc. (3) 2.3 Agreement and Plan of Reorganization dated as of November 16, 1999, by and among Tut Systems, Inc., Fortress Acquisition Corporation and FreeGate Corporation. (5) 2.4 Asset Purchase Agreement by and between Tut Systems, Inc. and OneWorld Systems, Inc. dated as of February 3, 2000. 2.5 Amendment No. 1 to Asset Purchase Agreement by and between Tut Systems, Inc. and OneWorld Systems, Inc. dated as of February 17, 2000. 3.1 Restated Certificate of Incorporation of Registrant, as currently in effect. (1) 3.2 Second Amended and Restated Certificate of Incorporation of Registrant. (1) 3.3 Bylaws of Registrant, as currently in effect. (1) 4.1 Specimen Common Stock Certificate. (1) 10.1 1992 Stock Plan, as amended, and form of Stock Option Agreement thereunder. (1) 10.2 1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase Agreement thereunder. (1) 10.3 1998 Employee Stock Purchase Plan, as amended. (2) 10.4 1998 Stock Plan Inland Revenue Approved Rules for UK Employees. 10.5 American Capital Marketing, Inc. 401(k) Plan. (1) 10.6 Fourth Amended and Restated Shareholders' Rights Agreement, dated December 16, 1997, between Registrant and certain stockholders. (1) 10.7 Lease by and between Pleasant Hill Industrial Park Associates, a California Limited Partnership, and Registrant dated April 4, 1995, as amended. (1) 10.8 Office Building Lease between Petula Associates, Ltd., an Iowa corporation, and Principal Mutual Life Insurance Co., an Iowa corporation, doing business as RC Creekside Phase VI and Registrant dated April 25, 1997. (1) 10.9 Licensing and Cooperative Marketing Agreement between Microsoft Corporation and Registrant dated August 27, 1997, as modified and restated on July 30, 1998. (1) 10.10 Form of Indemnification Agreement entered into between Registrant and each director and officer. (1) 10.11 Employment Agreement by and between Tut Systems, Inc., FreeGate Corporation and Sandy Benett dated as of November 17, 1999. 10.12 Non-competition Agreement by and between Tut Systems, Inc. FreeGate Corporation and Sandy Benett dated as of November 17, 1999. 10.13 Agreement and General Release between Registrant and And Yet, Inc. dated July 31, 1998. (1) 10.14 Software License Agreement between RouterWare, Inc. and Registrant dated December 16, 1997. (1)
63 10.15 Home Phoneline Promoters Agreement by and between IBM Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Advanced Micro Devices, Inc., Intel Corporation, Epigram, Inc., AT&T Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998. (1) 10.16 Master Agreement between Registrant and Compaq Computer Corporation dated April 21, 1998 including supplements thereto. (1) 10.17 Loan Agreement, General Security Agreement, and Collateral Assignment and Patent Mortgage and Security Agreement with Imperial Bank, each dated August 16, 1997. (1) 10.18 Loan and Security Agreement, Streamlined Facility Agreement, Revolving Credit Note, Patent and Trademark Security Agreement, Security Agreement in Copyrighted Works and Stock Subscription Warrant between Registrant and TransAmerica Business Credit Corporation, each dated December 18, 1998. (1) 10.19 Extension Agreement among Registrant, And Yet, Inc. and Marty Graham dated December 21, 1998. (1) 10.20 Registration Rights Agreement dated as of June 8, 1999, by and between Registrant and Public Port stockholders listed therein. (3) 11.1 Calculation of earnings per share (contained in Note 2 of Notes to Financial Statements). (1) 21.1 List of Subsidiaries of Registrant. 23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants. 24.1 Power of Attorney (See page 60). 27 Financial Data Schedule.
- -------- (1) Incorporated by reference to our Registration Statement on Form S-1 (File No. 333-60419) as declared effective by the Securities and Exchange Commission on January 28, 1999. (2) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended March 31, 1999. (3) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. (4) Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended September 30, 1999. (5) Incorporated by reference to our Current Report on Form 8-K dated February 14, 2000. 64 EX-2.4 2 ASSET PURCHASE AGREEMENT Exhibit 2.4 ASSET PURCHASE AGREEMENT FOR THE ASSETS OF ONEWORLD SYSTEMS, INC. BY TUT SYSTEMS, INC. February 3, 2000 ASSET PURCHASE AGREEMENT Asset Purchase Agreement (the "Agreement") dated as of February 3, 2000, by and between TUT SYSTEMS, INC., a Delaware corporation ("Buyer"), and ONEWORLD SYSTEMS, INC., a Delaware corporation (the "Company"). This Agreement sets forth the terms and conditions upon which the Buyer will purchase from the Company, and the Company will sell to the Buyer, all of those assets (other than the Retained Assets, as hereinafter defined), subject to those liabilities of the Company which are specifically hereinafter described, for the consideration provided herein. In consideration of the foregoing, the mutual representations, warranties and covenants set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties to this Agreement hereby agree as follows: ARTICLE I DEFINITIONS 1.1 Definitions. For the purposes of this Agreement, all capitalized ----------- words or expressions used in this Agreement (including the Schedules and Exhibits annexed hereto) shall have the meanings specified in this Article (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Affiliate" means when used with respect to any Person, (a) if such --------- Person is a corporation, any officer or director thereof and any Person which is, directly or indirectly, the beneficial owner (by itself or as part of any group) of more than five percent (5%) of any class of any Equity Security thereof, and, if such beneficial owner is a partnership, any general or limited partner thereof, or if such beneficial owner is a corporation, any Person controlling, controlled by or under common control with such beneficial owner, or any officer or director of such beneficial owner or of any corporation occupying any such control relationship, (b) if such Person is a partnership, any general or limited partner thereof and (c) any other Person which, directly or indirectly, controls or is controlled by or is under common control with such Person. For purposes of this definition, (i) "control" (including the correlative terms "controlling", "controlled by" and "under common control with"), with respect to any Person, shall mean possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise; and (ii) all employees, stockholders, consultants and agents of Buyer and any direct or indirect stockholder of Buyer shall be considered an Affiliate of Buyer. "Agreement" means this Asset Purchase Agreement (together with all --------- Exhibits and Schedules hereto) as from time to time assigned, supplemented, modified, amended, or restated or as the terms hereof may be waived. 2 "Business Day" means any day, excluding Saturday, Sunday and any other day on which commercial banks in San Francisco, California are authorized or required by law to close. "Buyer" means TUT SYSTEMS, INC., a Delaware corporation, and its successors and assigns. "Charter" means the Certificate of Incorporation, Articles of Incorporation or Organization or other organizational document of a corporation, as amended and restated through the date hereof. "Claim" means an action, suit, proceeding, hearing, investigation, litigation, charge, complaint, claim or demand. "Code" means the Internal Revenue Code of 1986, and the regulations thereunder, published Internal Revenue Service rulings, and court decisions in respect thereof, all as the same shall be in effect at the time. "Commission" means the Securities and Exchange Commission and any other similar or successor agency of the federal government administering the Securities Act or the Exchange Act. "Company" means ONEWORLD SYSTEMS, INC., a Delaware corporation, and its successors and assigns. "Equity Security" shall have the meaning given to such term in Section 3(a)(ii) of the Exchange Act. "ERISA" means the Employee Retirement Income Security Act of 1974, and any similar or successor federal statute, and the rules, regulations and interpretations thereunder, all as the same shall be in effect at the time. "ERISA Affiliate" means, for purposes of Title IV of ERISA, any trade or business, whether or not incorporated, that together with the Company or any Subsidiary of the Company, would be deemed to be a "single employer" within the meaning of Section 4001 of ERISA, and, for purposes of the Code, any member of any group that, together with the Company or any Subsidiary of the Company, is treated as a "single employer" for purposes of Section 414 of the Code. "Exchange Act" means the Securities Exchange Act of 1934, and any similar or successor federal statute, and the rules and regulations and interpretations of the Commission thereunder, all as the same shall be in effect at the time. "GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as may be approved by a significant segment of the accounting profession, which are applicable to the circumstances as of the date of determination. 3 "Indebtedness" means all obligations, contingent or otherwise, whether current or long-term, which in accordance with GAAP would be classified upon the obligor's balance sheet as liabilities (other than deferred taxes) and shall also include capitalized leases, guaranties, endorsements (other than for collection in the ordinary course of business) or other arrangements whereby responsibility is assumed for the obligations of others, including any agreement to purchase or otherwise acquire the obligations of others or any agreement, contingent or otherwise, to furnish funds for the purchase of goods, supplies or services for the purpose of payment of the obligations of others. "IRS" means the Internal Revenue Service and any similar or successor agency of the federal government administering the Code. "Knowledge of the Company" or "Known to the Company" means the knowledge of each director, officer or any member of the Company's management, in each case after due inquiry. "Lien" means, with respect to any asset, any mortgage, deed of trust, pledge, hypothecation, assignment, security interest, lien, charge, restriction, adverse claim by a third party, title defect or encumbrance of any kind (including any conditional sale or other title retention agreement, any lease in the nature thereof, any assignment or other conveyance of any right to receive income and any assignment of receivables with recourse against assignor), any filing of any financing statement as debtor under the Uniform Commercial Code or comparable law of any jurisdiction and any agreement to give or make any of the foregoing. "Material Adverse Effect" shall be defined as an event, occurrence or act which shall result in a material adverse impact or effect on (a) the business, operations, assets, liabilities, prospects or condition (financial or otherwise) of a party, (b) the ability of such party to perform its respective obligations under any of the Purchase Documents, (c) the validity or enforceability of any of the Purchase Documents or (d) the rights and remedies of a party under any of the Purchase Documents. "Person" means any individual, firm, partnership, association, trust, corporation, limited liability company, governmental body or other entity. "Purchase Documents" means this Agreement, the Noncompetition Agreements and any other certificate, document, instrument, stock power, or agreement executed in connection therewith. "Securities Act" means the Securities Act of 1933, and any similar or successor federal statute, and the rules, regulations and interpretations of the Commission thereunder, all as the same shall be in effect at the time. "Tax" means any federal, state, local or foreign income, gross receipts, license, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental, customs duties, capital stock, franchise, profits, withholding, social security, unemployment, disability, real property, personal property, sales, use, transfer, registration, value added, alternative or add-on minimum, estimated, or other tax of any kind whatsoever, including any interest, penalty, or addition thereto, whether disputed or not. 4 "Tax Return" means any return, declaration, report, claim for refund, or information return or statement relating to Taxes, including any schedule or attachment thereto, and including any amendment thereof. "Transferred Employee" shall have the meaning defined in Section 3.13. ARTICLE II PURCHASE AND SALE OF ASSETS 2.1 Purchase of Assets. Upon the terms and subject to the conditions ------------------ contained in this Agreement, at the Closing (as defined in Section 2.7 below), the Company shall sell, assign, transfer and convey to Buyer, and Buyer shall purchase, acquire and accept from the Company, all of the Company's assets of every kind and description (other than those assets included in the Retained Assets as defined in Section 2.2 below) (the "Transferred Assets"), and subject only to the liabilities and obligations of the Company which are defined in Section 2.3 (the "Assumed Liabilities"). The Transferred Assets include, without limitation, the following assets and properties (other than those assets included in the Retained Assets as defined in Section 2.2): (a) all machinery, equipment, fixtures and furniture, a complete listing of which is included herein on Schedule 2.1; (b) all rights and interests of the Company, to the extent they are transferable, in and to any contracts, including contracts for the purchase of materials, supplies and services and the sale of products and services, equipment leases, and any other contract of the Company, including, without limitation, those listed on Schedule 3.10 attached hereto, however specifically excluding those identified on Schedule 3.10 not to be transferred; (c) originals of license agreements, trademark applications and software code and copies of all of the Company's other books, records and data relating to the Transferred Assets (the "Company Books and Records"); (d) all of the Company's goodwill, dealer and customer lists and all other sales and marketing information, and all know-how, technology, drawings, engineering specifications, bills of materials, software and other intangible assets of the Company; (e) all of the Company's interest in patents, patent applications, proprietary designs, copyrights, and all patents, proprietary designs, copyrights, trademarks, tradenames (including, without limitations, the name "ONEWORLD SYSTEMS" and all variations thereof), and together with the goodwill appurtenant thereto, all federal, state, local and foreign registrations thereof, if applicable, all common law rights thereto, and all claims or causes of action for infringement thereof; (f) all permits, licenses, orders, ratings and approvals of all federal, state, local or foreign governmental or regulatory authorities or industrial bodies that are held by the Company to the extent the same are transferable; 5 (g) all present and future insurance proceeds which may be payable under the Company's insurance policies to the extent that such proceeds relate to the future loss of asset value of the Purchased Assets; (h) except for Retained Assets described in Section 2.2 below, all other items of property, real or personal, tangible or intangible, including, without limitation, all restrictive and negative covenant agreements with employees and others, including, without limitation, nondisclosure agreements, computer programs, tapes, discs and timesharing files, owned, used by or accruing to the benefit of the Company; (i) the "oneworldsystems.com" domain name used in the operation of the Company's business; and (j) the capital stock of OneWorld Services, Inc. 2.2 Retained Assets. The Company will retain ownership of the assets of --------------- the Company listed on Schedule 2.2 attached hereto (collectively, the "Retained Assets"). 2.3 Assumed Liabilities. The Buyer shall assume and agree to pay, perform ------------------- and discharge only the Assumed Liabilities, and will pay, perform and discharge the Assumed Liabilities as they become due. The Assumed Liabilities shall consist of only those liabilities of the Company listed on Schedule 2.3 attached hereto or otherwise specifically provided for in this Agreement. 2.4 Retained Liabilities. The liabilities and obligations which shall be -------------------- retained by the Company (the "Retained Liabilities") shall consist of all liabilities of the Company other than Assumed Liabilities, including, without limitation, the following: (a) all liabilities of the Company relating to indebtedness for borrowed money; (b) all liabilities of the Company for federal, state, local or foreign Taxes, including Taxes incurred in respect of or measured by the income of the Company earned on or realized prior to the Closing Date, including any gain and income from the sale of the Assets and other transactions contemplated herein, excluding those incurred by Buyer in connection with this transaction; (c) all liabilities for all environmental, ecological, health or safety claims to the extent arising out of the operation of the Company on or before the Closing Date; (d) any liability of the Company based on its tortious or illegal conduct; (e) all warranty liabilities for products of the Company sold prior to the Closing; (f) any liability or obligation incurred by the Company in connection with the negotiation, execution or performance of this Agreement, including, without limitation, all legal, 6 accounting, brokers', finders' and other professional fees and expenses other than through Buyer's breach of this Agreement; (g) all liabilities incurred by the Company after the Closing Date other than through Buyer's breach of this Agreement (except to the extent such liability is specifically assumed by Buyer); and (h) all liabilities or obligations associated with the employees of the Company, including but not limited to any liability or obligation under or with respect to any collective bargaining agreement, accrued paid time off (PTO), 401K plan, employment agreement, any plan, unemployment or workers' compensation laws, sales commissions (other than on orders shipped and billed after the Closing Date) unless specifically provided for elsewhere in this Agreement. 2.5 Purchase Price. Upon the terms and subject to the conditions -------------- contained in this Agreement, in reliance upon the representations, warranties and agreements of the Company contained herein, and in consideration of the sale, assignment, transfer and delivery of the Transferred Assets, Buyer will assume the Assumed Liabilities and will pay an aggregate purchase price of $2.33 million (the "Purchase Price"), payable in the following manner: (a) At the Closing, Buyer shall pay the Company up to $580,000 (which shall be indicated in a written notice to Buyer at least two days prior to the Closing) in cash by wire transfer of immediately available funds to an account designated by the Company; and (b) shares of Buyer's common stock comprising the balance of such $2.33 million amount, with such shares having an assigned value of $44.4125 per share. 2.6 Allocation of Purchase Price. The Purchase Price shall be allocated ---------------------------- among the Transferred Assets received from the Company in a manner that is mutually agreed upon by the parties prior to the Closing. The Company and Buyer shall be bound by such allocation for all purposes and to account for and report the purchase and sale contemplated hereby for all financial, accounting and Tax purposes in accordance with such allocation. 2.7 Time and Place of Closing. The closing of the transactions described ------------------------- above (the "Closing") shall take place at the offices of Wilson Sonsini Goodrich & Rosati, 650 Page Mill Road, Palo Alto, California, at 10:00 a.m. (local time) on the third business day following the satisfaction of the conditions to closing as provided in this Agreement, but in no event later than May 30, 2000, or at such other place or time as the parties hereto may agree. The date and time at which the Closing actually occurs is hereinafter referred to as the "Closing Date." 2.8 Execution and Delivery of Documents of Title by the Company; Further -------------------------------------------------------------------- Assurances. At the Closing, the Company shall execute and deliver to Buyer the - ---------- Bill of Sale attached hereto as Exhibit A and such deeds, conveyances, bills of sale, certificates of title, assignments, assurances and other instruments and documents as Buyer may reasonably request to effect the sale, conveyance, and transfer of the Purchased Assets from the Company to the Buyer. Such instruments and documents shall be sufficient to convey to Buyer good and merchantable title in all of the Transferred Assets. The Company will, from time to time after the Closing Date, take such additional actions and execute and deliver such further documents as 7 Buyer may reasonably request in order more effectively to sell, transfer and convey the Transferred Assets to Buyer and to place Buyer in position to operate and control all of the Transferred Assets, provided however that it shall be Buyer's responsibility to secure the assignment of all Transferred Assets for which a consent of transfer is required. 2.9 Execution and Delivery of Documents by Buyer; Further Assurances. At ---------------------------------------------------------------- the Closing, Buyer shall execute and deliver to the Company an Instrument of Assumption in the form attached hereto as Exhibit B and such other documents as the Company may reasonably request in order to evidence Buyer's assumption of the Assumed Liabilities. Buyer will, from time to time after the Closing Date, take such additional action and deliver such further documents as the Company may reasonably request to assume the Assumed Liabilities. ARTICLE III REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to Buyer as follows: 3.1 Organization and Qualification. The Company is a corporation duly ------------------------------ organized, validly existing and in good standing under the laws of the State of Delaware. The Company has full power and authority to own, use and lease its properties and to conduct its business as such properties are owned, used or leased and as such business is currently conducted. The copies of the Company's Charter and ByLaws, as amended to date, which have been delivered to Buyer's counsel prior to the Closing, are true, complete and correct. Except as set forth on Schedule 3.1 attached hereto, the Company is qualified to do business as a foreign corporation and is in good standing in each jurisdiction in which it owns or leases property or maintains inventories or where the conduct of its business would require such qualification, except where such qualification to do business or be in good standing would not have a Material Adverse Effect on the Company. 3.2 Authority; No Violation. The Company has all requisite corporate ----------------------- power and authority to enter into this Agreement and to carry out the transactions contemplated hereby. The execution, delivery and performance of this Agreement by the Company have been duly and validly authorized and approved by all necessary corporate action. This Agreement constitutes the legal and binding obligation of the Company, enforceable against it in accordance with its terms. Except as set forth on Schedule 3.2, the entering into of this Agreement by the Company does not, and the consummation by the Company of the transactions contemplated hereby, including specifically the transfer of the Transferred Assets to Buyer by the Company, will not violate the provisions of (a) any applicable federal, state, local or foreign laws, (b) the Company's respective Charter or ByLaws, or (c) any provision of, or result in a default or acceleration of any obligation under, or result in any change in the rights or obligations of the Company under any Lien, contract, agreement, license, lease, instrument, indenture, order, 8 arbitration award, judgment, or decree to which the Company is a party or by which any of them is bound, or to which any property of the Company is subject. 3.3 SEC Reports and Financial Statements. Since March 31, 1999, the ------------------------------------ Company has filed all forms, reports and documents with the Commission required to be filed by it pursuant to the Securities Act and the Exchange Act (the "SEC Reports"), and all of such filings complied in all material respects with all applicable requirements of the Securities Act and the Exchange Act. None of the Company's SEC Reports contained any untrue statements of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances in which they were made, not misleading, except to the extent corrected by a document subsequently filed with the SEC. Attached hereto as Schedule 3.3 are the following financial statements (collectively the "Financial Statements"): (i) audited consolidated and unaudited consolidating balance sheets and statements of operations, changes in owners' equity and consolidated statements of cash flow as of and for the fiscal year ended March 31, 1999; and (ii) unaudited consolidated and consolidating balance sheets and statements of income, changes in stockholders' equity, and cash flow (the "Most Recent Financial Statements") as of and for the nine (9) months ended December 31, 1999, for the Company. The Financial Statements are (i) true, correct and complete, (ii) are prepared in accordance with GAAP, and (iii) fairly present the financial condition and results of operations of the Company as of the respective dates thereof and for the periods covered thereby. 3.4 Absence of Undisclosed Liabilities. Except as set forth in Schedule ---------------------------------- 3.4 attached hereto, there are no material liabilities of the Company, whether accrued, absolute, contingent or otherwise (including, without limitation, liabilities as guarantor or otherwise with respect to obligations of any other Person, or liabilities for Taxes due or then accrued or to become due), except for liabilities which have arisen in the ordinary course of business of the Company since the date of the Most Recent Financial Statements. 3.5 Title to the Transferred Assets. Schedule 3.5 lists all Liens, if ------------------------------- any, on the Purchased Assets. The Company has good and marketable title to, or a valid leasehold interest in, all of the Transferred Assets, free and clear of all Liens, and free of any infractions or noncompliance with zoning and building laws (collectively, "Defects") and the sale and delivery of the Transferred Assets to Buyer pursuant hereto shall vest in Buyer good and marketable title thereto, free and clear of any and all Liens or Defects, other than as disclosed in Schedule 3.5 hereto or as may be created by Buyer. The Company shall prior to the Closing use their commercially reasonable efforts to cure at their expense any Defect identified by Buyer. 3.6 Sufficiency and Condition of Assets. ----------------------------------- (a) All tangible properties and assets that have an assigned value owned or leased by the Company and contained in the Transferred Assets are in good operating condition and repair, ordinary wear and tear excepted, have been well maintained, and to the Knowledge of the Company, conform with all applicable laws, statutes, ordinances, rules and regulations, other than as disclosed on Schedule 3.6. Since December 21, 1999, the Company has not sold, leased or otherwise disposed of or agreed (other than pursuant to this Agreement) to sell, lease or otherwise dispose of any of the Transferred Assets. 9 (b) The Company shall have on the date of any liquidation or dissolution of the Company sufficient assets to pay its obligations and to cease operations and liquidate or dissolve in an orderly manner. 3.7 Accounts Receivable. Except as set forth in Schedule 3.7 attached ------------------- hereto, the Company does not have any accounts receivable or loans or notes receivable to be assigned to the Buyer pursuant to this Agreement. 3.8 Inventories. The Company is not transferring any Inventory to Buyer. ----------- 3.9 Intellectual Property. All patents, patent applications, proprietary --------------------- designs, copy-righted works, trademarks and tradenames which are owned by or licensed to the Company are listed in Schedule 3.9 attached hereto (the "Company Intellectual Property"), which indicates with respect to each the nature of the Company's interest. Except as set forth on Schedule 3.9, all of the Company's patents filed in or issued by the United States Patent Office or the corresponding offices of other countries identified in Schedule 3.9, and have been properly maintained and renewed in accordance with all applicable laws and regulations in the United States and each such country. Except as set forth on Schedule 3.9, those copyrighted works for which copyright registration has been secured with the U.S. Register of Copyright or corresponding offices in other countries are set forth in Schedule 3.9, which indicates the registration number and date of registration of each such registered work. Except as set forth in Schedule 3.9, each such registration has been secured and maintained in accordance with all applicable laws and regulations in the United States and each such country. Except as set forth in Schedule 3.9, the Company's use of the Company Intellectual Property does not require the consent of any other Person and the same are freely transferable (except as otherwise provided by law) and are owned exclusively by the Company, free and clear of any Liens. Except as set forth in Schedule 3.9, (a) no other Person has an interest in or right or license to use, or the right to license any other Person to use, any of the Company Intellectual Property, (b) except as set forth on Schedule 3.9, there are no claims or demands of any other Person pertaining thereto and no proceedings have been instituted, or are pending or, to the Knowledge of the Company, threatened, which challenge the Company's rights in respect thereof, (c) to the Knowledge of the Company, none of the Company Intellectual Property is being infringed by another Person or is subject to any outstanding order, decree, ruling, charge, injunction, judgment or stipulation, (d) no Claim has been made or to the Knowledge of the Company is threatened charging the Company with infringement of any adversely held patent, copyright, tradename or trademark and (e) to the Knowledge of the Company, there does not exist (i) any unexpired patent with claims which are or would be infringed by products of the Company or any Subsidiary of the Company or by apparatus, methods or designs employed by it in manufacturing such products or (ii) any patent or application therefor or invention which would materially adversely affect the Company's or any Subsidiary's ability to manufacture, use or sell any such product, apparatus, method or design. 3.10 Contracts. Except for contracts, commitments, leases, licenses, --------- plans and agreements described in Schedule 3.10 attached hereto (the "Company Contracts"), pursuant to the terms of this Agreement, Buyer will not assume or otherwise become subject to any such contract or agreement, including without limitation: 10 (a) any plan or contract regarding or providing for bonuses, pensions, options, stock purchases, deferred compensation, severance benefits retirement payments, profit sharing, stock appreciation, collective bargaining or the like relating to the Transferred Employees, or any contract or agreement with any labor union; (b) any employment or consulting contract or contract for personal services relating to Transferred Employees not terminable at will by the Company without penalty to the Company; (c) any contract or agreement for the purchase of any commodity, product, material, supplies, equipment or other personal property, or for the receipt of any service; (d) any contract or agreement for the purchase or lease of any fixed asset, whether or not such purchase or lease is in the ordinary course of business; (e) any contract or agreement for the sale of any commodity, product, material, equipment, or other personal property, or the furnishing by the Buyer of any service; (f) any supplier contract or agreement; (g) any contract or agreement with any sales agent, distributor or OEM of products of the Company; (h) any contract or agreement concerning a partnership or joint venture with one or more Persons; (i) any confidentiality agreement or any non-competition agreement or other contract or agreement containing covenants limiting the Buyer's freedom to compete in any line of business or in any location or with any Person; (j) any license agreement (as licensor or licensee); (k) any contract or agreement with any present or former officer, director, consultant, agent or stockholder of the Company or with any Affiliate of any of them; (l) any loan agreement, indenture, note, bond, debenture or any other document or agreement evidencing a capitalized lease obligation or Indebtedness to any Person; or (m) any agreement of guaranty, indemnification, or other similar commitment with respect to the obligations or liabilities of any other Person; or (n) any contract pursuant to which Buyer would become obligated to provide warranty services to customers of the company. 11 (o) Copies of all Company Contracts have been provided or made available to Buyer or its counsel prior to the execution of this Agreement, and all such copies are true, correct and complete and have been subject to no amendment, extension or other modification as of the date hereof, except such as are described in Schedule 3.10 or as indicated in the provided copies. Except as listed and described in Schedule 3.10, each of the Company Contracts is in full force and effect, constitutes a legal, valid and binding agreement, enforceable in accordance with its terms, of each party thereto. The Company is not, and to the Knowledge of the Company, no other Person, is in material default under any such Company Contract (a "default" being defined for purposes hereof as an actual default or event of default or the existence of any fact or circumstance which would, upon receipt of notice or passage of time, constitute a default). 3.11 Compliance with Laws. -------------------- (a) Except as disclosed in Schedule 3.11, the Company has all licenses, permits, franchises, orders, approvals, accreditations, written waivers and other authorizations as are necessary in order to enable it to own and conduct its business and to occupy and use its real and personal properties without incurring any material liability ("Necessary Permits"). No registration, filing, application, notice, transfer, consent, approval, order, qualification, waiver or other action of any kind is required by virtue of the execution and delivery of this Agreement or the consummation of the transactions contemplated hereby to effect the transfer to Buyer of such Necessary Permits. The Company is in full compliance with the terms and conditions of all Necessary Permits except where the failure to be in compliance would not have a Material Adverse Effect. (b) Except as disclosed in Schedule 3.11, the Company has conducted and is conducting its business in material compliance with applicable federal, state, local or foreign laws, statutes, ordinances, regulations, rules or orders or other requirements of any governmental, regulatory or administrative agency or authority or court or other tribunal relating to it (including, but not limited to, any law, statute, ordinance, regulation, rule, order or requirement relating to securities, properties, business, products, advertising, sales or employment practices, immigration, terms and conditions of employment, wages and hours, safety, occupational safety, health or welfare conditions relating to premises occupied, product safety and liability or civil rights). The Company is not now charged with, and to the Knowledge of the Company, is not now under investigation with respect to, any possible violation of any applicable law, statute, ordinance, regulation, rule, order or requirement relating to any of the foregoing in connection with the Transferred Assets and the Company has filed all material reports required to be filed with any governmental, regulatory or administrative agency or authority. The Company shall promptly inform Buyer of any notice relating to the foregoing received after the date hereof and on or prior to the Closing Date. 3.12 Taxes. Except as disclosed in Schedule 3.12, ----- (a) to the extent a failure to do so would adversely impact Buyer, the Transferred Assets or Buyer's use of such Transferred Assets, (i) the Company has timely filed within the time period for filing or any extension granted with respect thereto, all federal, state, local and foreign tax returns, reports and estimates ("Returns") which it is required to file relating or pertaining to any and all taxes attributable to or levied upon the Transferred Assets and (ii) 12 paid any and all taxes it is required to pay in connection with the taxable periods to which such Returns relate. There are (and immediately following the Closing there will be) no liens or similar encumbrances on the Transferred Assets relating or pertaining to taxes, except with respect to taxes not yet due and payable. To the Knowledge of the Company, there is no basis for the assertion of any claims which, if adversely determined, would result in a Lien on the Transferred Assets or otherwise adversely effect Buyer or the Transferred Assets; and (b) to the extent relevant to the Transferred Assets, the Company shall (i) provide Buyer with such assistance as may reasonably be required in connection with the preparation of any tax Return and the conduct of any audit or other examination by any taxing authority or in connection with judicial or administrative proceedings relating to any liability for taxes and (ii) retain and provide Buyer with copies of or access to all records or other information that may be relevant to the preparation of any tax Returns, or the conduct of any audit or examination, or other tax proceeding. The Company shall retain all relevant documents, including prior year's tax Returns, supporting work schedules and other records or information that may be relevant to such returns and shall not destroy or otherwise dispose of any such records without the prior written consent of Buyer. 3.13 Employees. Prior to the date hereof, the Company has set forth --------- a true and complete list of (a) all officers (with office held) of the Company who are contemplated to be transferred, (b) all consultants and independent contractors retained by the Company currently or during the last fiscal year who are contemplated to be transferred and (c) all employees of the Company and OneWorld Sub with who are contemplated to be transferred, including each such employee's job title, remuneration and duration of employment period, who are currently employed by the Company's OneWorld Services, Inc. subsidiary, each, a "Transferred Employee". The Company and OneWorld Sub have complied with all applicable laws relating to the employment of labor, including provisions thereof relating to wages, hours, equal opportunity, collective bargaining, discrimination against race, color, national origin, religious creed, physical or mental disability, sex, age, ancestry, medical condition, marital status or sexual orientation, and the witholding and payment of social security and other taxes. Except as disclosed in Schedule 3.13, neither the Company nor OneWorld Sub is a party to any written or oral employment, consulting, service, severance or pension agreement to which the Buyer will become subject. Neither the Company nor OneWorld Sub is a party to, and none of their respective employees are subject to, any collective bargaining agreement or other union contract. The Company and OneWorld Sub enjoy good relations with its employees and there is no pending or, to the Knowledge of the Company, threatened labor trouble with or effort to organize any of its employees, and there has been no such labor trouble or, to the Knowledge of the Company, effort to organize during the past five (5) years. 3.14 Litigation. Except as disclosed on Schedule 3.14 attached hereto, ---------- (a) there is no Claim pending or, to the Knowledge of the Company, threatened (or, to the knowledge of the Company, any facts which could lead to such a claim) by, against, affecting or regarding the Company or the Transferred Assets at law or in equity, before any federal, state, local or foreign court or any other governmental or administrative agency or tribunal or any arbitrator or arbitration panel, and (b) there are no judgments, orders, rulings, charges, decrees, injunctions, notices of violation or other mandates against or affecting the Company or the Transferred Assets. 13 3.15 Company Products. Each product manufactured, sold, leased, ---------------- distributed or delivered by the Company ("Company Products") has been in conformity with all applicable contractual commitments and all applicable express and implied service and product warranties. There are no existing or, to the Knowledge of the Company, threatened Claims that would be assumed by the Buyer for services or merchandise which are defective or fail to meet any express or implied service or product warranties, or any facts which, if discovered by a third party, would support such a Claim; and there is no Claim that would be assumed by the Buyer has been asserted against the Company for renegotiation or price redetermination with respect to any transaction, and there are no facts upon which any such Claim could be based other than through the ordinary course of business. Except as set forth on Schedule 3.15, there are no statements, citations or decisions by any governmental or regulatory body or agency that any Company Product is defective or fails to meet any standards promulgated by any such governmental or regulatory body or agency. There have been no recalls ordered by any such governmental or regulatory body or agency with respect to any Company Product. 3.16 Brokers. None of the Company, its Subsidiaries, or anyone acting on ------- their behalf, has engaged, retained, or incurred any liability to any broker, investment banker, finder or agent or has agreed to pay any brokerage fees, commissions, finder's fees or other fees with respect to the sale of the Transferred Assets or the transactions contemplated by this Agreement. 3.17 Copies of Documents. The Company Books and Records are true, correct ------------------- and complete. The Company has made available for inspection and copying by Buyer and its counsel true, correct and complete copies of all documents referred to in this Article III or in the Schedules delivered to Buyer pursuant to this Agreement. 3.18 Disclosure of Material Information. Neither this Agreement ---------------------------------- (including the Schedules and Exhibits hereto) nor any document, certificate or instrument furnished in connection therewith contains, when all such documents are read together, with respect to the Company, any untrue statement of a material fact or omits to state a material fact necessary to make the statements therein not misleading. The representations and warranties contained in this Article are the only representations and warranties made by the Company in connection with the transactions contemplated by this Agreement and supersede any and all previous written or oral statements made by the Company to the Buyer. 3.19 Board Recommendation. The Board of Directors of the Company, at a -------------------- meeting duly called and held, has (a) determined that this Agreement and the transactions contemplated hereby, taken together, are advisable and in the best interests of the Company and its stockholders, and (b) subject to the other provisions hereof, resolved to recommend that the holders of the shares of the Company's Common Stock approve this Agreement and the transactions contemplated hereby. 3.20 Required Company Vote. The affirmative vote of a majority of the --------------------- shares of the Company's Common Stock and Preferred Stock, voting together as a single class, is the only vote of the holders of any class or series of the Company's securities necessary to approve this Agreement and the transactions contemplated hereby. 3.21 OneWorld Sub. ------------ 14 (a) OneWorld Sub is a corporation duly organized, validly existing, and in good standing under the laws of the State of Delaware. OneWorld Sub is duly authorized to conduct business and is in good standing in the state of Delaware. OneWorld Sub has full power and authority, and holds all permits and authorizations necessary to carry on its business and to own and use its assets and properties owned and used by OneWorld Sub. OneWorld Sub has delivered to Buyer correct and complete copies of its charter documents and organizational documents, each as amended to date. (b) The authorized capital stock of OneWorld Sub consists of one hundred (100) shares of common stock, par value $0.01 per share (the "OneWorld Sub Stock"), of which one hundred (100) shares are issued and outstanding as of the date hereof, no shares in treasury, and no shares of Preferred Stock. No shares of the Company's capital stock have been issued since December 20, 1999. The OneWorld Sub Stock is duly authorized, validly issued, fully paid and nonassessable. Except for this Agreement, there are no outstanding subscriptions, options, warrants, calls, commitments or other rights of any kind for the purchase or acquisition of, nor any securities convertible or exchangeable for, any capital stock of the OneWorld Sub. (c) The Company owns beneficially and of record all of the issued and outstanding shares of the OneWorld Sub Stock, free and clear of all Liens, and has good and valid title to such shares. The delivery of the stock certificate representing the OneWorld Sub Stock owned by the Company will transfer to Buyer good and valid title thereto free and clear of all Liens. (d) OneWorld Sub has no liabilities, whether accrued, absolute, contingent or otherwise, other than with respect to the employment of the Transferred Employees or pursuant to the Services Agreement dated December 21, 1999 between OneWorld Sub and Buyer. 3.22 Benefit Plans. The Company does not (i) maintain or administer any ------------- benefit plans or (ii) have any severance or similar arrangements in respect of any present or former personnel that would result in any obligations (absolute or contingent) of Buyer to make any payment or be subject to any other obligations to the Company, any present or former personnel of the Company or any other third party upon the consummation of the transactions contemplated in this Agreement, following the termination of such personnel's employment by the Company or the employment of any such personnel by Buyer after the Closing. 3.23 Proprietary Information of Third Parties. To the Knowledge of the ---------------------------------------- Company, no third party has claimed that any person employed by or affiliated with the Company in connection with and during the Company's ownership and operation of its business has (i) violated or may be violating any of the terms or conditions of such person's employment, non-competition or non-disclosure agreement with such third party, (ii) disclosed or may be disclosing or utilized or may be utilizing any trade secret or proprietary information or documentation of such third party, or (iii) interfered or may be interfering in the employment relationship between such third party and any of its present or former employees. No third party has requested information from the Company which suggests that such a claim might be contemplated. To the Knowledge of the Company, no person employed by or affiliated with the Company in connection with and during the Company's ownership and operation of its business has employed or proposes to employ any trade secret or any information or documentation 15 proprietary to any former employer and no person employed or affiliated with the Company has violated any confidential relationship which such person may have had with any third party, in connection with the development, manufacture or sale of any product or proposed product or the development or sale of any service or proposed service of the Company. 3.24 Third Party Consent. No consent, approval or authorization of any ------------------- third party on the part of the Company is required in connection with the consummation of the transactions contemplated hereunder except as otherwise provided in Schedule 3.24. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF BUYER Buyer hereby represents and warrants to the Company as follows: 4.1 Organization and Qualification. Buyer is a corporation duly ------------------------------ organized, validly existing and in good standing under the laws of the State of Delaware and has full power and authority to own, use and lease their properties and to conduct its business as such properties are owned, used or leased and as such business is currently conducted and as it is proposed to be conducted. The copies of the Buyer's Charter and ByLaw, as amended to date, which have been delivered to the Company's counsel prior to the Closing, are true, complete and correct. Except as set forth on Schedule 4.1 attached hereto, the Buyer is qualified to do business as a foreign corporation and is in good standing in each jurisdiction in which it owns or leases property or maintains inventories or where the conduct of its business would require such qualification, except where such qualification to do business or be in good standing would not have a Material Adverse Effect on Buyer. 4.2 Authority; No Violation. Buyer has all requisite corporate power and ----------------------- authority to enter into this Agreement and to carry out the transactions contemplated hereby. The execution, delivery and performance of this Agreement by the Buyer have been duly and validly authorized and approved by all necessary corporate action. This Agreement constitutes the legal and binding obligation of the Buyer, enforceable against it in accordance with its terms. To the best knowledge of the Buyer, the entering into of this Agreement by the Buyer does not, and the consummation by the Buyer of the transactions contemplated hereby, including specifically the transfer of the Transferred Assets to Buyer by the Company, will not violate the provisions of (a) any applicable federal, state, local or foreign laws, (b) the Buyer's Charter or ByLaws, or (c) any provision of, or result in a default or acceleration of any obligation under, or result in any change in the rights or obligations of the Buyer, any subsidiary of the Buyer under, any Lien, contract, agreement, license, lease, instrument, indenture, order, arbitration award, judgment, or decree to which the Buyer is a party or by which it is bound, or to which any property of the Buyer is subject. 16 4.3 SEC Reports and Financial Statements. Since its initial public ------------------------------------ offering, Buyer has filed all material forms, reports and documents with the Commission required to be filed by it pursuant to the Securities Act and the Exchange Act (the "SEC Reports"), and all of such filings complied in all material respects with all applicable requirements of the Securities Act and the Exchange Act. 4.4 Board Authorization. The Board of Directors of the Buyer, at meetings ------------------- duly called and held, has approved this agreement and the transactions contemplated hereby and has authorized the execution, delivery and performance of this Agreement in accordance with its terms. The Shares, when issued in accordance with this Agreement shall be fully paid, nonassessable and free of any Liens. 4.5 Sole Representations and Warranties. The representations and ----------------------------------- warranties contained in this Article IV are the only representations and warranties made by Buyer and Buyer in connection with the transactions contemplated by this Agreement and supersede any and all previous written or oral statements made by Buyer and Buyer to the Company. ARTICLE V COVENANTS 5.1 Covenants of the Company. The Company shall keep, perform and fully ------------------------ discharge the following covenants and agreements: (a) Interim Conduct of Business. Except as contemplated by the terms --- --------------------------- of this Agreement, from the date hereof until the Closing, the Company shall not: (i) except as contemplated hereby, enter into or amend any employment, bonus, severance, or retirement contract or arrangement (including any Plan as described in Section 3.19), or increase any salary or other form of compensation payable or to become payable to any Transferred Employee; (ii) purchase, lease or otherwise acquire any real estate or any interest therein that would be assumed by the Buyer; (iii) sell, lease or otherwise dispose of or agree to sell, lease or otherwise dispose of any of the Transferred Assets; (iv) incur any liability, guaranty or obligation (fixed or contingent) that would be assumed by the Buyer; (v) place or permit to be placed any Lien on any of the Transferred Assets, other than statutory Liens arising in the ordinary course of business; (vi) make or authorize any amendments or changes to its Charter or ByLaws preventing the consummation or the transactions contemplated by this Agreement; 17 (vii) make any investment in property, plant and equipment and other items of capital expenditure that would be transferred to the Buyer; (viii) fail to protect the character, quality and transferability of the Transferred Assets, including without limitation, the Intellectual Property, at the same level of care that the Company takes with its intellectual property. (b) Access. The Company shall, upon reasonable notice, give Buyer ------ and its representatives full and free access to all properties, assets, books, contracts, commitments and records of the Company during reasonable business hours and shall promptly furnish Buyer with all financial and operating data and other information as to the history, ownership, Affiliates, business, operations, properties, assets, liabilities, or condition (financial or otherwise) of the Company as Buyer may from time to time reasonably request. It being understood and agreed by Buyer that any such request for information relates solely to the Transferred Assets or the Assumed Liabilities, and the Company's ability to transfer the same. (c) Transfer of Necessary Permits. From and after the date hereof ----------------------------- through to the Closing Date and following the Closing, the Company assist with the transfer to Buyer of all of the Necessary Permits and all other permits, licenses, and leases which are associated with the Company's business as presently conducted, to the extent the same are by their terms transferable. (d) Satisfaction of Conditions. The Company shall use its -------------------------- commercially reasonable efforts to accomplish the satisfaction of the conditions precedent to Closing contained in Section 6.1 herein on or prior to the Closing Date. 5.2 Covenants of the Company and Buyer. The Company shall keep, perform ---------------------------------- and fully discharge the following covenants and agreements: (a) Confidentiality. The Buyer, and the Company (individually, a "Party", and collectively, the "Parties") have and will request certain written and verbal information that is material and confidential in nature (the "Information") relating to a possible purchase of the Transferred Assets (such purchase to be referred to herein as the "Transaction"). For purposes of this Asset Purchase Agreement, the term Information shall include all information relating to the Transaction that has been received as of the date of this Asset Purchase Agreement and any additional information that may be received in the future from or between the Parties in conjunction with their evaluation of the Transaction. In consideration of the Parties being furnished with the Information: (i) The Parties agree that the Information will be kept confidential and will not, without the other's prior written consent, be disclosed by the Parties or the Parties' representatives (which term shall mean, for all purposes herein, Parties' directors, officers, employees, agents or representatives, including, without limitation, attorneys, accountants, consultants, lenders and financial advisors), in any manner whatsoever, in whole or in part, and will not be used by the Parties or the Parties' representatives directly or indirectly for any purpose other than for the sole purpose of evaluating the Transaction. The Parties agree to transmit the Information only to those representatives who need to know the Information for the 18 purpose of evaluating the Transaction, who are informed by the Parties of the confidential nature of the Information and who agree to be bound by the terms of this Agreement. The Parties will be responsible for any breach of this Agreement by the Parties representatives. (ii) Without the other Party's prior written consent, the Parties and their representatives will not disclose to any other person the fact that the Information has been made available, or any of the terms, conditions or other facts with respect to the Transaction, including the status thereof, except as permitted by Subparagraph "v" hereof. (iii) The Information and all copies thereof will be returned promptly to the other Party's attention in the event that the such other Party makes such a request or if the contemplated Transaction shall not be consummated, and neither Party nor any representative will make or retain any copies, extracts or other reproductions, in whole or in part, of the Information. (iv) This Section shall be inoperative as to such portions of the Information which (i) are or become generally available to the public other than as a result of a disclosure by a Party or its representatives; (ii) become available to a Party on a non-confidential basis from a source other than the other Party; or (iii) was known to a Party on a non-confidential basis prior to its disclosure to such Party by the other Party. (v) In the event that a Party or anyone to whom a Party transmits the Information pursuant to this Agreement is requested or becomes legally compelled (by oral questions, interrogatories, request for information or documents, subpoena, civil investigative demand or similar process, including regulatory inquiries) to disclose any of the Information, such Party will provide the other Party with prompt prior written notice so that such other Party may seek a protective order or other appropriate remedy and/or waive compliance with the provisions of this Agreement. In the event that such protective order or other remedy is not obtained, or such other Party waives compliance with Paragraph 5.2(e)(ii) of this Agreement, the Party will furnish only that portion of the Information that is legally required (which determination may be based upon advice of outside legal counsel) and will exercise all reasonable means to obtain reliable assurance that confidential treatment will be accorded the Information. (vi) It is agreed and understood that in the event of any breach or threatened breach thereof by a Party, such other Party shall, in addition to any other remedies which may be available, be entitled to injunctive and other equitable relief in any court of competent jurisdiction. (vii) It is understood and agreed that no failure or delay by the a Party in exercising any right, power or privilege under this Agreement shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other further exercise of any right, power or privilege hereunder. (viii) If any provision of this Section shall be determined to be void or unenforceable, the remaining provisions of this Section shall nonetheless constitute valid and enforceable obligations of the parties hereto. 19 (ix) Any consent or waiver of compliance with any provision hereof shall be effective only if in writing, and no such consent or waiver shall be deemed to extend beyond the particular subject thereof. (b) Exclusive Dealings. Subject to the provisions of Section 7.1, ------------------ the Company, on its own behalf and on behalf of its shareholders, agrees that, in consideration of Buyer undertaking to prepare the necessary legal documentation to evidence the contemplated transaction, the Company will not engage in discussions or negotiations of any level with any other person or entity regarding the sale of the Transferred Assets prior to the termination of this Agreement. Notwithstanding the foregoing, the Company shall be entitled to entertain, discuss and negotiate with any third party that provides an unsolicited offer for the sale of the Company, Transferred Assets that is potentially superior to the terms of this Agreement in satisfaction of its fiduciary obligations to the Company's Stockholders, as advised by its independent legal counsel. 5.3 Preparation of Proxy Statement; Stockholder Meeting. --------------------------------------------------- (a) Promptly following the date of this Agreement (and in no event later than ten business days following execution and delivery of this Agreement), the Company (i) shall prepare a proxy statement (the "Proxy Statement") and other materials relating to the solicitation of the vote of a majority of the issued and outstanding shares of the Company's common stock, ("Common Stock"), in favor of this Agreement and the consummation of the transactions contemplated hereby and (ii) shall file preliminary proxy materials with the Securities and Exchange Commission ("SEC"). The Company shall use its commercially reasonable efforts as promptly as practicable to respond to and resolve any comments raised by the SEC with respect to such materials. The Company will use its commercially reasonable efforts to cause the Proxy Statement and other materials to be mailed to the Company's stockholders as promptly as practicable and in any event no later than the eleventh (11th) calendar day following clearance by the SEC for distribution. (b) The Company will immediately notify the Buyer of (i) the receipt of any comments from the SEC regarding the Proxy Statement and (ii) any request by the SEC for any amendment to the Proxy Statement or for additional information. Buyer shall be given a reasonable opportunity to review and comment on (1) all filings with the SEC, including the Proxy Statement and any amendments thereto, (2) all correspondence from the SEC to the Company in respect of the Proxy Statement, this Agreement and the transactions contemplated hereby, and (3) all mailings to the Company's stockholders in connection with the transactions contemplated hereby, including the Proxy Statement, prior to the filing or mailing thereof. The Company shall use its commercially reasonable efforts to reflect all reasonable comments raised by Buyer in respect of any of the foregoing. (c) The Company will, as promptly as practicable following the date of this Agreement and in consultation with Buyer, duly call, give notice of, convene and hold a meeting of its stockholders (the "Stockholders' Meeting") for the purpose of approving this Agreement and the transactions contemplated by this Agreement. The Company will, through its Board of Directors, recommend to its stockholders approval of the foregoing matters. Subject to obtaining the approval by the SEC of the Proxy Statement and other proxy materials, the Company will use 20 its commercially reasonable efforts to hold the Stockholders' Meeting as soon as practicable after the date hereof. 5.4 Covenants of Buyer. Buyer shall use its commercially reasonable ------------------ efforts to accomplish the satisfaction of the conditions precedent to Closing contained in Section 6.2 herein on or prior to the Closing Date. 5.5 Covenants of Buyer and the Company. The parties hereto hereby agree ---------------------------------- to keep, perform and fully discharge the following covenants and agreements: (a) Waiver of Compliance with the Bulk Sales Act. In connection with the transactions contemplated hereby, the parties shall waive compliance with the provisions of Article 6 of the Uniform Commercial Code Bulk Transfers and the Bulk Sales Act and any other applicable United States, state or provincial bulk sales act or statute ("Bulk Sales Acts"); provided, however, the Company shall be indemnify Buyer for any and all Losses incurred by Buyer arising from the Company's failure to comply with the Bulk Sales Act. (b) Employees. --------- (i) Provided that each of the Transferred Employees has entered into an employment relationship with Buyer prior to signing of this Agreement, the form of which having been previously provided to the Company, Buyer agrees to assume the employment of, and preserve the tenure and continuity of employment of, the Transferred Employees; provided, however, that nothing contained herein shall be construed to create any third party beneficiaries and in any event such employee relationship shall be governed by the terms of any offer letters or employment agreements between Buyer and the Transferred Employees. The employment relationship between the Buyer and the non-engineer Transferred Employees will be on an at-will basis pursuant to an offer letter mutually agreeable to the parties thereto and the Buyer does not warrant any term of longevity of such employment nor the terms and conditions of such employment. The employment relationship between Buyer and the engineer Transferred Employees so hired will be pursuant to employment agreements in the form mutually agreeable to the parties thereto. The Company shall be solely responsible for any employment benefits, including pension or profit sharing, medical insurance and accrued vacation due by the Company to such employees. Subject to the terms of any such offer letter or employment agreement, the Transferred Employees shall be entitled to participate in Buyer's employment benefit plans, including its stock option or stock purchase plans, as such plans are determined and directed by the Buyer's Board of Directors and shall be required to execute Buyer's standard form of confidentiality and nondisclosure agreement. Selected Transferred Employees of the Company retained by Buyer will be provided with retention incentives as determined by the Buyer. (ii) As to any such Transferred Employee who is employed by Buyer pursuant to this Section 5.5(b), the Company agrees to cause the release of such employee from any contractual provision with the Company, or any affiliate of the Company which would impair the utility of such employee's services to Buyer, or that would impose upon such employee any monetary or other obligation to the Company that otherwise would be occasioned by the termination of such employee's employment or any agreement of non-competition or confidentiality. Notwithstanding the foregoing, nothing contained herein shall prevent the 21 Company from seeking redress from such employees for violations of such employees' duties as an employee of the Company. (c) COBRA. The Company shall be responsible for any group health plan continuation or conversion coverage required under section 4980B of the Code, Part 6 of Title I or ERISA, or applicable State or local laws ("Required COBRA Coverage") with respect to the Transferred Employees due to a qualifying event occurring on or before the Closing Date. The Buyer shall be responsible for any Required COBRA Coverage with respect to the Transferred Employees due to a qualifying event occurring after the Closing Date. (d) Distributions from Plans. Except where prohibited by applicable law (including but not limited to section 401(k)(2)(B)(i) of the Code), the Company shall distribute to the Transferred Employees their accrued benefits under the Plans (subject, however, to any vesting schedule not otherwise accelerated by applicable law or any term of the Plan), including but not limited to accrued vacation, bonus, and sick pay (but determined without regard to any last day of the plan year employment requirement or any other similar condition). Such distributions shall be made in the manner and at the time as prescribed by the terms of the Plan and applicable law. ARTICLE VI CLOSING CONDITIONS 6.1 Conditions to Obligations of Buyer. The obligations of Buyer to ---------------------------------- consummate this Agreement and the transactions contemplated hereby are subject to the fulfillment, prior to or at the Closing, of the following conditions precedent: (a) Representations, Warranties and Covenants. Each of the ----------------------------------------- representations and warranties of the Company contained in this Agreement shall be true and correct in all material respects at the Closing Date. The Company shall have performed, on or before the Closing Date, all of its respective obligations under this Agreement and the other Purchase Documents which by the terms thereof are to be performed on or before the Closing Date; and the Company shall have delivered to Buyer an Officer's Certificate dated the Closing Date of the Company to such effect. (b) No Pending Action. No legislation, order, rule, ruling or ----------------- regulation shall have been proposed, enacted or made by or on behalf of any governmental body, department or agency, and no legislation shall have been introduced in either House of Congress or in the legislature of any state, and no investigation by any governmental authority shall have been commenced or threatened, and no action, suit, investigation or proceeding shall have been commenced before, and no decision shall have been rendered by, any court or other governmental authority or arbitrator, which, in any such case, in the reasonable judgment of Buyer could materially prevent or rescind the transactions contemplated by this Agreement (including, without limitation, the purchase and sale of the Transferred Assets) or result in a Material Adverse Effect 22 (c) Purchase Permitted by Applicable Laws; Legal Investment. Buyer's ------------------------------------------------------- purchase of and payment for the Transferred Assets (a) shall not be prohibited by any applicable law or governmental order, rule, ruling, regulation, release or interpretation, (b) shall not constitute a fraudulent or voidable conveyance under any applicable law and (c) shall be permitted by all applicable laws, statutes, ordinances, regulations and rules of the jurisdictions to which Buyer is subject. (d) Proceedings Satisfactory. All proceedings taken in connection ------------------------ with the purchase and sale of the Transferred Assets, the transactions contemplated by Section 6.1(o) hereof, all of the other Purchase Documents and all documents and papers relating thereto, shall be in form and substance reasonably satisfactory to Buyer. Buyer and its counsel shall have received copies of such documents and papers as Buyer or its counsel may reasonably request in connection therewith, all in form and substance reasonably satisfactory to Buyer. Any Purchase Document, any Schedule or Exhibit to this Agreement and any other document, agreement or certificate contemplated by this Agreement, not approved by Buyer in writing as to form and substance on the date this Agreement is executed, shall be reasonably satisfactory in form and substance to Buyer. (e) Consents Permits. The Company shall have received (and there ---------------- shall be in full force and effect) all material consents, approvals, licenses, permits, orders and other authorizations of, and shall have made (and there shall be in full force and effect) all such filings, registrations, qualifications and declarations with, any Person pursuant to any applicable law, statute, ordinance regulation or rule or pursuant to any agreement, order or decree to which the Company is a party or to which it is subject, in connection with the transactions contemplated by this Agreement and the sale of the Transferred Assets. (f) Corporate Documents. The Company shall have delivered to Buyer ------------------- an Officer's Certificate of the Secretary of the Company certifying (A) the incumbency and genuineness of signatures of all officers of the Company executing this Agreement, any document delivered by the Company at the Closing and any other document, instrument or agreement executed in connection herewith, (B) the truth and correctness of resolutions of the Company authorizing the entry by the Company into this Agreement and the transactions contemplated hereby. (g) Transfer of Necessary Permits. All of the Necessary Permits ----------------------------- shall have been transferred, to the extent transferable, to Buyer on or before the Closing Date. (h) Transfer of Transferred Assets. All of the Transferred Assets ------------------------------ shall have been effectively sold, transferred, conveyed and assigned to Buyer, free and clear of all Liens, and all of the deeds, conveyances, bills of sale, certificates of title, assignments, assurances and other instruments and documents referenced in Section 3.2 shall have been executed, delivered and, if appropriate, filed or recorded 6.2 Conditions to Obligations of the Company. The obligations of the ---------------------------------------- Company to consummate this Agreement and the transactions contemplated hereby are subject to the fulfillment, prior to or at the Closing, of the following conditions precedent: 23 (a) Representations and Warranties. Each of the representations and ------------------------------ warranties of Buyer and Buyer in this Agreement shall remain true and correct in all material respects at the Closing Date, and Buyer shall, on or before the Closing Date, have performed all of its obligations under this Agreement and the Other Purchase Documents which by the terms thereof are to be performed by it on or before the Closing Date; and Buyer shall have delivered an Officer's Certificate to the Company dated the Closing Date to such effect. (b) No Pending Action. No legislation, order, rule, ruling or ----------------- regulation shall have been proposed, enacted or made by or on behalf of any governmental body, department or agency, and no legislation shall have been introduced in either House of Congress or in the legislature of any state, and no investigation by any governmental authority shall have been commenced or threatened, and no action, suit, investigation or proceeding shall have been commenced before, and no decision shall have been rendered by, any court or other governmental authority or arbitrator, which, in any such case, was not known by the Company on the date hereof or which could adversely affect, restrain, prevent or rescind the transactions contemplated by this Agreement (including, without limitation, the purchase and sale of the Transferred Assets) or result in a Material Adverse Effect. (c) Corporate Documents. Buyer shall have delivered respectively to ------------------- the Company: (i) an Officer's Certificate of the Secretary of such party certifying (A) the incumbency and genuineness of signatures of all officers of Buyer executing this Agreement, any document delivered by Buyer at the Closing and any other document, instrument or agreement executed in connection herewith, (B) the truth and correctness of resolutions of Buyer authorizing the entry by Buyer into this Agreement and the transactions contemplated hereby and (C) the truth, correctness and completeness of the ByLaws of Buyer; and (ii) the Charter of Buyer certified as of a recent date by the Secretary of State of the State of Delaware. (d) Purchase Permitted by Applicable Laws; Legal Investment. The Buyer's purchase of and payment for the Transferred Assets (a) shall not be prohibited by any applicable law or governmental order, rule, ruling, regulation, release or interpretation, (b) shall not constitute a fraudulent or voidable conveyance under any applicable law and (c) shall be permitted by all applicable laws, statutes, ordinances, regulations and rules of the jurisdictions to which the Buyer is subject. (e) License Agreement. The Company and Buyer shall have entered into a license agreement in substantially the form of Exhibit __ attached hereto. (f) Proceedings Satisfactory. All proceedings taken in connection with the purchase and sale of the Transferred Assets, the transactions contemplated by Section 6.1(o) hereof, all of the other Purchase Documents and all documents and papers relating thereto, shall be in form and substance reasonably satisfactory to the Company. The Company and its counsel shall have received copies of such documents and papers as the Company or its counsel may reasonably request in connection therewith, all in form and substance reasonably satisfactory to 24 the Company. Any Purchase Document, any Schedule or Exhibit to this Agreement and any other document, agreement or certificate contemplated by this Agreement, not approved by the Company in writing as to form and substance on the date this Agreement is executed, shall be reasonably satisfactory in form and substance to the Company. ARTICLE VII TERMINATION 7.1 Termination of Agreement. This Agreement and the transactions ------------------------ contemplated hereby may (at the option of the party having the right to do so) be terminated at any time on or prior to the Closing Date: (a) Mutual Consent. By mutual written consent of Buyer and the -------------- Company; (b) Court Order. By Buyer, or the Company if any court of competent ----------- jurisdiction shall have issued an order pursuant to the request of a third party restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated by this Agreement; (c) Failure to Close By May 30, 2000. By Buyer or the Company if the -------------------------------- transactions contemplated hereby shall not have been consummated on or before May 30, 2000 provided, however, that such right to terminate this Agreement shall not be available to any party whose failure to fulfill any obligation of this Agreement has been the cause of, or resulted in, the failure of the transactions contemplated hereby to be consummated on or before such date; (d) Termination by Company. By the Company upon notice to Buyer at ---------------------- any time prior to May 30, 2000 if (i) a condition to the performance of the Company set forth in Section 6.2 hereof shall not be fulfilled at the time specified for the fulfillment thereof, (ii) a material default under or a material breach of this Agreement shall be made by Buyer and such default or breach shall not be curable prior to May 30, 2000; or (e) Termination by Buyer. By Buyer by notice to the Company at any -------------------- time prior to May 30, 2000, if (i) a condition to the performance of Buyer set forth in Section 6.1 hereof shall not be fulfilled at the time specified for the fulfillment thereof; (ii) a material default under or a material breach of this Agreement shall be made by the Company, and such default or breach shall not be curable prior to May 30, 2000; (f) Termination by Buyer and/or the Company. By Buyer or the Company --------------------------------------- by notice to the other party if the Company enters into any agreement with a third party that would have a Material Adverse Effect on the Company's ability to perform its obligations hereunder with respect to any of the following involving the Company and/or its subsidiaries: (i) any merger, consolidation, share exchange, recapitalization, business combination, or other similar transaction involving the sale of the Company, the Business or Transferred Assets ; (ii) any sale, lease, exchange, mortgage, pledge, transfer or other disposition of the Company, the Business or the Transferred Assets in a single transaction or series of transactions; (iii) any tender offer or exchange offer for 25% or more of the outstanding shares of capital stock of the Company or the 25 filing of a registration statement under the Securities Act of 1933 in connection therewith; or (iv) any public announcement by the Company of a proposal, plan or intention to do any of the foregoing or any agreement to engage in any of the foregoing. 7.2 Effect of Termination and Right to Proceed. If this Agreement is ------------------------------------------ terminated pursuant to this Article VII, then except as provided below, all further obligations of Buyer and the Company under this Agreement shall terminate without further liability of Buyer or any Affiliate thereof to the Company or to Buyer or any Affiliate thereof, except with respect to the obligations set forth in Sections 5.2 and 7.1, and except, in the case of termination pursuant to Section 7.1(d) or Section 7.1(e) as to liability for misrepresentation, breach or default in connection with any warranty, representation, covenant or obligation given, occurring or arising to the date of termination. In addition, anything in this Agreement to the contrary notwithstanding, if any of conditions to obligations specified in Sections 6.1 or 6.2 hereof have not been satisfied, Buyer, in addition to any other rights which it may have, shall have the right to waive its rights to have such conditions satisfied and elect to proceed with the transactions contemplated hereby and, if any of the conditions to the obligations of the Company specified in Section 6.2 hereof have not been satisfied, the Company in addition to any other rights which may be available to them, shall have the right to waive their rights to have such conditions satisfied and elect to proceed with the transactions contemplated hereby. 7.3 Penalties Upon Termination. In the event the Company consummates a -------------------------- merger or consolidation with any third party, the Company agrees that it shall, as promptly as possible and in any event no later than five (5) days following the closing of such merger or consolidation, pay to Buyer an amount equal to all amounts paid by Buyer to Company pursuant to Section 4 of that certain Services Agreement dated December 20, 1999 (the "Services Agreement"). In the event that Buyer voluntarily terminates this Agreement other than pursuant to Sections 7.1(e) or (f) above, it shall pay to the Company the lesser of (1) $100,000, or (2) the actual expenses incurred by the Company for items identified on Schedule 2 of the Services Agreement from the date hereof through the date of such termination. ARTICLE VIII INDEMNIFICATION 8.1 Survival of Representations and Warranties. The parties hereby ------------------------------------------ shorten the applicable period of limitation of claims made under representations and warranties, and for that purpose each and every such representation and warranty set forth in this Agreement (including the Officer's Certificates required by Sections 6.1 and 6.2 above), shall survive until the first anniversary of the Closing Date; provided, however, that nothing contained herein shall cause the delay in dissolution of the Company's business and such survival shall terminate upon the filing of a certificate of dissolution by the Company. From and after the applicable period of survival with respect to such respective representations and warranties of the Company and Buyer, none of the Company, or Buyer or any Affiliate of the Company or Buyer shall have any liability whatsoever with respect to any such representation or warranty, except for breaches as to which any party shall have notified the other party prior to such date. This Section 8.1 shall have no effect upon any other obligation of the parties hereto, whether to be performed before or after the Closing Date. 26 8.2 Indemnification by the Company. The Company shall indemnify, defend ------------------------------ and hold the Buyer, its officers, directors, employees, consultants, owners, agents and Affiliates, harmless from and in respect of any and all Losses which are actually sustained or suffered by any of them arising out of or resulting from any breach or inaccuracy of any representation or warranty or the breach of or failure to perform any warranty, covenant, undertaking or other agreement of the Company contained in this Agreement or any other Purchase Document and arising out of any and all actions, suits, claims and administrative or other proceedings of every kind and nature instituted or pending against the Company or Buyer or any of their Affiliates at any time before or after the Closing Date to the extent that such Losses (a) relate to or arise out of or in connection with the assets, businesses, operations, conduct, products and/or employees (including former employees) of the Company, whether relating to or arising out of or in connection with occurrences before or after the Closing Date, (b) do not arise out of a breach or inaccuracy of the Buyer's representations and warranties in, or a breach or default by Buyer in the performance of any warranty, covenant under, undertaking or other agreement contained in this Agreement or any other Purchase Document, and (c) arise out of or in connection with matters disclosed in Schedule 3.9(1) attached hereto (the "Losses"). 8.3 Indemnification by Buyer. Buyer shall indemnify, defend and hold the ------------------------ Company, its respective officers, directors, employees, consultants, owners, agents and Affiliates, harmless from and in respect of any and all Losses which are actually sustained or suffered by any of them arising out of or resulting from any breach or inaccuracy of any representation or warranty or the breach of or failure to perform any warranty, covenant, undertaking or other agreement of Buyer contained in this Agreement or any other Purchase Document to the extent that such Losses do not arise out of a breach or inaccuracy of the Company's representations and warranties in, or a breach or default in the performance of any warranty, covenant under, undertaking or other agreement contained in this Agreement or any other Purchase. 8.4 Minimum Indemnification; Materiality. Notwithstanding anything to the ------------------------------------ contrary contained herein, no party hereto shall be entitled to recover from any other party unless and until the total of all claims for indemnity or damages with respect to any inaccuracy or breach of any such representations or warranties or breach of or default in the performance of any covenants, undertakings or other agreements, whether such claims are brought under this Article VIII or otherwise, exceeds $50,000. Under no circumstances shall the Company be obligated to indemnify Buyer for Losses in excess of the Purchase Price received by the Company. Notwithstanding the foregoing, under no circumstances shall Buyer collectively be obligated to indemnify the Company for Losses in excess of the Purchase Price. 8.5 Notice and Opportunity to Defend. If there occurs an event that a -------------------------------- party asserts is an indemnifiable event pursuant to Section 8.2 or 8.3, the parties seeking indemnification shall promptly notify the other parties obligated to provide indemnification (collectively, the "Indemnifying Party"). If such event involves (a) any Claim or (b) the commencement of any action, suit or proceeding by a third person, the party seeking indemnification will give such Indemnifying Party prompt written notice of such Claim or the commencement of such action, suit or proceeding, provided, however, that the failure to provide prompt notice as provided herein will relieve the Indemnifying Party of its obligations hereunder only to the extent that such failure prejudices the Indemnifying Party hereunder. In case any such action, suit or proceeding shall be brought against any party seeking indemnification and it shall notify the 27 Indemnifying Party of the commencement thereof, the Indemnifying Party shall be entitled to participate therein and, to the extent that it desires to do so, to assume the defense thereof, with counsel reasonably satisfactory to such party seeking indemnification and, after notice from the Indemnifying Party to such party seeking indemnification of such election so to assume the defense thereof, the Indemnifying Party shall not be liable to the party seeking indemnification hereunder for any attorneys' fees or any other expenses, in each case subsequently incurred by such party, in connection with the defense of such action, suit or proceeding. The party seeking indemnification agrees to cooperate fully with the Indemnifying Party and its counsel in the defense against any such action, suit or proceeding. In any event, the party seeking indemnification shall have the right to participate at its own expense in the defense of such action, suit or proceeding. In no event shall an Indemnifying Party be liable for any settlement or compromise effected without its prior consent. 8.6 Full Access . The Company shall also give the Buyer full access to: ----------- (i) the premises occupied by the Company; (ii) the Company's books and records; (iii) the Company's Seller's information systems; and (iv) the Transferred Employees. ARTICLE IX ARTICLE IX MISCELLANEOUS 9.1 Fees and Expenses. Each of the parties hereto will pay and discharge ----------------- its own expenses and fees in connection of with the negotiation of and entry into this Agreement and the consummation of the transactions contemplated hereby. 9.2 Publicity and Disclosures. Prior to the Closing, no press release or ------------------------- any public disclosure, either written or oral, of the transactions contemplated by this Agreement shall be made by any party without the prior knowledge and written consent of the Company and Buyer other than compliance with the Securities Act disclosures and other regulatory bodies. 9.3 Notices. All notices, requests, demands, consents and communications ------- necessary or required under this Agreement or any other Purchase Document shall be made in the manner specified, or, if not specified, shall be delivered by hand or sent by registered or certified mail, return receipt requested, or by telecopy (receipt confirmed) to: if to Buyer: Tut Systems, Inc. 2495 Estand Way Pleasant Hill, Ca 28 Attention: Nelson Caldwell Facsimile: (925) 682-4125 with a copy to: Brobeck, Phleger & Harrison LLP 550 West C Street, Suite 1200 San Diego, CA 92101 Attention: Eddie Rodriguez, Esq. Facsimile: (619) 699-0252 if to the Company: One World Systems, Inc. 1144 East Arques Avenue Sunnyvale, CA 94086 Attention: Neil Selvin Facsimile Transmission Number: (408) 523-2019 with a copy to: Wilson Sonsini Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94304 Attention: Alan K. Austin Facsimile Transmission Number: (650) 493-6811 All such notices, requests, demands, consents and communications shall be deemed to have been duly given only when such notice, request, demand, consent or communication is delivered or, if sent by telecopier, when received. 9.4 Successors and Assigns. All covenants and agreements set forth in ---------------------- this Agreement and made by or on behalf of any of the parties hereto shall bind and inure to the benefit of the successors and assigns of such party, whether or not so expressed. 9.5 Descriptive Headings. The headings of the sections and paragraphs of -------------------- this Agreement have been inserted for convenience of reference only and shall not be deemed to be part of this Agreement. 9.6 Counterparts. This Agreement may be executed in any number of ------------ counterparts and by the different parties hereto on separate counterparts, each of which when so executed and delivered shall be an original, but all of which together shall constitute one and the same instrument, and it shall not be necessary in making proof of this Agreement to produce or account for more than one such counterpart. 9.7 Severability. In the event that any one or more of the provisions ------------ contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable in any respect for any reason in any jurisdiction, the validity, legality and enforceability of any such 29 provision in every other respect and of the remaining provisions hereof shall not be in any way impaired or affected, it being intended that each of parties' rights and privileges shall be enforceable to the fullest extent permitted by law, and any such invalidity, illegality and unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. To the fullest extent permitted by law, the parties hereby waive any provision of any law, statute, ordinance, rule or regulation which might render any provision hereof invalid, illegal or unenforceable. 9.8 Attorneys' Fees. In any action or proceeding brought to enforce any --------------- provision of this Agreement or the other Purchase Documents, or where any provision hereof or thereof is validly asserted as a defense, the successful party shall be entitled to recover reasonable attorneys' fees in addition to any other available remedy. 9.9 Course of Dealing. No course of dealing and no delay on the part of ----------------- any party hereto in exercising any right, power, or remedy conferred by this Agreement shall operate as a waiver thereof or otherwise prejudice such party's rights, powers and remedies. The failure of any of the parties to this Agreement to require the performance of a term or obligation under this Agreement or the waiver by any of the parties to this Agreement of any breach hereunder shall not prevent subsequent enforcement of such term or obligation or be deemed a waiver of any subsequent breach hereunder. No single or partial exercise of any rights, powers or remedies conferred by this Agreement shall preclude any other or further exercise thereof or the exercise of any other right, power or remedy. 9.10 Third Parties. Except as specifically set forth or referred to ------------- herein, nothing herein expressed or implied is intended or shall be construed to confer upon or give to any Person, other than the parties hereto and their permitted successors or assigns, any rights or remedies under or by reason of this Agreement or any other Purchase Document. 9.11 Tax Matters. ----------- (a) The Buyer shall pay all use and transfer taxes associated with the transfer of the Transferred Assets. (b) The Company shall be responsible for and shall timely pay or cause to be paid any and all Taxes (other than Buyer's Taxes, as defined below) with respect to or relating to the Transferred Assets, whensoever arising, that are attributable to any taxable period ending on or prior to the Closing Date and, in the case of a taxable period that includes, but does not end on the Closing Date, the portion of such taxable period that ends on the Closing Date ("the Company's Taxes"). Notwithstanding anything in this Agreement to the contrary, the Company's Taxes shall constitute a Retained Liability. (c) Buyer shall be responsible for and shall timely pay or cause to be paid any and all Taxes (other than the Company's Taxes) with respect to the Transferred Assets, whensoever arising, that are attributable to any taxable period commencing after the Closing Date and, in the case of a taxable period that includes, but does not end on, the Closing Date, the portion of such taxable period that begins on the day after the Closing Date ("Buyer's Taxes"). 30 Notwithstanding anything in this Agreement to the contrary, Buyer's Taxes shall constitute an Assumed Liability. (d) The obligations of the Company set forth in the Agreement relating to Taxes shall, except as otherwise agreed in writing, be unconditional and absolute and shall remain in effect without limitation as to time or amount of recovery by Buyer until thirty (30) days after the expiration of the applicable statute of limitations governing the Taxes to which such obligations relate (after giving effect to any agreement extending or tolling such statute of limitations). 9.12 Variations in Pronouns. All pronouns and any variations thereof ---------------------- refer to the masculine, feminine or neuter, singular or plural, as the identity of the Person or Persons may require. 9.13 WAIVER OF JURY TRIAL. EACH OF BUYER AND THE COMPANY HEREBY EXPRESSLY -------------------- WAIVES ITS RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT, ANY OTHER PURCHASE DOCUMENT OR THE TRANSFERRED ASSETS OR ANY DEALINGS BETWEEN THEM RELATING TO THE SUBJECT MATTER OF THIS AGREEMENT. THE COMPANY AND BUYER ALSO WAIVE ANY BOND OR SURETY OR SECURITY UPON SUCH BOND WHICH MIGHT, BUT FOR THIS WAIVER, BE REQUIRED OF ANY PARTY. THE SCOPE OF THIS WAIVER IS INTENDED TO BE ALL ENCOMPASSING OF ANY AND ALL DISPUTES THAT MAY BE FILED IN ANY COURT AND THAT RELATE TO THE SUBJECT MATTER OF THIS TRANSACTION, INCLUDING, WITHOUT LIMITATION, CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW AND STATUTORY CLAIMS. THE COMPANY AND BUYER FURTHER WARRANT AND REPRESENT THAT EACH HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL, AND THAT EACH VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. THIS WAVIER IS IRREVOCABLE AND MAY ONLY BE MODIFIED EITHER ORALLY OR IN AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT, ANY OTHER PURCHASE DOCUMENT OR THE SHARES. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL (WITHOUT A JURY) BY THE COURT. 9.14 GOVERNING LAW. THIS AGREEMENT, INCLUDING THE VALIDITY HEREOF AND THE ------------- RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER, SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF CALIFORNIA APPLICABLE TO CONTRACTS MADE AND TO BE PERFORMED ENTIRELY IN SUCH STATE (WITHOUT GIVING EFFECT TO THE CONFLICTS OF LAWS PROVISIONS THEREOF). EACH OF THE PARTIES HERETO FURTHER AGREES THAT PROCESS MAY BE SERVED UPON IT BY CERTIFIED MAIL, RETURN RECEIPT REQUESTED, ADDRESSED AS MORE GENERALLY PROVIDED IN SECTION 9.3 HEREOF, AND CONSENTS TO THE EXERCISE OF JURISDICTION OVER IT AND ITS PROPERTIES WITH RESPECT TO ANY ACTION, SUIT OR PROCEEDING ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT OR THE 31 TRANSACTIONS CONTEMPLATED HEREBY OR THE ENFORCEMENT OF ANY RIGHTS UNDER THIS AGREEMENT. 9.15 Entire Agreement. This Agreement, including the Schedules and ---------------- Exhibits referred to herein, is complete, and all promises, representations, understandings, warranties and agreements with reference to the subject matter hereof, and all inducements to the making of this Agreement relied upon by all the parties hereto, have been expressed herein or in said Schedules or Exhibits. This Agreement may not be amended except by an instrument in writing signed on behalf of the Company and Buyer. 32 IN WITNESS WHEREOF the parties hereto have executed this Agreement under seal as of the date first set forth above. ONE WORLD SYSTEMS, INC. /s/ Neil Selvin ------------------------------- President TUT SYSTEMS, INC. /s/ Nelson Caldwell ------------------------------- Chief Financial Officer 33 TABLE OF SCHEDULES - ------------------ TITLE ----------------------------------- Schedule 2.1 Fixed Assets Schedule 2.2 Retained Assets Schedule 2.3 Assumed Liabilities Schedule 3.1 Qualification Schedule 3.2 No Violations Schedule 3.3 OneWorld Financial Statements Schedule 3.4 Liabilities Schedule 3.5 Material Liens or Defects Schedule 3.6 Assets; Condition Schedule 3.7 Accounts Receivable Schedule 3.8 Inventories Schedule 3.9 Intellectual Property Schedule 3.10 Contracts Schedule 3.11 Necessary Permits Schedule 3.12 Taxes Schedule 3.13 Employee Agreements Schedule 3.14 Litigation Schedule 3.15 Warranty and other Claims Schedule 4.1 Organization and Qualification EXHIBIT A --------- Bill of Sale EXHIBIT B --------- Form of Assigment and Assumption Agreement EXHIBIT C --------- Form of License Agreement EX-2.5 3 AM. 1 TO ASSET PURCHASE AGREEMENT EXHIBIT 2.5 AMENDMENT NO. 1 TO ASSET PURCHASE AGREEMENT The Amendment No. 1 to Asset Purchase Agreement (the "Amendment") dated as of February 17, 2000 by and between TUT SYSTEMS, INC., a Delaware corporation ("Buyer"), and ONEWORLD SYSTEMS, INC., a Delaware corporation (the "Company"), amends certain provisions of the Asset Purchase Agreement (the "Agreement") dated as of February 3, 2000, by and between Buyer and the Company. ARTICLE I AMENDMENT. 1.1 Section 2.5 of the Agreement shall be amended and restated in its entirety as follows: "2.5 Purchase Price. Upon the terms and subject to the conditions -------------- contained in this Agreement, in reliance upon the representations, warranties and agreements of the Company contained herein, and in consideration of the sale, assignment, transfer and delivery of the Transferred Assets, Buyer will assume the Assumed Liabilities and will pay an aggregate purchase price of $2,330,000 (the "Purchase Price"), payable at the Closing in cash by wire transfer of immediately available funds to an account designated by the Company." 1.2 The last sentence of Section 4.4 shall be deleted in its entirety. ARTICLE II MISCELLANEOUS 2.1 Counterparts. This Amendment may be executed in any number of counterparts and by the different parties hereto on separate counterparts, each of which when so executed and delivered shall be an original, but all of which together shall constitute one and the same instrument, and it shall not be necessary in making proof of this Amendment to produce or account for more than one such counterpart. 2.2 GOVERNING LAW. THIS AMENDMENT, INCLUDING THE VALIDITY HEREOF AND THE ------------- RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER, SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF CALIFORNIA APPLICABLE TO CONTRACTS MADE AND TO BE PERFORMED ENTIRELY IN SUCH STATE (WITHOUT GIVING EFFECT TO THE CONFLICTS OF LAWS PROVISIONS THEREOF). EACH OF THE PARTIES HERETO FURTHER AGREES THAT PROCESS MAY BE SERVED UPON IT BY CERTIFIED MAIL, RETURN RECEIPT REQUESTED, ADDRESSED AS MORE GENERALLY PROVIDED IN SECTION 9.3 OF THE AGREEMENT, AND CONSENTS TO THE EXERCISE OF JURISDICTION OVER IT AND ITS PROPERTIES WITH RESPECT TO ANY ACTION, SUIT OR PROCEEDING ARISING OUT OF OR IN CONNECTION WITH THIS AMENDMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY OR BY THE AGREEMENT OR THE ENFORCEMENT OF ANY RIGHTS UNDER THIS AMENDMENT. IN WITNESS WHEREOF the parties hereto have executed this Amendment as of the date first set forth above. ONE WORLD SYSTEMS, INC. /s/ Neil Selvin ------------------------------- President TUT SYSTEMS, INC. /s/ Nelson Caldwell ------------------------------- Chief Financial Officer 2 EX-10.4 4 1998 STOCK PLAN Exihibit 10.4 TUT SYSTEMS INC. 1998 STOCK PLAN INLAND REVENUE APPROVED RULES FOR UK EMPLOYEES ("THE SUB-PLAN") Adopted by the Company on: January 28, 2000 Approved by the Inland Revenue on: Inland Revenue reference no: PricewaterhouseCoopers 9 Greyfriars Road Reading Berkshire RG1 1JG Tel: 0118 959 7111 Fax: 0118 960 7700 Ref: RFM/NJD/4751 SCHEDULE TUT SYSTEMS INC. 1998 STOCK PLAN INLAND REVENUE APPROVED RULES FOR UK EMPLOYEES ("THE SUB-PLAN") 1. General This schedule to the Tut Systems Inc. 1998 Stock Plan ("the Plan") sets out the Inland Revenue Approved Rules for UK Employees ("the Sub-Plan"). 2. Establishment of Sub-Plan Tut Systems Inc. ("the Company") has established the Sub-Plan under section 4(b)(ix) of the Plan, which authorises the Company to establish sub-plans to the Plan(1). 3. Purpose of Sub-Plan The purpose of the Sub-Plan is to enable the grant to, and subsequent exercise by, employees and directors in the United Kingdom, on a tax favoured basis, of options to acquire shares in the Company under the Plan. 4. Inland Revenue approval of Sub-Plan The Sub-Plan is intended to be approved by the Inland Revenue under Schedule 9 to ICTA 1988. 5. Rules of Sub-Plan The rules of the Plan, in their present form and as amended from time to time, shall, with the modifications set out in this schedule, form the rules of the Sub-Plan. In the event of any conflict between the rules of the Plan and this schedule, the schedule shall prevail. 6 Relationship of Sub-Plan to Plan The Sub-Plan shall form part of the Plan and not a separate and independent plan. 7. Interpretation In the Sub-Plan, unless the context otherwise requires, the following words and expressions have the following meanings: 1 Acquiring Company a company which obtains Control of the Company in the circumstances referred to in rule 26; Approval Date the date on which the Sub-Plan is approved by the Inland Revenue under Schedule 9 to ICTA 1988; Associated Company The meaning given to that expression by section 187(2) of ICTA 1988;(2) Close Company The meaning given to that expression by section 414(1) of, and paragraph 8 of Schedule 9 to, ICTA 1988;(3) Consortium the meaning given to that word by section 187(7) of ICTA 1988;(4) Control the meaning given to that word by section 840 of ICTA 1988 and "Controlled" shall be construed accordingly;(5) Date of Grant the date on which an Option is granted to an Eligible Employee determined in accordance with section 14 of the Plan; Eligible Employee An Employee who is: (a) An employee (other than a director) of the Company or a company participating in the Sub-Plan; or (b) a director (other than a non-executive director) of the Company or a company participating in the Sub-Plan who is contracted to work at least 25 hours per week for the Company and its subsidiaries or any of them (exclusive of meal breaks) and who, in either case, does not have at the Date of Grant of an Option, and has not had during the preceding twelve months, a Material Interest in a Close Company which is the Company or a company which has Control of the Company or a member of a Consortium which owns the Company; ICTA 1988 the Income and Corporation Taxes Act 1988; 2 Market Value Notwithstanding section 2(m) of the Plan, (a) in the case of an Option granted under the Sub Plan: (i) if at the relevant time the Shares are listed on the London or New York Stock Exchange, the market value as defined in section 2(m)(i) of the Plan; (ii) if paragraph (i) does not apply, the market value of a Share as determined in accordance with Part VIII of the Taxation of Chargeable Gains Act 1992 and agreed in advance with the Inland Revenue Shares Valuation Division on the Date of Grant of the Option or such earlier date or dates as may be agreed with the Board of Inland Revenue; (b) in the case of an option granted under any other share option scheme, the market value of an ordinary share in the capital of the Company determined under the rules of such scheme for the purpose of the grant of the option; Material Interest The meaning given to that expression by section 187(3) of ICTA 1988;(6) New Option an option granted by way of exchange under rule 26.1; New Shares the shares subject to a New Option referred to in rule 26.1; Option a subsisting right to acquire Shares granted under the Sub-Plan; Optionee an individual who holds an Option or, where the context permits, his legal personal representatives; Ordinary Share Capital the meaning given to that expression by section 832(1) of ICTA 1988; and In this schedule, unless the context otherwise requires: 3 words and expressions not defined above have the same meanings as are given to them in the Plan; the rule headings are inserted for ease of reference only and do not affect their interpretation; a reference to a rule is a reference to a rule in this schedule; the singular includes the plural and vice-versa and the masculine includes the feminine; and a reference to a statutory provision is a reference to a United Kingdom statutory provision and includes any statutory modification, amendment or re-enactment thereof. 8. Companies participating in Sub-Plan The companies participating in the Sub-Plan shall be the Company and any company Controlled by the Company which has been nominated by the Company to participate in the Sub-Plan. 9. Shares used in Sub-Plan The Shares shall form part of the Ordinary Share Capital of the Company and shall at all times comply with the requirements of paragraphs 10 to 14 of Schedule 9 to ICTA 1988.(7) 10. Grant of Options An option granted under the Sub-Plan shall be granted under and subject to the rules of the Plan as modified by this schedule. 11. Identification of Options An Option Agreement issued in respect of an Option shall expressly state that it is issued in respect of an Option. An option which is not so identified shall not constitute an Option. 12. Contents of Option Agreement An Option Agreement issued in respect of an Option shall state: that it is issued in respect of an Option; the date of grant of the Option; the number of Shares subject to the Option; the exercise price under the Option; 4 any performance target or other condition imposed on the exercise of the Option; the date(s) on which the Option will ordinarily become exercisable; and the period during which an Option may be exercised by an Optionee who ceases to be an Eligible Employee.. 13. Earliest date for grant of Options An Option may not be granted earlier than the Approval Date. 14. Persons to whom Options may be granted An Option may not be granted to an individual who is not an Eligible Employee at the Date of Grant. For the avoidance of doubt, Options may not be granted under the Sub-Plan to Consultants. 15. Options non transferable An Option shall be personal to the Eligible Employee to whom it is granted and, subject to rule 25, shall not be capable of being transferred, charged or otherwise alienated and shall lapse immediately if the Optionee purports to transfer, charge or otherwise alienate the Option. Section 12 of the Plan shall be construed accordingly. 16. Limit on number of Shares placed under Option under Sub-Plan For the avoidance of doubt, Shares placed under Option under the Sub-Plan shall be taken into account for the purpose of section 3 of the Plan. 17. Inland Revenue limit ((Pounds)30,000) Notwithstanding section 6(c) of the Plan, an Option may not be granted to an Eligible Employee if the result of granting the Option would be that the aggregate Market Value of the shares subject to all outstanding options granted to him under the Sub-Plan or any other share option scheme established by the Company or an Associated Company and approved by the Board of Inland Revenue under Schedule 9 to ICTA 1988 (other than a savings related share option scheme) would exceed sterling (Pounds)30,000 or such other limit as may from time to time be specified in paragraph 28 of Schedule 9 to ICTA 1988(8). For this purpose, the United Kingdom sterling equivalent of the market value of a share on any day shall be determined by taking the spot sterling/dollar exchange rate for that as shown in the Financial Times. 5 18. Exercise price under Options Notwithstanding section 9(a)(ii) and (iii) of the Plan, the amount payable per Share on the exercise of an Option shall not be less than the Market Value of a Share on the Date of Grant and shall be stated on the Date of Grant. 19. Performance target or other condition imposed on exercise of Option Any performance target or other condition imposed on the exercise of an Option under sections 4(b)(v) and 9(b) of the Plan shall be: 19.1 objective; 19.2 such that, once satisfied, the exercise of the Option is not subject to the discretion of any person; and 19.3 stated on the Date of Grant. If an event occurs as a result of which the Plan Administrator considers that a performance target or other condition imposed on the exercise of an Option is no longer appropriate and substitutes, varies or waives under section 4(b)(x) of the Plan the performance target or condition, such substitution, variation or waiver shall: 19.4 be reasonable in the circumstances; and 19.5 produce a fairer measure of performance and be neither materially more nor less difficult to satisfy. 20. Exercise of Options by leavers If an Optionee ceases to be an Eligible Employee, the Option may be exercised within the post termination period specified in the Option Agreement or, in the absence of a specified period, the period specified in the Plan. Reference in the Plan (section 4(b)(x)) to a discretionary authority to extend the post-termination exercisability period, shall for the purposes of the Sub-Plan be disregarded. 21. Latest date for exercise of Options The period during which an Option shall be capable of being exercised shall be stated in the Option Agreement and any Option not so exercised by that time shall lapse immediately. 22. Material Interest An Option may not be exercised if the Optionee then has, or has had within the preceding twelve months, a Material Interest in a Close Company which is the Company or which is a company which has Control of the Company or which is a member of a Consortium which owns the Company. 6 23. Manner of payment for Shares on exercise of Options The amount due on the exercise of an Option shall be paid in cash or by cheque or banker's draft and may be paid out of funds provided to the Optionee on loan by a bank, broker or other person. Notwithstanding section 9(c)(iv) of the Plan, the amount may not be paid by the transfer to the Company of Shares or any other shares or securities. The date of exercise of an Option shall be the date on which the Company receives the amount due on the exercise of the Option. 24. Issue or transfer of Shares on exercise of Options The Company shall, as soon as reasonably practicable and in any event not later than thirty days after the date of exercise of an Option, issue or transfer to the Optionee, or procure the issue or transfer to the Optionee of, the number of Shares specified in the notice of exercise and shall deliver to the Optionee, or procure the delivery to the Optionee of, a Stock Certificate in respect of such Shares together with, in the case of the partial exercise of an Option, an Option Agreement in respect of, or the original Option Agreement endorsed to show, the unexercised part of the Option, subject only to compliance by the Optionee with the rules of the Sub-Plan and to any delay necessary to complete or obtain: 24.1 the listing of the Shares on any stock exchange on which Shares are then listed; 24.2 such registration or other qualification of the Shares under any applicable law, rule or regulation as the Company determines is necessary or desirable; or 24.3 the making of provision for the payment or withholding of any taxes required to be withheld in accordance with any applicable law in respect of the exercise of the Option or the receipt of the Shares. Sections 10(a) and 16 of the Plan shall be read accordingly. 25. Death of Optionee If an Optionee dies before the tenth anniversary of the Date of Grant, his personal representatives shall be entitled to exercise his Options in accordance with the Plan. If not so exercised, the Options shall lapse immediately. Reference in section 10(d) of the plan, to exercise by a person who acquired the right be bequest or inheritance or under the Optionee's will or the laws of descent and distribution shall be disregarded for the purposes of the Sub-Plan. 26. Change in Control of Tut Systems Inc. 26.1 Exchange of Options If a company ("Acquiring Company") obtains Control of the Company as a result of making: 7 26.1.1 a general offer to acquire the whole of the issued ordinary share capital of the Company which is made on a condition such that if it is satisfied the person making the offer will have Control of the Company; or 26.1.2 a general offer to acquire all the shares in the Company of the same class as the Shares an Optionee may, at any time during the period set out in rule 26.2, by agreement with the Acquiring Company, release his Option in whole or in part in consideration of the grant to him of a new option ("New Option") which is equivalent to the Option but which relates to shares ("New Shares") in: 26.1.3 the Acquiring Company; 26.1.4 a company which has Control of the Acquiring Company; or 26.1.5 a company which either is, or has Control of, a company which is a member of a Consortium which owns either the Acquiring Company or a company having Control of the Acquiring Company. References in Section 13(c) of the Plan to a successor corporation assuming or substituting the Option shall be disapplied for the purposes of the Sub- Plan. 26.2 Period allowed for exchange of Options The period referred to in rule 26.1 is the period of six months beginning with the time when the person making the offer has obtained Control of the Company and any condition subject to which the offer is made has been satisfied. 26.3 Meaning of "equivalent" The New Option shall not be regarded for the purpose of this rule 26 as equivalent to the Option unless: 26.3.1 the New Shares satisfy the conditions in paragraphs 10 to 14 of Schedule 9 to ICTA 1988; and 26.3.2 save for any performance target or other condition imposed on the exercise of the Option, the New Option will be exercisable in the same manner as the Option and subject to the provisions of the Sub- Plan as it had effect immediately before the release of the Option; and 26.3.3 the total market value, immediately before the release of the Option, of the Shares which were subject to the Option is equal to the total market value, immediately after the grant of the New Option, of the New Shares (market value being determined for this purpose in accordance with Part VIII of the Taxation of Chargeable Gains Act 1992); and 8 26.3.4 the total amount payable by the Optionee for the acquisition of the New Shares under the New Option is equal to the total amount that would have been payable by the Optionee for the acquisition of the Shares under the Option. 26.4 Date of grant of New Option The date of grant of the New Option shall be deemed to be the same as the Date of Grant of the Option. 26.5 Application of Sub-Plan to New Option In the application of the Sub-Plan to the New Option, where appropriate, references to "Company" and "Shares" shall be read as if they were references to the company to whose shares the New Option relates and the New Shares, respectively, save that in the definition of "Board" the reference to "Company" shall be read as if it were a reference to Tut Systems Inc. 26.6 Disapplication of Merger/Asset Sale Provisions The provisions of the Plan in Section 13(c) relating to merger or asset sale shall be disapplied for the purposes of the Sub-Plan, however should the Acquiring Company not agree to grant a New Option in accordance with rule 26.1 above, the Option shall fully vest and become exercisable in accordance with the terms of Section 13(c). 27. Rights attaching to Shares issued on exercise of Options All Shares issued on the exercise of an Option shall, as to any voting, dividend, transfer and other rights, including those arising on a liquidation of the Company, rank equally in all respects and as one class with the Shares in issue at the date of such exercise save as regards any rights attaching to such Shares by reference to a record date prior to the date of such exercise. Reference in section 4(b)(v) of the Plan to restrictions/limitations imposed on Option Shares shall be disapplied for the purposes of the Sub- Plan, to the extent that they do not apply to all shares of the same class. 28. Amendment of Sub-Plan Notwithstanding section 15 of the Plan, no amendment of the Sub-Plan shall take effect until it has been approved by the Inland Revenue. 29. Adjustment of Options Notwithstanding sections 4(b)(vi) and (x) of the Plan, no adjustment to an Option shall take effect until it has been approved by the Inland Revenue. Reference in Section 13(a) of the Plan to `stock dividend, combination or reclassification' shall be disapplied for the purposes of the Sub-Plan. 9 30. Exercise of discretion by Plan Administrator In exercising any discretion which it may have under the Sub-Plan, the Plan Administrator shall act fairly and reasonably. 31. Disapplication of certain provisions of Plan The provisions of the Plan dealing with: Incentive Stock Options; Stock purchase rights; Option Exchange Program; Restricted Stock; and Buyout Provisions shall not form part of, and shall therefore be disregarded for the purposes of the Sub-Plan. 10 - ------------------------------ Notes (1) The Company is the "grantor" as defined in paragraph 1 of Schedule 9 to ICTA 1988 because it has established the Sub-Plan. In most cases, it will also be the Company which grants options under the Sub-Plan, although this is not a requirement of UK tax legislation. (2) A company is treated as another's "associated company" at a given time if, at that time or at any other time within one year previously, one of the two has control of the other, or both are under the control of the same person or persons. A person is taken to have control of a company if he exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs and, in particular, if he possesses or is entitled to acquire the greater part of the company's issued share capital or the voting power in the company. UK tax legislation contains two definitions of control: the definition of control here is different from that in paragraph 4 below. (3) A close company is a company which is under the control (as defined in paragraph 1 above) of five or fewer participators (eg shareholders) or of any number of participators who are directors. There are attributed to a participator all the rights and powers (eg shares, voting power) of, inter alia, a company which he controls or of an "associate" (eg relative) of his. Ordinarily, a company is excluded from being a close company if it is non UK resident or 35% of the voting power in the company is held by the public and its shares have been listed, and the subject of dealings, on a recognised stock exchange within the preceding 12 months. However, for the purpose of the material interest test (see paragraph 5 below), this exclusion does not apply with the result that the normal definition of a "close company" is extended. (4) A company is a member of a consortium owning another company if it is one of a number of companies which between them beneficially own not less than three-quarters of the other company's ordinary share capital and each of which beneficially owns not less than one-twentieth of that capital. (5) Control means the power of a person to secure: (a) by means of the holding of shares or the possession of voting power in or in relation to that or any other body corporate; or (b) by virtue of any powers conferred by the articles of association or other document regulating that or any other body corporate that the affairs of the first-mentioned body corporate are conducted in accordance with the wishes of that person. (6) A person has a material interest in a company if he, either on his own or with one or more associates, or if any associate of his with or without such other associates: (a) is the beneficial owner of, or able, directly or through the medium of other companies, or by any other indirect means to control, more than 10 per cent of the ordinary share capital of the company; or (b) where the company is a close company, possesses, or is entitled to acquire, such rights as would, in the event of the winding-up of the company or in any other circumstances, give an entitlement to receive more than 10 per cent of the assets which would then be available for distribution among the participators. (7) The shares used in the scheme must be: 11 - -------------------------------------------------------------------------------- (a) ordinary shares; (b) fully paid up; (c) not redeemable; and (d) save for certain limited exceptions, not subject to any restrictions which do not apply to all shares of the same class. The shares used in the scheme must be: (a) of a class listed on a recognised stock exchange; or (b) shares in a company which is not under the control of another company; or (c) shares in a company which is under the control of another company (other than a company which is, or would if resident in the UK be, a close company) whose shares are listed on a recognised stock exchange. The shares used in the scheme form part of the ordinary share capital of: (a) the grantor (ie the company which has established the scheme); or (b) a company which has control of the grantor; or (c) a company which either is, or has control of, a company which is a member of a consortium owning either the grantor or a company having control of the grantor. Where the company whose shares are to be used in a scheme has more than one class of ordinary share, the majority of the issued shares of the same class as those which are to be used must be either employee control shares (see below) or: (a) must not be held by persons (including trustees holding shares on behalf of such persons) who acquired their shares in pursuance of a right conferred on them or opportunity offered to them as directors or employees of any company, and not in pursuance of an offer to the public; and (b) if the shares are not listed on a recognised stock exchange and the company is under the control of another company whose shares are so listed, must not be held by companies which have control of the company whose shares are in question or of which that company is an associated company. Shares are employee control shares if: (a) the persons holding them are, by virtue of their holding of shares of that class, together able to control the company; and (b) those persons are, or have been, employees or directors of the company or of another company which is under the control of the company. (8) UK tax legislation imposes a limit (currently (Pounds)30,000) on the "value" of the outstanding options which may be held by an individual participant in an Inland Revenue approved executive share option scheme. 12 EX-10.11 5 EMPLOYMENT AGREEMENT EXHIBIT 10.11 EMPLOYMENT AGREEMENT This Employment Agreement is entered into by and between Tut Systems, Inc., a Delaware corporation ("Tut Systems"), FreeGate Corporation, a Delaware corporation ("FreeGate"), and Sandy Benett ("Employee") as of November 17, 1999. Recitals A. Pursuant to that certain Agreement and Plan of Reorganization (the "Merger Agreement") dated as of November 15, 1999 by and among Tut Systems, FreeGate Acquisition Corporation ("Sub") and FreeGate, Sub will merge with and into FreeGate (the "Merger") and any shares of FreeGate capital stock and vested options to acquire such shares of capital stock owned by Employee will be exchanged for Tut Systems Common Stock; B. Employee has served as President and Chief Operating Officer at FreeGate and has gained substantial knowledge and expertise in connection with FreeGate's products, organization and customers; C. Tut Systems desires to provide for the continued services of Employee following the Merger; D. As inducement to Tut Systems to consummate the Merger, and in consideration of the amounts paid to stockholders of FreeGate under the Merger Agreement, Employee desires to agree with Tut Systems as further provided herein; NOW, THEREFORE, intending to be legally bound hereby, the parties hereto agree as follows: Agreement 1. Employment ---------- 1.1 Period of Employment. Contingent upon the Closing of the Merger, Tut -------------------- Systems hereby agrees to employ Employee to render services to Tut Systems in the position and with the duties and responsibilities described in Section 1.2 for the period (the "Period of Employment") commencing on the Closing (as -------------------- defined in the Merger Agreement) and ending upon the earlier of (i) eighteen (18) months from such date (the "Term Date"), and (ii) the date the Period of --------- Employment is terminated in accordance with Section 1.4. 1.2 Position, Duties, Responsibilities. ---------------------------------- (a) Position. Contingent upon the closing of the Merger (the -------- "Closing"), Employee hereby accepts employment with Tut Systems as Executive Vice President - Products and Support. Subject to a review of performance by the President and Board of Directors of Tut Systems, with such review to occur prior to June 1, 2000, the employment position will be changed to that of Chief Operating Officer, which shall include a reconsideration of commesurate salary and granting of options to purchase 75,000 shares of Tut Systems common stock (subject to approval by the Board of Directors). Employee agrees to devote his or her entire time, attention, energies and skills during usual business hours (and outside those hours when reasonably necessary to the performance of his or her duties hereunder) to the business and interests of Tut Systems during the Period of Employment. However, Employee may (i) devote a reasonable amount of his or her time to civic, community, or charitable activities, and, with the prior approval of the Tut Systems the Board of Directors, to serve as a director of other corporations and to other types of business or public activities not expressly mentioned in this paragraph, (ii) take usual, ordinary and customary periods of vacation, (iii) except as otherwise provided for total disability (as hereinafter defined), be absent due to illness or other allowed absences in accordance with Tut Systems policies, and (iv) devote a reasonable amount of time to academic activities (including, but not limited to, teaching and lecturing) for which Employee does not receive significant compensation. (b) Other Services. Employee may be required in pursuance of his or -------------- her duties hereunder to perform services for any affiliated company but shall not be entitled to any additional compensation for such services. Employee shall obey all reasonable policies of Tut Systems and reasonable applicable policies of its affiliated companies. 1.3 Compensation, Benefits, Expenses. -------------------------------- (a) Base Salary. In consideration of the services to be rendered ----------- hereunder, including, without limitation, services to any affiliated company, Employee shall be paid an annual salary of $150,000(the "Base Salary"), payable at the time and pursuant to the procedures regularly established, and as such time and procedures may be amended, by Tut Systems during the Period of Employment. Tut Systems shall review the Base Salary and in light of such review may, in its discretion, increase the Base Salary, taking into account Employee's responsibilities. (b) Incentive Compensation; Bonuses. In addition to Base Salary, ------------------------------- the Employee shall be entitled to (i) participate in the cash incentive bonus program, initially set at $50,000 per year (paid quarterly based on achievement of mutually agreed to objectives), (ii) participate in any other incentive plans in effect from time to time, and (iii) receive such other bonuses or discretionary compensation payments as the Board of Directors may determine from time to time. Any bonus and incentive plans covered by this subparagraph 1.3(b) shall be referred to herein in the aggregate as the "Incentive Plans." (c) Benefits Plans. Employee shall be entitled to such employee -------------- benefit plans and other terms and conditions of employment as Tut Systems generally provides to its employees. These include, but are not limited to, employee health plans, cafeteria plans, Employee Stock Purchase Plans and Stock Option Plans. An option to purchase 125,000 shares of Tut Systems common stock under Tut Systems 1998 Stock Plan , subject to approval by the Board of Directors, at fair market value at the close of business the day prior to the beginning of the Period of -2- Employment, will be granted to the Employee. (d) Expenses. During the Period of Employment, the Employee shall -------- be entitled to receive prompt reimbursement in accordance with the policies and procedures of Tut Systems for all reasonable expenses incurred by the Employee in the normal course of Tut Systems business. 1.4 Termination of Employment. ------------------------- (a) By Death. The Period of Employment shall terminate automatically -------- upon the death of Employee. Tut Systems shall pay to Employee's beneficiaries or estate, as appropriate, the Compensation and Benefits to which he or she is entitled through the end of the month in which death occurs. Thereafter, Tut Systems's obligations hereunder shall terminate. Nothing in this Subsection (a) shall affect any entitlement of Employee's heirs to the benefits of any life insurance plan. (b) By Disability. If, during the term of this Agreement, Employee ------------- should become Totally Disabled (as hereinafter defined), Tut Systems shall have the right, to the extent permitted by law, in its sole discretion, to terminate this Agreement and Employee's employment with Tut Systems, in which case Employee's Compensation and Benefits shall be paid up through the last day of the month in which it has been determined that Employee has become Totally Disabled. Nothing in this Subsection (b) shall affect Employee's rights under any disability plan in which he or she is a participant. For purposes hereof, Employee shall be considered "Totally Disabled" if (i) Employee is entitled to ---------------- benefits under any long-term disability income plan applicable to Employee or (ii) Employee's physical and/or mental condition is such that Employee is unable to perform those duties Employee would otherwise be expected to continue to perform as an employee of Tut Systems, and Employee's non-performance of such duties can reasonably be expected to continue or does continue for not less than six (6) months. The determination that Employee is Totally Disabled shall be made by a qualified medical examiner reasonably acceptable to Tut Systems. (c) By Tut Systems for Cause. Tut Systems may terminate, without ------------------------ liability, the Period of Employment for Cause (as defined below) at any time and upon written notice to Employee. Tut Systems shall pay Employee his or her Compensation and Benefits through the date of such notice and thereafter Tut Systems's obligations hereunder shall terminate. Termination shall be for "Cause" if (i) Employee commits a material breach of Tut Systems policies and ----- procedures to the detriment of Tut Systems or any affiliated company; (ii) Employee is convicted of a felony or other criminal act involving moral turpitude; (iii) Employee willfully fails to perform his or her reasonable employment duties (other than any such failure resulting from Employee's incapacity due to physical or mental illness) after a written demand for substantial performance is delivered to Employee by Tut Systems, which demand specifically identifies the manner in which Tut Systems believes that Employee has not substantially performed his or her duties; or (iv) Employee breaches any material term of this Agreement or the Employee Confidentiality Agreement (as defined in Section 2.4 below), which breach causes or is reasonably expected to cause material harm to Tut Systems, and, as to any such breach which is subject to cure, such failure or breach continues for a period of ten (10) days after Employee receives written notice of such breach from Tut Systems. -3- (d) Termination By Tut Systems Without Cause. Tut systems may ---------------------------------------- terminate this Agreement without cause on sixty (60) days notice. If Tut Systems terminates this Agreement without cause, then Tut Systems shall pay, on the date of termination, the total amount that would be due under this Agreement had Employee continued as an employee until the end of the Agreement's term. For purposes of this Agreement a termination "without cause" shall mean a termination by Tut Systems for a reason other than that described in Sections 1.4(a), (b) or (c), above. (e) By Employee. Employee will be entitled to terminate his or her ----------- Employment for Good Reason (as defined below) at any time within 180 days after the facts or circumstances constituting such Good Reason first exist and are known to Employee. For purposes of this Agreement, "Good Reason" shall be defined as (i) any violation by Tut Systems of any material provision of this Agreement or (ii) any action by Tut Systems which results in the constructive termination of Employee. If Employee terminates this Agreement for Good Reason, then Tut Systems shall pay, on the date of termination, the total amount that would be due under this Agreement had Employee continued as an employee until the end of the Agreement's term. 1.5 Relocation. Tut Systems agrees that, without the Employee's express ---------- consent, Employee will not be required to make special commute arrangements should Tut Systems consolidate the Sunnyvale, CA office with a headquarters office or relocate the Sunnyvale office, in either case, to a location outside of a 30-mile radius from the current Sunnyvale office, and as such, may terminate this employment agreement. 2 . Miscellaneous ------------- 2.1 Successors, Assigns, Merger. This Agreement shall be binding upon and --------------------------- shall inure to the benefit of Tut Systems and its successors and assigns. Notwithstanding any assignment by Tut Systems, Tut Systems shall remain liable for the payment of all Compensation and Benefits payable to Employee under this Employment Agreement. This Agreement shall be binding upon Employee and shall inure to his or her benefit and to the benefit of his or her heirs, executors, administrators and legal representatives, but shall not be assignable by Employee. 2.2 Entire Agreement. This Agreement constitutes the entire agreement ---------------- between Tut Systems and Employee relating to his or her employment and the additional matters herein provided for. This Agreement supersedes and replaces any prior verbal or written agreements between the parties. This Agreement may be amended or altered only in a writing signed by the President of Tut Systems and Employee. 2.3 Applicable Law; Severability. This Agreement shall be construed and ---------------------------- interpreted in accordance with the laws of the State of California without regard to conflicts of laws and principles. Each provision of this Agreement is severable from the others, and if any provision hereof shall be to any extent unenforceable it and the other provisions hereof shall continue to be enforceable to the full extent allow Tut Systems, as if such offending provision had not been a part of this Agreement. -4- 2.4 Proprietary Information Agreement. Employee shall execute Tut --------------------------------- Systems's Confidentiality and Disclosure Agreement in the form attached hereto as Exhibit A concurrent with his or her execution of this Agreement. --------- 2.5 Effectiveness. This Agreement shall become effective upon the Closing, ------------- and, if the Closing does not occur prior to February 29, 2000, this Agreement shall immediately terminate and be of no further force or effect. 2.6 Arbitration. The Employee and Tut Systems agree that any and all past ----------- or present dispute or controversy arising out of or relating to this Agreement, other than matters related to the Confidentiality and Disclosure Agreement, shall be subject to binding arbitration held in San Mateo County, California, under the Arbitration Rules set forth in California Code of Civil Procedure Section 1280 through 1294.2, including Section 1283.05 (the "Rules") and pursuant to California law. Each party shall be allowed to take three (3) depositions and to make a reasonable request for documents. The arbitrator shall be knowledgeable in the industry and shall be mutually agreed upon by the Employee and Tut Systems. If an arbitrator cannot be mutually agreed upon, each party shall select an arbitrator and the two arbitrators shall select a third to constitute an arbitration panel. Any arbitration shall take place within sixty (60) days of the initial demand or, if the parties are unable to agree on a mutual arbitrator, then within sixty (60) days of the date the three person panel is chosen, except if the arbitrator(s) are unable to hold the arbitration within such time period then the arbitration shall be held based upon the availability and schedule of such arbitrator(s). (a) Equitable Remedies. Employee agrees that if he or she breaches ------------------ any Section of this Agreement, Tut Systems will have available, in addition to any rights under this Arbitration Provision, the right to obtain an injunction from a Court of competent jurisdiction restraining such breach or threatened breach and to specific performance. Employee further agrees that no bond or other security shall be required in obtaining such equitable relief and hereby consents to the issuance of such injunction and to the ordering of specific performance. -5- IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the date first written above. FREEGATE COMMUNICATIONS, INC. TUT SYSTEMS, INC. By:/s/ Jean-Marc Frailong By: /s/ Nelson B. Caldwell ---------------------- ---------------------- Its: Founder and Chief Technology Officer By: Nelson B. Caldwell ------------------------------------ ---------------------- EMPLOYEE /s/ Sandy Benett -------------------------- Name: Sandy Benett [Signature Page to Employment Agreement] -6- Exhibit A --------- Form of Confidentiality and Discolsure Agreement. EX-10.12 6 NON-COMPETITION AGREEMENT EXHIBIT 10.12 TUT SYSTEMS, INC. NON-COMPETITION AGREEMENT THIS NON-COMPETITION AGREEMENT (the "Agreement") dated as of November 17, 1999 (the "Effective Date") (as defined below) by and between Tut Systems, Inc., a Delaware corporation ("TUT"), Freegate Corporation, a Delaware corporation and wholly owned subsidiary of TUT (the "Company"), and Sandy Benett ("Stockholder"). Capitalized terms used but not otherwise defined herein shall have the meanings ascribed to them in the Agreement and Plan of Reorganization (as defined below). Background A. TUT, the Company, Freegate Acquisition Corporation, a Delaware corporation and wholly owned subsidiary of TUT ("Sub"), and, with respect to Article VII thereto, James Mongiello, as Stockholder Representative, and U.S. Bank Trust, as Escrow Agent, have entered into an Agreement and Plan of Reorganization dated as of November 16, 1999 (the "Reorganization Agreement"), which provides for the merger (the "Merger") of Sub with and into the Company. The effective date of the consummation of the Merger shall be the Effective Date of this Agreement. B. Stockholder has entered into an Employment Agreement with TUT and the Company dated November 17, 1999. C. Stockholder is receiving significant consideration pursuant to the terms of the Reorganization Agreement. D. As a condition to the Merger and to preserve the value of the business being acquired by TUT, the Reorganization Agreement contemplates, among other things, that Stockholder enter into this Agreement and that this Agreement become effective upon the closing of the Merger. E. The Company and TUT are each currently engaged or planning to engage in its business in each of the fifty (50) states of the United States and certain other countries throughout the world. TUT and the Company, following the Merger, will continue conducting such business in all parts of the United States and certain other countries throughout the world. NOW THEREFORE, in consideration of the mutual promises made herein, TUT, Sub and Stockholder (collectively referred to as the "Parties") hereby agree as follows: 1. Covenant Not to Compete or Solicit. (a) Beginning on the Effective Date and ending eighteen (18) months following the Closing Date (the "Non-Compete Period"), Stockholder shall not, other than on behalf of the Company or TUT, directly or indirectly, without the prior written consent of TUT, engage anywhere in the Geographic Area in (whether as an employee, agent, consultant, advisor, independent contractor, proprietor, partner, officer, director or otherwise), or have any ownership interest in (except for passive ownership of five percent (5%) or less of any entity whose securities have been registered under the Securities Act of 1933 or Section 12 of the Securities Exchange Act of 1934), or participate in the financing, operation, management or control of, any firm, partnership, corporation, entity or business that engages or participates in a "competing business purpose." The term "competing business purpose" shall mean the design, development, marketing and sale of any product competing with a product that was planned, designed, marketed or sold by Tut or the Company while Stockholder was employed by Tut or the Company. Notwithstanding the foregoing, in the event Stockholder's employment with the Company is terminated by the Company without Cause (as defined in the Stockholder's Employment Agreement with the Company) or by Employee for Good Reason (as defined in the Stockholder's Employment Agreement with the Company), then the Non-Compete Period shall terminate upon the earlier to occur of (i) one (1) year following the date of such termination of employment or (ii) eighteen (18) months following the Closing Date. (b) During the Non-Compete Period, Stockholder shall not, directly or indirectly, without the prior written consent of TUT or the Company, solicit, encourage, hire or take any other action which is intended to induce or encourage, or has the effect of inducing or encouraging, any employee of TUT, any subsidiary of TUT or the Company to terminate his or her employment with TUT, any subsidiary of TUT or the Company. (c) The Geographic Area shall mean (i) the United States or (ii) anywhere in the world outside the United States where Parent or any subsidiary of Parent conducts business that falls within the definition of a "competing business purpose" in Section 1(a) above. (d) The covenants contained in the preceding paragraphs shall be construed as a series of separate covenants, one for each county, city, state, or any similar subdivision in any Geographic Area. Except for geographic coverage, each such separate covenant shall be deemed identical in terms to the covenant contained in the preceding paragraphs. If, in any judicial proceeding, a court refuses to enforce any of such separate covenants (or any part thereof), then such unenforceable covenant (or such part) shall be eliminated from this Agreement to the extent necessary to permit the remaining separate covenants (or portions thereof) to be enforced. In the event that the provisions of this Section 1 are deemed to exceed the time, geographic or scope limitations permitted by applicable law, then such provisions shall be reformed to the maximum time, geographic or scope limitations, as the case may be, permitted by applicable laws. (e) Stockholder acknowledges that (i) the goodwill associated with the Company prior to the Merger is an integral component of the value of the Company to TUT and is reflected in the consideration to be received by Stockholder in the Merger, and (ii) Stockholder's Agreement as set forth herein is necessary to preserve the value of the Company for TUT following the Merger. -2- (f) Stockholder also acknowledges and agrees that the limitations of time, geography, and scope of activity set forth in this Agreement are reasonable because, among other things, (i) the Company and Parent are engaged in a highly competitive industry, (ii) the Stockholder has unique access to, and will continue to have access to, the trade secrets and know how of the Company, including without limitation the plans and strategy (and in particular the competitive strategy) of the Company, (iii) the Stockholder is receiving significant compensation in connection with the Merger, and (iv) in the event the Stockholder's employment with the Company ended, the Stockholder would be able to obtain suitable and satisfactory employment without violation of this Agreement. (g) Equitable Remedy. Stockholder agrees that it would be impossible or inadequate to measure TUT's or the Company's damages from any breach of the covenants set forth in this Section 1. Accordingly, Stockholder agrees that if he breaches any provision of this Section 1, TUT or the Company will have available, in addition to any other right or remedy otherwise available, the right to obtain an injunction from a court of competent jurisdiction restraining such breach or threatened breach and to specific performance of any such provision of this Agreement. Stockholder further agrees that no bond or other security shall be required in obtaining such equitable relief, nor will proof of actual damages be required for such equitable relief. Stockholder hereby expressly consents to the issuance of such injunction and to the ordering of such specific performance. (h) Stockholder's obligations under this Agreement shall remain in effect if Stockholder's employment with TUT or the Company is terminated. 2. Arbitration; Consent to Personal Jurisdiction. (a) Stockholder agrees that, except as provided in Section 1(g) above, any dispute or controversy arising out of, relating to, or in connection with this Agreement, or the interpretation, validity, construction, performance, breach, or termination thereof, shall be settled by binding arbitration to be held in California, in accordance with the Commercial Arbitration Rules of the American Arbitration Association, supplemented by the Large Complex Case Procedures of the American Arbitration Association (the "Rules"). The arbitrator may grant injunctions or other relief in such dispute or controversy. The decision of the arbitrator shall be final, conclusive and binding on the parties to the arbitration. Judgment may be entered on the arbitrator's decision in any court having jurisdiction. (b) At the request of either party, the arbitration proceedings pursuant hereto will be conducted confidentially. In such case all documents, testimony and records shall be received, heard and maintained by the arbitrator(s) in confidence under seal, available for inspection only by the arbitrator(s), the parties and their respective attorneys and their respective experts, who shall agree in advance and in writing to receive all such information confidentially and to maintain such information in confidence. (c) The arbitrator(s) shall apply California law to the merits of any dispute or claim, without reference to rules of conflicts of law. The arbitration proceedings shall be governed by federal arbitration law and by the Rules, without reference to state arbitration law. -3- (d) The arbitrator shall determine how all expenses related to the arbitration shall be paid, including without limitation, the respective expenses (including reasonable attorneys' fees) of each party, the fees of the arbitrator and the administrative fee of the American Arbitration Association. (e) STOCKHOLDER HAS READ AND UNDERSTANDS THIS SECTION 2, WHICH DISCUSSES ARBITRATION. STOCKHOLDER UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, STOCKHOLDER AGREES TO SUBMIT ANY CLAIMS ARISING OUT OF, RELATING TO, OR IN CONNECTION WITH THIS AGREEMENT, OR THE INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE, BREACH OR TERMINATION THEREOF TO BINDING ARBITRATION, AND THAT THIS ARBITRATION CLAUSE CONSTITUTES A WAIVER OF STOCKHOLDER'S RIGHT TO A JURY TRIAL AND RELATES TO THE RESOLUTION OF ALL DISPUTES RELATING TO THIS AGREEMENT. 3. Miscellaneous. (a) Governing Law. This Agreement shall be governed by the laws of the State of California without reference to rules of conflicts of law. (b) Severability. If any portion of this Agreement is held by an arbitrator or a court of competent jurisdiction to conflict with any federal, state or local law, or to be otherwise invalid or unenforceable, such portion of this Agreement shall be of no force or effect and this Agreement shall otherwise remain in full force and effect and be construed as if such portion had not been included in this Agreement. (c) No Assignment. Stockholder shall not assign this Agreement or any rights or obligations under this Agreement without the prior written consent of TUT and the Company. This Agreement is specific to TUT and its affiliated entities and may not be assigned by TUT and/or its affiliates to any unaffiliated entity. (d) Notices. All notices and other communications hereunder shall be in writing and shall be deemed given if delivered personally or by commercial messenger or courier service, or mailed by registered or certified mail (return receipt requested) or sent via facsimile (with acknowledgment of complete transmission) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (a) if to TUT or the Company, to: Tut Systems, Inc. 2495 Estand Way Pleasant Hill, CA 94304 Attention: Salvatore D'Auria Telephone No.: (925) 682-6510 Facsimile No.: (925) 682-1841 (b) if to the Stockholder, to: -4- Name: ____________________ Telephone No.: Facsimile No.: (e) Entire Agreement. This Agreement contains the entire agreement and understanding of the parties and supersedes all prior discussions, agreements and understandings relating to the subject matter hereof. This Agreement may not be changed or modified, except by an agreement in writing executed by TUT, the Company and Stockholder. (f) Waiver of Breach. The waiver of a breach of any term or provision of this Agreement, which must be in writing, shall not operate as or be construed to be a waiver of any other previous or subsequent breach of this Agreement. (g) Headings. All captions and section headings used in this Agreement are for convenience only and do not form a part of this Agreement. (h) Counterparts. This Agreement may be executed in counterparts, and each counterpart shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the undersigned. -5- IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. TUT SYSTEMS, INC. STOCKHOLDER /s/ Nelson B. Caldwell /s/ Sandy Benett - --------------------------------- ------------------------------- Signature of Authorized Signatory Signature Nelson B. Caldwell, CFO Sandy Benett - --------------------------------- ------------------------------ Print Name and Title Print Name FREEGATE CORPORATION /s/ Jean-Marc Frailong - --------------------------------- Signature of Authorized Signatory Jean-Marc Frailong - --------------------------------- Print Name and Title [Signature Page to Non-Competition Agreement] -6- EX-21.1 7 LIST OF SUBSIDIARIES EXHIBIT 21.1 TUT SYSTEMS, INC. SUBSIDIARIES FreeGate Corporation PublicPort, Inc. Vintel Communications, Inc. EX-23.1 8 CONSENT OF INDEPENDENT ACCOUNTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-83495 and 333-92759) of Tut Systems, Inc. of our report dated January 20, 2000, except as to Note 14 which is as of February 14, 2000, relating to the financial statements and financial statement schedule, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP San Jose, California February 22, 2000 EX-27 9 FINANCIAL DATA SCEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM *AUDITED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. *Identify the financial statement(s) to be referenced in the legend: 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 13,405 18,831 12,077 335 8,401 56,125 5,556 2,080 65,356 11,709 0 0 0 12 51,510 65,356 26,266 27,807 15,459 25,677 0 0 608 (11,733) 1 (11,734) 0 0 0 (11,969) (1.12) (1.12)
-----END PRIVACY-ENHANCED MESSAGE-----