Form 10-K

Date: February 23, 2006

/s/ RANDALL K. GAUSMAN

Randall K. Gausman

Vice President, Finance and Administration,

Chief Financial Officer and Secretary

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act:

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of voting and non-voting common stock held by non-affiliates of the Registrant was approximately $59,246,751 as of June 30, 2005 based on the closing price of the common stock as reported on The Nasdaq National Market for June 30, 2005. There were 33,561,514 shares of the Registrant’s common stock issued and outstanding on February 21, 2006.

Parts of the Proxy Statement for registrant’s Annual Meeting of Stockholders for fiscal year ended December 31, 2006 are Incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K.

The section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth below contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. When used in this annual report, the words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “seeks,” “should,” “will” or the negative of these terms or similar expressions are generally intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The forward-looking statements contained in this annual report include statements about the following: (1) our belief that the market for enterprise and government video systems will expand as advanced video encoding techniques lower the bandwidth requirements for transmitting video signals, (2) our belief that the lower encoding rates of MPEG-4 AVC will extend the reach of video services and enable high-definition TV to be delivered over bandwidth-constrained copper networks, (3) our anticipation that our acquisition efforts will be focused on targets that will extend our existing video-based products and markets, (4) our expectation that small to medium sized independent telephone operating companies in the United States will remain the primary near-term market for Astria products, (5) our expectation that tier-one telco market opportunities for our products will continue to expand over the next several quarters, (6) our anticipation that we will introduce products to support new technologies, (7) our belief that the market for video and broadband data systems will continue to become more competitive in the future, (8) our belief that our facilities will be suitable and adequate for the present purposes, (9) our belief that our cash and cash equivalents as of December 31, 2005 are sufficient to fund our operating activities and capital expenditures for at least the next twelve months, (10) our expectation that customers outside of the United States will represent a significant and growing portion of our revenue, (11) our belief that our total liability to settle the Whalen v. Tut Systems, Inc. et. al and the In re Copper Mountain Networks, Inc. Initial Public Offering Security litigation will not exceed $7.0 million, (12) our expectation that capital expenditures in 2006 will increase compared with 2005 and will be funded from operations and borrowings from our existing credit facility, (13) our expectation that we will incur losses in the near future, (14) our anticipation that our sales and operating margins will continue to fluctuate, (15) our anticipation that we will continue to invoice foreign sales in U.S. dollars, (16) our expectation that our independent registered public accounting firm will be required to attest to the design and effectiveness of our internal controls over financial reporting, (17) our expectation that we will incur significant additional accounting and legal expenses to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, (18) our anticipation that our cash flows from operations will begin to increase, (19) our expectation that our revenue will increase and our net loss decrease, (20) our expectation that the amount of cash used to fund our operations will decrease in 2006.

The cautionary statements contained in Item 1A and other similar statements contained elsewhere in this report, identify important factors with respect to such forward-looking statements, including certain risks and uncertainties that could cause our actual results, performance or achievements to differ from those expressed or implied by such forward-looking statements.

Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can not assure you that we will attain such expectations or that any deviations will not be material. We disclaim any obligation or undertaking to disseminate any updates or revision to any forward-looking statement contained herein or reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

Our principal executive offices are located at 6000 SW Meadows Road, Suite 200, Lake Oswego, Oregon 97035 and our telephone number is (971) 217-0400. We commenced operations in California in 1991. In January 2004, we relocated our headquarters to Oregon. We were re-incorporated in Delaware in 1998.

We design, develop, and sell digital video processing systems that enable telephony-based and cable-based service providers to deliver broadcast quality digital video signals across their networks. We refer to these systems as digital TV headends or video content processing systems. We also offer digital video processing systems that enable private enterprise and government entities to transport video signals across satellite, fiber, radio, or copper facilities for surveillance and TV production applications.

On June 1, 2005, we acquired Copper Mountain Networks, Inc., referred to in this report as Copper Mountain, for its technology and engineering resources which we have refocused to further address our expanding video market opportunities for delivering advanced video services over coax and fiber networks.

We earn revenue primarily by selling video content processing systems both directly and through resellers to telecommunications service providers. We also earn revenue by selling video transmission systems to TV broadcasters and governments, and by selling broadband transport and service management products directly and through distributors to the hospitality industry and to owners of private multi-tenant campus facilities.

During the years ended December 31, 2003, 2004 and 2005, international sales represented 18.4%, 23.3% and 22.6% of our total sales, respectively.

Historically, traditional telephone companies, or telcos, have been the sole providers of voice services to the residential market in the United States. Beginning in the 1990’s, cable television operators and satellite television providers became the primary providers of multi-channel broadcast TV services. More recently, traditional telephone companies and cable operators have become direct competitors for the growing market for high-speed Internet access. In addition, many large cable system operators have begun to offer local and long distance telephone service to their customers as part of a bundle of services, including voice, data, and video over the same network on the same bill. Thus, telcos are now at risk of losing traditional voice lines to both cable operators offering bundled services and to wireless telephone vendors that compete on mobility and price.

As a result of these competitive threats, both large and small telcos are beginning to use their existing digital subscriber line, or DSL, and fiber-to-the-home infrastructures to offer broadcast TV services and to compete for the end customer with a bundled offering of voice, data, and video services. DSL technologies use sophisticated signal blending techniques to deliver high speed digital signals through copper wires that can then be used to carry video, data, and/or voice services. Fiber-to-the-home refers to optical fiber that is installed from a telephone switch directly to a subscriber’s home. While large US telcos are just beginning deployment of video services, many small independent operating telephone companies, or IOCs, in the United States and international carriers are already installing or planning to install digital video headends to offer broadcast TV service over their DSL and fiber infrastructures. According to a recent release from Infonetics Research in November 2005, the number of IPTV subscribers worldwide is expected to grow to over 53.7 million by the end of 2009.

Technical Challenges for Delivering Broadcast Quality Video over Telco Networks

To deliver broadcast quality video, a non-satellite-based service provider typically must install a digital TV headend to receive both national and local broadcast TV signals and to properly process these signals for delivery over fiber, cable, or copper-based DSL infrastructures. The limitations on the amount of data that telco DSL facilities can transmit in a fixed amount of time (such limitations are often referred to as bandwidth) when compared to the high bandwidth capacity of cable facilities means that telco headends require greater video processing performance. For example, video headends deployed by cable operators have been able to simply pass high-speed satellite-fed TV signals directly to their cable networks without further video compression. Telcos, however, must use video headends that compress the variable data transmission rate of the source signal to a low constant data transmission rate for transmission over their DSL networks. Additionally, telco networks often are comprised of multiple hardware platforms that use varying sets of rules, or protocols, for transmitting signals. Therefore, to deliver video services, telcos require digital TV headends and ancillary video-centric equipment that are capable of converting video signals between different hardware platforms using various protocols.

Technical Advancements Are Increasing the Available Market for Telcos to Deliver Video

The bandwidth and distance limitations of the copper-based infrastructure from the telco to the subscriber’s home constrain both the number of video channels that may be delivered simultaneously over a DSL system and the number of customers that are reachable from a telco central office. Emerging advancements in video compression technology will soon enable high quality video streams to be transported at much lower data transfer speeds. These emerging advancements are expected to lower data transfer rates by more than 35% relative to technologies currently used in existing satellite and cable facilities. These emerging compression advancements also introduce the possibility of delivering high-definition television over bandwidth constrained DSL lines for the first time. Additionally, there are DSL advancements emerging that expand the available bandwidth from the telco to the subscriber’s home thereby supporting higher DSL data transfer rates over longer distances. The combination of these advancements will enable telcos to reach a higher percentage of their customers with a larger number of video channels.

While DSL technology will continue to dominate telco broadband networks for the foreseeable future, telephone companies are also constructing fiber networks to their customers’ homes in certain markets. Though fiber-to-the-home will eliminate bandwidth limitations on delivering higher speed data services and high-quality video offerings, telephone companies deploying fiber-to-the-home will require advanced video processing to convert signals between multiple protocols used in their networks.

Private enterprises and government entities also use digital video processing systems to distribute video for applications that include corporate training, video and film production, video surveillance, and distance education. In these applications, the particular video source to be encoded may be a signal from a local TV station that needs to be brought back to a regional or statewide digital TV headend that may be 100 miles away, it may be a signal received from an outdoor surveillance camera that needs to reach a decoder or personal computer for viewing hundreds of miles away, or it may be a signal from a university seminar that needs to feed multiple remote classroom sites. This market is also characterized by tradeoffs between the cost of long-distance broadband facilities and the cost of video encoding systems to reduce the need for additional bandwidth. We believe that this market will also expand as advanced video encoding techniques lower the bandwidth requirements for transmitting video signals.

Our suite of products is focused on enabling the delivery of broadcast quality video over traditional telco networks. We leverage VTC’s previous 20 years of experience to develop video-based products that meet the special video processing requirements of telcos. Unlike standard cable headends, our Astria digital video headend solution converts the high and varying data transfer rate signal received as input from a satellite or terrestrial

source into a lower constant data transfer rate video stream for subsequent delivery over a telco’s DSL or fiber-to-the-home access network. Our high-performance, cost-effective systems are based on the standards developed by the Motion Pictures Expert Group, or MPEG, including MPEG-1 and MPEG-2. In 2005, we upgraded our Astria family of products to support the new MPEG-4 AVC compression technology that provides lower encoding rates and more advanced interactivity than the current MPEG standards. We believe that the lower encoding rates of MPEG-4 AVC will extend the reach of video services and enable high-definition TV to be delivered over bandwidth-constrained copper networks. Customers for our Astria video content processing systems include independent operating companies in North America, such as D&E Communications Inc., and international incumbent carriers, such as PCCW in Hong Kong.

Our video transmission systems use software and hardware components from our digital TV headend systems packaged in a smaller form factor to encode video signals for transmission over private or government networks. These products are used for applications such as studio-to-transmitter transport, video surveillance, and distance education. We primarily sell our video transmission systems to TV broadcasters and government agencies.

We also offer broadband transport and service management products that enable the provisioning of high speed Internet access and other broadband data services over existing copper networks within hotels and private campus facilities. Customers for our broadband data systems include system integrators, competitive carriers for the hospitality industry and private educational and commercial entities.

Our objective is to be the leading provider of video content processing solutions for the delivery of broadcast video services to residential customers over telephony networks. Key elements of our business strategy are as follows:

Maintain Market Leadership in North American Telco Market for Digital TV Headends

We believe that our installed base of digital video headend systems represents over 50% of the North American headend market for video over DSL services. Our strategy is to maintain this leadership position with continued enhancements to the Astria product line as more and larger telephone companies in North America begin to introduce bundled voice, data and video services. Our development efforts are focused on enhancements to MPEG-4 AVC standard definition products and introducing high definition products to new customers and as an upgrade option to our installed base. MPEG-4 AVC enable our telco customers to address a larger percentage of their geographic market.

While we continue to grow our North American customer base, we will also continue to strengthen our direct sales force and expand our network of value-added distributors and partners. In 2005, we expanded our direct sales force to focus on major European, Middle East, and Asia service providers that see a need for a bundled voice, data and video offering. In the Middle East and Asia, in addition to our direct sales force, we have developed relationships and will continue to develop new relationships with value-added distributors and partners to focus on key opportunities to market and sell our Astria products.

To encourage service providers to more rapidly accept the business case for video over telco networks, we are working simultaneously on several initiatives to:

To deliver a complete end-to-end video solution, we are partnering with leading industry vendors that provide key system elements such as broadband access systems, network switches and routers, customer premises set-top boxes, video-on-demand systems and service management software that, together with our Astria content processor products, provide a complete video solution. As a result, we have focused our business development and strategic marketing efforts on working with such partners to facilitate a cost-effective, ready-to-deploy, high-performance solution based on customers’ architecture and business requirements. Our strategy with these partners is to design, develop, market and sell end-to-end systems solutions that will allow any form of video content (including broadcast TV, video-on-demand and streaming media from the Internet) to be carried over any telephony network to any TV, personal computer, or mobile end-user device.

Selectively Pursue Acquisitions to Expand Our Markets and Product Offerings

In addition to our internal research and development efforts, we continually evaluate acquisitions of companies and technologies that could extend our product offerings, technology expertise, industry knowledge and global customer base. Since 2000, we have completed five acquisitions, including the acquisition of VideoTele.com in November 2002 and the acquisition of Copper Mountain Networks, Inc. in June 2005. The products and technologies that we acquired through these acquisitions have facilitated our entry into new markets, expanded our product line in existing markets, and added additional technical expertise to develop new products for evolving markets in the future. Going forward, we anticipate our acquisition efforts will be focused on targets that will further extend our existing video-based products and markets.

We design, develop and sell video content processing systems and broadband transport and service management products. Our digital TV headend system enables telephony-based service providers to transport broadcast quality digital video signals across their networks and our digital video transmission systems optimize the delivery of video signals across enterprise, government and education networks. Our broadband transport and service management products enable the transmission of broadband data over existing hotels and private campus networks.

Our video processing products must interoperate with other products from third-parties to enable a complete end-to-end broadcast TV system. To ensure proper interoperation for our customers, we offer a system integration service whereby we purchase, assemble, configure and test key components together before delivering the integrated system to the customer. Typical third-party components include satellite receivers, antennas and decoders, network switches and routers, radio frequency modulation units, and service management software.

Astria CP (Content Processor). Our Astria CP is a digital video processing platform typically used by carriers at a digital TV headend location to convert hundreds of TV channels into low, constant-data-transmission-rate video formats for delivery over any broadband access network. It is a third-generation, video processing system that we have specifically designed for the digital TV marketplace. The Astria CP uses our

QualView^™ software applications that employ patented and patent pending technologies to deliver high quality video when converting satellite-based variable data transmission rate video and audio signals to low, constant-data-transmission-rate content for delivery over telco networks. These QualView applications can separate the desired TV channels from a mix of over 200 channels received from various satellites, lower the data transmission rate of the desired channels, and convert the video signals to the appropriate network interface and protocol. The Astria CP also supports encoder modules that convert uncompressed video signals to compressed constant-data-transmission-rate video streams.

Each Astria CP can process up to 200 video and audio channels, depending on the type of processing required. The Astria CP works with various telephone company copper, fiber, or cable networks providing ultimate flexibility when designing a commercial video delivery system. The Astria CP may be populated with a mix of video encoders and flexible processor modules, which in turn may be configured and reconfigured with a simple QualView software download to enable a variety of video processing functions. Up to 12 system modules may be configured within a single Astria chassis.

The Astria CP processes video content in standard MPEG-1 or MPEG-2 formats as well as MPEG-4 AVC encoding technology. MPEG-4 AVC provides lower encoding rates and more advanced interactivity than previous MPEG standards provided. We deployed the first commercial Astria CP supporting MPEG-4 AVC in the first half of 2005. This model of our Astria CP enables our customers to reach the next stage of video transmission rate reduction without having to upgrade their complete headend, thus preserving the customer’s original investment.

Astria RCP (Remote Content Processor). For service providers delivering digital TV over regional or statewide networks, our Astria RCP provides an affordable way to distribute video signals sourced from a single digital TV headend. The Astria RCP typically accepts pre-processed TV channels from a centralized Astria CP via a fiber backbone network and performs appropriate network and protocol conversion for delivery of the video streams over a variety of telco access networks. The Astria RCP can also be used to encode and compress local TV channels and to insert advertisements into the feeds from national or local channels. This flexibility allows service providers to place Astria RCPs at the edge of a fiber optic transport network to deliver aggregated and localized content to a specific region or community. The ability to add or drop channels into the line-up at the edge of the transport network allows service providers to incorporate local programming, advertising, and emergency alert system content. This capability enables a service provider to offer a customized mix of channels and content that is relevant to local subscribers. The Astria RCP is available in four-, two- and one- slot form factors.

Several service providers have announced plans to offer MPEG-4 AVC signals over a satellite infrastructure. If these services become available, the Astria RCP can be used at a receiving site to perform protocol translation, local channel encoding, and local ad insertion as if the national content came from a fiber network instead of a satellite network.

Astria VSP (Video Service Processor). Our Astria VSP is a high-density integrated platform for simulcasting both analog and digital video programs at the edge of a carrier’s IP network. The Astria VSP provides scalability, flexibility and reliability built on a powerful, highly programmable architecture consisting of network processors, Field Programmable Gate Arrays, or FPGAs and Digital Signal Processors or DSPs. As cable multiple system operators, or (MSOs), and telco service providers seek to leverage the cost and operational benefits of IP networks to deliver advanced video services, intelligent devices are required at the edge of these IP networks where they meet last-mile radio frequency, or RF, access networks. At the IP edge the Astria VSP converts video and audio channels to both analog and digital formats for delivery over either coax cable in the case of cable MSOs or fiber to the premises, or FTTP, in the case of telco service providers.

Aveon ^™Element Management System. Our Aveon Element Management System enables the service provider to configure and monitor Astria CP and RCP systems across wide area networks. The ability to use

Aveon to create a single network view of the system gives service providers a simple to use yet powerful tool for controlling all aspects of operating a video network from a single management location.

T-View ^™Element Management System. Our T-View Element Management System supports the Astria VSP, Astria CP, and third-party network elements. T-View is a proven application that has been deployed in one of the world’s largest broadband networks managing over 3000 remote nodes. It provides complete graphical-user-interfaces for all network operations functions and easy integration with service providers’ operations support systems.

Video Transmission Systems for Enterprise and Government Applications. Our video transmission system leverages the software components and hardware modules used within the Astria CP, but is packaged in a smaller form factor for private enterprise and government markets.

Our video transmission system delivers mission critical, high-quality video in real-time for private network applications or local encoding at the edge of networks used for public broadcast service. Each chassis is designed to hold multiple encoders, decoders and network interfaces. It supports up to 6 system modules in contrast to the Astria CP that supports up to 12 system modules. The system works across satellite, radio, or fiber networks. An embedded web server controls and manages the system via an intuitive web-based graphical user interface, enabling administration of the product from any location on the network. Our video transmission system is also supported by third-party scheduling software for video conferencing and distance learning applications.

In addition to our video processing products, we sell broadband transport and service management products. The market for these systems is characterized by the need to transport high-speed data signals across private buildings or campus locations, where the only available transmission facility is composed of copper telephone wires. We have been a participant in this market since the introduction of our first XL Ethernet extension product in 1992. Applications within this market include: (i) connecting hotel guests to broadband Internet services over the hotel’s telephone wires, (ii) connecting video surveillance cameras, back office PC’s, and railroad station ticket machines to a backbone network, and (iii) connecting two local area networks, or LANs, across a business campus without having to run new wires or cables.

Our Expresso line of products uses proprietary transmission technology to provide a low-cost, easy to install solution that can deliver broadband Internet access to multiple nodes over a single pair of copper wire for broadband Internet applications across multi-tenant complexes such as hotels, apartments and private campus facilities. Optional high-speed DSL configurations enable our customers to deliver broadcast TV, video-on-demand service, and Internet service throughout a multi-tenant complex.

Our XL line of Ethernet extension products is often used by individual enterprises to extend their data networks over distances that cannot be accommodated by standard Ethernet wiring. Various XL products operate over distances of up to 20,000 feet, at data transmission rates up to 10 Mbps, all over a single pair of ordinary telephone wires. In certain situations, these XL products are used in combination with our video transmission system products to support the encoding of local content to feed digital video headends.

Our Expresso and XL transport products are augmented by our Expresso subscriber management system, which authenticates users, manages bandwidth and IP addresses, and processes credit card or password information for billing purposes. Subscriber management systems are typically found in hotels that offer broadband Internet service to guests, in campus housing complexes to manage broadband Internet access, and in wireless Wi-Fi “hot spots” such as hotel lobbies and Internet cafes.

Our target customers for our Astria video content processing systems are telephony-based incumbent local exchange companies, independent operating telephone companies and international post, telephone and telegraph

companies that aim to deliver advanced video services over their existing copper, fiber or coaxial cable infrastructures. Target customers for our video transmission systems include TV broadcasters and government agencies. Target customers for our broadband data systems are system integrators, competitive carriers for the hospitality industry, and private educational and commercial entities.

Over 150 service providers now use our Astria products to deliver digital TV over DSL and other broadband networks. We installed our first commercial digital TV headend at Chibardun Telephone Cooperative in Dallas, Wisconsin in 2000. Since that time, we have deployed our digital TV headend solution throughout the world to service providers that range in size from 5,000 to more than 500,000 access lines.

Our international sales to service providers have been concentrated primarily in Asia, Europe, the Middle East, and Mexico. In 2002, Telenor AS, Norway’s largest telecommunications provider with more than 1.8 million customers, launched digital TV services over its network using an Astria CP. In 2003, PCCW, which acquired the former Hong Kong Telephone Company in 2000, launched service to its customers from an Astria headend and signed up more than 150,000 customers to its Broadband TV service in the first two months after launch. Currently, PCCW is delivering service to more than 500,000 customers from an Astria headend. Additionally in 2003, our broadband transport and service management products were deployed by Telefonos de Mexico, S.A., or TelMex, to offer a national “hot spot” wireless Internet in Mexico’s major public facilities such as airports, hotel lobbies, restaurants and hospitals.

We expect the small to medium sized independent telephone operating companies in the United States to remain the primary near-term market for Astria products. In 2005, we saw tier-one telcos in the U.S. begin to test, and in one case deploy, broadcast video services over their access networks. We expect that tier-one telco market opportunities for our products will continue to expand over the next several quarters.

We market our broadband transport and service management products to domestic and international system integrators who in turn market and sell our products to educational and government institutions, commercial enterprises, regional competitive service providers and national carriers. Our distributors and system integrators include local resellers, large volume distributors such as Ingram Micro Inc., and international integrators such as Huawei Technologies Ltd. and ZTE Kangxun Telecom Co., Ltd.

We seek to increase both the demand and visibility of our products in the markets we serve through attendance at major industry tradeshows and conferences, distribution of sales and product literature, operation of a company web site, direct marketing and ongoing communications with our customers, the press, and industry analysts. As appropriate, we enter into cooperative marketing and/or development agreements with strategic partners that may include key customers, and manufacturers of various products, including radio, fiber, video equipment, set-top boxes and others.

In North America, we sell our products primarily to service providers and through multiple sales channels, including a select group of regional value added resellers, system integrators and distributors. Internationally, we sell and market our products through systems integrators and distributors. We have regional account managers throughout the United States and sales offices in Beijing, China; Hong Kong; and Paris, France. Sales to customers outside of the United States accounted for approximately 18.4%, 23.3% and 22.6% of revenue for the years ended December 31, 2003, 2004 and 2005 respectively. We believe that our products can serve the substantial emerging market for digital video and high-speed data access products world-wide and we are continuing to expand our sales channels to capitalize upon these opportunities.

We believe that consistent high-quality service and support is a key factor in attracting and retaining customers. Service and technical support of our products is coordinated by our customer support organization. Our systems application engineers, located in each of our sales regions, support pre-sales and post-sales activities. Customers can also access technical information and receive technical support via our web site.

Our systems integration group in Cary, Illinois integrates our products with third-party equipment and then tests, delivers and installs complete headend systems for our customers that require an end-to-end solution.

Our research and development efforts are focused on enhancing our existing products and developing new products through our emphasis on early stage system engineering. Most of our research and development efforts relate to our video content processing and video service processor technologies. The product development process begins with a comprehensive functional product specification based on input from the sales and marketing organizations. We incorporate feedback from end users and distribution channels, and through participation in industry events, industry organizations and standards development bodies, such as the Broadband World Forum and MPEG-4 AVC Industry Forum. Key elements of our research and development efforts include:

Our success and ability to compete depends in part upon on our proprietary technology and our ability to protect that 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 47 United States patents and 32 foreign

patents and have 12 United States patent applications pending and 34 foreign patent applications pending. Furthermore, as a result of our acquisition of VTC, Tektronix has agreed not to assert against us or any of our affiliates or customers any of its patents that are based on applications filed prior to November 7, 2002 or that are based on inventions conceived or reduced to practice prior to that date where the assertion relates to our products for generating, processing or delivering video, audio or data for the education, entertainment, conferencing or security markets. We leverage readily available technology and standard components by adding proprietary software enhancements to gain competitive advantage, increase performance and lower cost. In addition, we have substantial trade secrets in the area of processing and managing video streams.

We do not manufacture any of our own products. We rely on contract manufacturers and third-party OEMs to manufacture, assemble, test and package our products. We require International Organization for Standardization (ISO) 9002 registration for our contract manufacturers as a condition of qualification. We monitor each contractor’s manufacturing process performance through audits, testing and inspections. Each contractor’s quality is also rigorously assessed through incoming testing and inspection of packaged products received from each contractor. In addition, we monitor the reliability of our products through in-house repair, reliability audit testing and field data analysis.

We currently purchase a substantial portion of the raw materials and components used in our products through contract manufacturers. We forecast our product requirements to maintain sufficient product inventory to ensure that we can meet the required delivery times demanded by our customers. Our future success will depend in significant part on our ability to obtain manufactured products on time, at low costs and in sufficient quantities to meet demand.

The market for video and broadband data systems is intensely competitive, and we expect that this market will continue to become more competitive in the future. Our immediate competitors for digital TV markets have been primarily small private companies that were focused on a narrower product line than ours and thereby may have been able to devote substantially more targeted resources to developing, marketing and selling new products than we can. The market is currently evolving as we witness consolidation of competitors therefore, we expect to compete with larger public companies, including Harmonic, Inc. (Harmonic), Tandberg Television ASA, (Tandberg), Scientific-Atlanta, Inc. (Scientific-Atlanta) and Motorola, Inc. (Motorola). These competitors have achieved success in providing TV headend components for cable multiple system operators and satellite TV providers. Although their products have been designed specifically to meet the needs of cable networks, we expect these competitors to market some of their products for use in TV over DSL applications. We attribute our success in this market to the quality, cost-effectiveness, and unique capabilities of our Astria video content processing system.

Indirect competition for our video content processing systems may arise from certain satellite service providers such as SES-Americom that intend to offer pre-compressed, constant-bit-rate video delivered via satellite to local terrestrial networks. If such a service were to be offered at competitive prices, the need for large local video headends would diminish, although there could be increased demand for our products which enable local encoding, protocol translation, and ad insertion.

Our competition in the market for surveillance and broadcast video transmission systems primarily comes from small private companies and public companies such as Tandberg that together offer a wide array of products with special features and functions. A few of these companies also compete with us in the digital TV headend market. Our competitive success in this market has depended upon having the right form factor and set of features required for a specific application, our long established distribution channels, and our ability to quickly modify an existing product to support the required features.

Our broadband transport and service management products business tends to compete against public network equipment providers, such as Zhone Technologies, and private and foreign companies. To maintain our competitive position in the private broadband market, we have focused our product development efforts on cost reduction and feature enhancement. Our expertise in particular vertical markets such as the hospitality industry, and our relationships with system integrators in those markets allow us to compete more effectively against larger competitors. We believe that we are among the market leaders for broadband systems in the United States hospitality industry.

All of our competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies and devote substantially more resources to developing new products than we can. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures that we face will not harm our business.

As of December 31, 2005, we employed 136 people, including 25 in manufacturing operations and customer support, 45 in sales and marketing, 48 in research and development and 18 in general and administrative.

During 2005, we reduced our work force to reduce our operating expense. None of our employees are represented by a labor union. We consider our relations with our employees to be good and we have experienced no work stoppages to date. Competition for skilled personnel in our industry remains strong and our future depends, in part on our ability to attract and retain a skilled workforce and key personnel. We cannot assure you that we will be successful in retaining key personnel or that we will be able to attract and retain skilled workers in the future.

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, are available on our website at www.tutsystems.com when such reports are available on the Securities and Exchange Commission website. The contents of our website are not incorporated into this Annual Report on Form 10-K.

We have a history of significant losses, and we may never achieve profitability.

We have incurred substantial net losses and experienced negative cash flow for each quarter since our inception. As of December 31, 2005, we had an accumulated deficit of $313.2 million. We expect to incur losses in the near future. Moreover, we may never achieve profitability and, even if we do, we may not be able to maintain profitability. We may not be able to generate a sufficient level of revenue to offset our current level of expenses. Moreover, because our expenditures for sales and marketing, research and development, and general and administrative functions are relatively fixed in the short-term, we may be unable to adjust our spending in a timely manner to respond to any unanticipated decline in revenue. If we fail to achieve and maintain profitability within the timeframe expected by securities analysts or investors, then the market price of our common stock will likely decline.

Each sale of our digital headend systems represents a significant portion of our revenue for any given quarter. Our failure to meet our quarterly forecast of sales of digital headend systems in any given quarter could have a material adverse impact on our financial results for a given quarter.

Since November 2002, when we entered the market for digital TV headends, a large part of our quarterly revenue is associated with the sale of digital headend systems. Each sale represents a significant portion of our

revenue for each quarter. We base our operating forecast on our historical sales. Because of the high cost per unit of our digital headend systems, if we were to sell even one less system than our forecasted number of headend sales per quarter, such a decrease in sales would have a material and adverse impact on our revenue for that quarter.

We operate in an intensely competitive marketplace, and many of our competitors have greater resources than we do.

Our primary competitors in the digital TV headend market have been small private companies that were focused on a more narrow product line than ours, thereby allowing these competitors to devote substantially more targeted resources to developing and marketing new products than we can. As the market is currently evolving, we are witnessing a consolidation of competitors and in the future, we expect more competition from large public companies like Harmonic, Inc., Tandberg Television ASA, Scientific Atlanta (SA) and Motorola, Inc., all of which have substantially greater financial, technical and other resources than we do. These competitors have achieved success in providing TV headend components for cable multiple system operators and satellite TV providers. Although their products have been designed specifically to meet the needs of cable networks, we expect these competitors to market some of their products for use in TV over DSL applications.

Our broadband transport and service management products business tends to compete against public network equipment providers, such as Zhone Technologies, and private and foreign companies.

To the extent that any of these current or potential future competitors enter or expand further into our markets, develop superior technology and products or offer superior prices or performance features relative to our products, such competition could result in lost sales and severe downward pressure on our pricing, either of which would adversely affect our revenue and profitability.

Commercial acceptance of any technological solution that competes with technology based on communication over copper telephone wire could materially and adversely impact demand for our products, our revenue and growth strategy.

The markets for video content processing, transmission and high-speed data access systems and services are characterized by several competing communication technologies, including fiber optic cables, coaxial cables, satellites and other wireless facilities. Many of our products are based on communication over copper telephone wire. Because there are physical limits to the speed and distance over which data can be transmitted over copper wire, our products may not be a viable solution for customers requiring service at performance levels beyond the current limits of copper telephone wire. Our customer base is concentrated on telephone service providers that have a large investment in copper wire technology. If these customers lose market share to their competitors who use competing technologies that are not as constrained by physical limitations as copper telephone wire, and that are able to provide faster access, greater reliability, increased cost-effectiveness or other advantages, demand for our products will decrease. Moreover, to the extent that our customers choose to install fiber optic cable or other transmission media as part of their infrastructure, or to the extent that homes and businesses install other transmission media within buildings, demand for our products may decline. The occurrence of any one or more of these events would harm demand for our products, which would thereby adversely affect our revenue and growth strategy.

If the projected growth in demand for video services from telephone service providers does not materialize or if our customers find alternative methods of delivering video services, future sales of our video content processing systems will suffer.

We manufacture video content processing systems that enable telephone service providers to offer video services to their customers. Our customers, the telephone service providers, face competition from cable companies, satellite service providers and wireless companies. For some users, these competing solutions provide fast access, high reliability and cost-effective solutions for delivering data, including video services. Telephone service providers hope to maintain their market share in their core business of voice telephony as well as increase their revenue per customer by offering their customers more services, including video services and high-speed data services. However, if the telephone service providers find alternative ways of maintaining and growing their market share in their core business that do not require that they offer video services, demand for our products will decrease substantially. Moreover, if technological advancements are developed that allow our customers to provide video services without upgrading their current system infrastructure, or that offer our customers a more cost-effective method of delivering video services, sales of our video content processing systems will suffer. Alternatively, even if the telephone service providers choose our video content processing systems, the service providers may not be successful in marketing video services to their customers, in which case our sales would decrease substantially.

Our operating results fluctuate significantly from quarter to quarter, and this may cause the price of our stock to decline.

Over the last 12 quarters, our revenue per quarter has fluctuated between $5.1 million and $10.7 million. Over the same periods, our losses from operations as a percentage of revenue have fluctuated between approximately 5.2% and 71.1% of revenue. We anticipate that our sales and operating margins will continue to fluctuate. We expect this fluctuation to continue for a variety of reasons, including:

Fluctuations in our sales and operating margins will make it more difficult for us to accurately forecast our results of operations and this could negatively impact the market price of our stock.

We depend on international sales for a significant portion of our revenue, which subjects our business to a number of risks. If we are unable to generate significant international sales, our revenue, profitability and share price could be materially and adversely affected.

Sales to customers outside of the United States accounted for approximately 18.4%, 23.3% and 22.6% of revenue for the years ended December 31, 2003, 2004, and 2005 respectively. Sales and operating activities outside of the United States are subject to inherent risks, including fluctuations in the value of the United States dollar relative to foreign currencies; tariffs, quotas, taxes and other market barriers; political and economic instability; restrictions on the export or import of technology; potentially limited intellectual property protection; difficulties in staffing and managing international operations and potentially adverse tax consequences. Any of these factors may have a material adverse effect on our ability to grow or maintain international revenue.

We expect sales to customers outside of the United States to represent a significant and growing portion of our revenue. However, we cannot assure you that foreign markets for our products will develop at the rate or to the extent that we anticipate. If we fail to generate significant international sales, our revenue, profitability and share price could be materially and adversely affected.

The sales cycle for video content processing systems is long and unpredictable, which requires us to incur high sales and marketing expenses with no assurance that a sale will result.

The sales cycle for our headend systems can be as long as 12-18 months. Additionally, with respect to the sale of our products to U.S. and foreign government organizations, we may experience long sales cycles as a result of government procurement processes. As a result, while we continue to incur costs associated with a particular sale prior to payment from the customer, we may not recognize revenue from efforts to sell particular products for extended periods of time. As a result, our quarter-to-quarter comparisons of our revenue and operating results may not be meaningful and may not provide an accurate indicator of our future performance. Our operating results in one or more future quarters may fail to meet the expectations of investment research analysts or investors, which could cause an immediate and significant decline in the market price of our common stock.

If we fail to accurately forecast demand for our products, our revenue, profitability and reputation could be harmed.

We rely on contract manufacturers and third-party equipment manufacturers, or OEMs, to manufacture, assemble, test and package our products. We also depend on third-party suppliers for the materials and parts that constitute our products. Our reliance on contract manufacturers, OEMs and third-party suppliers requires us to accurately forecast the demand for our products and coordinate our efforts with those of our contract manufacturers, OEMs and suppliers. We often make significant up-front financial commitments with our contract manufacturers, OEMs and suppliers in order to procure the raw materials and begin manufacturing and assembly of the products. If we fail to accurately forecast demand or coordinate our efforts with our suppliers, OEMs and contract manufacturers, we may face supply, manufacturing or testing capacity constraints. These constraints could result in delays in the delivery of our products, which could lead to the loss of existing or potential customers and could thereby result in lost sales and damage to our reputation, which would adversely affect our revenue and profitability. Further, we outsource the manufacturing of our products based on forecasts of sales. If orders for our products exceed our forecasts, we may have difficulty meeting customers’ orders in a timely manner, which could damage our reputation or result in lost sales. Conversely, if our forecasts exceed the orders we actually receive and we are unable to cancel future purchase and manufacturing commitments in a timely manner, our inventory levels would increase. This could expose us to losses related to slow moving and obsolete inventory, which would have a material adverse effect on our profitability.

If we fail to develop and introduce new products in response to the rapid technological changes in the markets in which we compete, we will not remain competitive.

The markets for video content processing, transmission and high-speed data access systems are characterized by rapid technological developments, frequent enhancements to existing products and new product introductions, changes in end-user requirements and evolving industry standards. To remain competitive, we must continually improve the performance, features and reliability of our products. For example, advances in compression technology are leading the video content processing industry to begin the transition to next generation compression standards. These advances will allow for further reductions in the bandwidth required to deliver standard definition video channels and introduce the capability of delivering high-definition television over asymmetrical digital subscriber lines or ADSL, for the first time. ADSL is a new technology that allows more data to be transmitted over copper telephone lines than standard DSL. Further advances in compression technology, or the emergence of new industry standards would require that we modify or redesign our products to incorporate, and remain compatible with, emerging technologies and industry standards.

We cannot assure you that we will be able to respond quickly and effectively to technological change. We may have only limited time to enter certain markets, and we cannot assure you that we will be successful in achieving widespread acceptance of our products before competitors can offer products and services similar or superior to our products. If we fail to introduce new products that address technological changes or if we experience delays in our product introductions, our ability to compete would be adversely affected, thereby harming our revenue, profitability and growth strategy.

Fluctuations in interest and currency exchange rates may decrease demand for our products.

Substantially all of our foreign sales are invoiced in U.S. dollars. As a result, fluctuations in currency exchange rates could cause our products to become relatively more expensive for international customers, thereby reducing demand for our products. We anticipate that we will generally continue to invoice foreign sales in U.S. dollars. We do not currently engage in foreign currency hedging transactions. However, as we expand our current international operations, we may allow payment in foreign currencies and, as a result, our exposure to foreign currency transaction losses may increase. To reduce this exposure, we may purchase forward foreign exchange contracts or use other hedging strategies. However, we cannot assure you that any currency hedging strategy would be successful in avoiding exchange-related losses. Any such losses would adversely impact our profitability.

If our contract manufacturers, third-party OEMs and third-party suppliers fail to produce quality products or parts in a timely manner, we may not be able to meet our customers’ demands.

We do not manufacture our products. We rely on contract manufacturers and OEMs to manufacture, assemble, package and test substantially all of our products and to purchase most of the raw materials and components used in our products. Additionally, we depend on third-party suppliers to provide quality parts and materials to our contract manufacturers and OEMs, and we obtain some of the key components and sub-assemblies used in our products from a single supplier or a limited group of suppliers. Neither we nor our contract manufacturers or OEMs have any guaranteed supply arrangements with the suppliers. If our suppliers fail to provide a sufficient supply of key components, we could experience difficulties in obtaining alternative sources at reasonable prices, if at all, or in altering product designs to use alternative components. Moreover, if our contract manufacturers or OEMs fail to deliver quality products in a timely manner, such failure would harm our ability to meet our scheduled product deliveries to customers. Delays and reductions in product shipments could increase our production costs, damage customer relationships and harm our revenue and profitability. In addition, if our contract manufacturers and OEMs fail to perform adequate quality control and testing of our products, we would experience increased production costs for product repair and replacement, and our profitability would be harmed. Moreover, defects in products that are not discovered in the quality assurance process could damage customer relationships and result in product returns or product liability claims, each of which could harm our revenue, profitability and reputation.

Design defects in our products could harm our reputation, revenue and profitability.

Any defect or deficiency in our products could reduce the functionality, effectiveness or marketability of our products. These defects or deficiencies could cause customers to cancel or delay their orders for our products, reduce revenue or render our product designs obsolete. In any of these events, we would be required to devote substantial financial and other resources for a significant period of time to develop new product designs. We cannot assure you that we would be successful in addressing any design defects in our products or in developing new product designs in a timely manner, if at all. Any of these events, individually or in the aggregate, could harm our revenue, profitability and reputation.

Our business depends on the integrity of our intellectual property rights. If we fail to adequately protect our intellectual property, our revenue, profitability, reputation or growth strategy could be adversely affected.

We attempt to protect our intellectual property and proprietary technology through patents, trademarks and copyrights, by generally entering into confidentiality or license agreements with our employees, consultants, vendors, strategic partners and customers as needed, and by generally limiting access to and distribution of our trade secret technology and proprietary information. However, any of our pending or future patent or trademark applications may not ultimately be issued as patents or trademarks of the scope that we sought, if at all, and any of our patents, trademarks or copyrights may be invalidated, deemed unenforceable, or otherwise challenged. In addition, other parties may circumvent or design around our patents and other intellectual property rights, may misappropriate our proprietary technology, or may otherwise develop similar, duplicate or superior products.

Further, the intellectual property laws and our agreements may not adequately protect our intellectual property rights and effective intellectual property protection may be unavailable or limited in certain foreign countries in which we do business or may do business in the future.

The telecommunications and data communications industries are characterized by the existence of extensive patent portfolios and frequent intellectual property litigation. From time to time, we have received, and may in the future receive, claims that we are infringing third parties’ intellectual property rights. Any present or future claims, with or without merit, could be time-consuming, result in costly litigation, divert management time and attention and other resources, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us. In addition, any such litigation could force us to cease selling or using certain products or services, or to redesign such products or services. Further, we may in the future, initiate claims or litigation against third-parties for infringement of our intellectual property rights or to determine the scope and validity of our intellectual property rights or those of competitors. Such litigation could result in substantial costs and diversion of resources. Any of the foregoing could have an adverse effect upon our revenue, profitability, reputation or growth strategy.

If we fail to provide our customers with adequate and timely customer support, our relationships with our customers could be damaged, which would harm our revenue and profitability.

Our ability to achieve our planned sales growth and retain customers will depend in part on the quality of our customer support operations. Our customers generally require significant support and training with respect to our products, 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. 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 revenue and profitability.

We routinely evaluate acquisition candidates and other diversification strategies.

We have completed a number of acquisitions as part of our efforts to expand and diversify our business. For example, we acquired our video content processing and video transmission businesses from Tektronix in November 2002 when we purchased its subsidiary, VTC. In addition, on June 1, 2005, we completed an acquisition with Copper Mountain Networks, Inc.

We intend to continue to evaluate new acquisition candidates, divestiture and diversification strategies, and if we fail to manage the integration of acquired companies, it could adversely affect our operations and growth strategy. Any acquisition involves numerous risks, including difficulties in the assimilation of the acquired company’s employees, operations and products, uncertainties associated with operating in new markets and working with new customers, and the potential loss of the acquired company’s key employees. Additionally, we may incur unanticipated expenses, difficulties and other adverse consequences relating to the integration of technologies, research and development, and administrative and other functions. Any future acquisitions may also result in potentially dilutive issuances of our equity securities, acquisition or divestiture related write-offs and the assumption of debt and contingent liabilities. Any of the above factors could adversely affect our revenue, profitability, operations or growth strategy.

Failure to integrate acquired businesses into our operations successfully could adversely affect our business.

As part of our strategy to develop and identify new products and technologies, we have made acquisitions, such as our acquisition of Copper Mountain. We are likely to make more acquisitions in the future. Our integration of the operations of acquired businesses requires significant efforts, including the coordination of

information technologies, research and development, sales and marketing, operations, manufacturing and finance. These efforts result in additional expenses and involve significant amounts of management’s time that cannot then be dedicated to other projects. Our failure to manage successfully and coordinate the growth of the combined company could also have an adverse impact on our business. In addition, there is no guarantee that any of the businesses we acquire will become profitable or remain so. If our acquisitions do not reach our initial expectations, we may record unexpected impairment charges. Factors that will affect the success of our acquisitions include but are not limited to:

These factors, among others, will affect whether our recent and proposed acquisitions are successfully integrated into our business. Additionally, any future acquisitions may also result in potentially dilutive issuances of our equity securities, acquisition or divestiture related write-offs and the assumption of debt and contingent liabilities. If we fail to integrate acquired businesses into our operations successfully, we may be unable to achieve our revenue, profitability, operations, strategic goals and our competitive position in the marketplace could suffer.

If we fail to manage our expanding operations, our ability to increase our revenues and improve our results of operations could be harmed.

We anticipate that, in the future, we may need to expand certain areas of our business to grow our customer base and exploit market opportunities. In particular, we expect to face numerous challenges in the implementation of our business strategy to focus on selling our products to the larger, more established service providers. To manage our operations, we must, among other things, continue to implement and improve our operational, financial and management information systems, hire and train additional qualified personnel, continue to expand and upgrade core technologies and effectively manage multiple relationships with various customers, suppliers and other third-parties. We cannot assure you that our systems, procedures or controls will be adequate to support our operations or that our management will be able to achieve the rapid execution necessary to exploit fully the market for our products or systems. If we are unable to manage our operations effectively, our revenue, results of operations and share price could be harmed.

If material weaknesses in our internal control over financial reporting were to develop and we were unable to remedy such weaknesses in an effective and timely manner, such weaknesses could materially and adversely affect our ability to provide the public with timely and accurate material information about Tut Systems.

In order for investors and the equity analyst community to make informed investment decisions and recommendations about our securities, it is important that we provide them with accurate and timely information in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the rules promulgated thereunder. Material weaknesses in our internal control over financial reporting and our disclosure controls and procedures would hinder the flow of timely and accurate information to investors. If such material weaknesses were to develop and we did not address them in a timely matter, investors might sell our shares and industry analysts might either make incorrect recommendations about Tut Systems or else end coverage of Tut Systems altogether, any of which results could harm our reputation and adversely impact our share price.

We are currently engaged in a securities class action lawsuit which, if it were to result in an unfavorable resolution, could adversely affect our reputation, profitability and share price.

We are currently engaged as a defendant in a lawsuit (i.e., Whalen v. Tut Systems, Inc. et al.) that alleges securities law violations against us and certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. Additionally, our subsidiary Copper Mountain, which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, we have inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability that may come out of the claims. The Whalen action and the Copper Mountain action are being coordinated with approximately 300 suits before United States District Judge Shira Scheindlin of the Southern District of New York under the matter In re Initial Public Offering Securities Litigation. While we have reached a settlement with the plaintiffs in the Whalen lawsuit, and prior to the acquisition Copper Mountain reached a settlement in the Copper Mountain action, the settlements are subject to certain contingencies, including court approval of the terms of settlements. If the court does not approve the settlements, or any other applicable contingencies are not resolved or otherwise addressed, we would be required to resume litigation in these matters.

If our products do not comply with complex government regulations, our product sales will suffer.

We and our customers are subject to varying degrees of federal, state and local as well as foreign governmental regulation. Our products must comply with various regulations and standards defined by the Federal Communications Commission, or FCC. The FCC has issued regulations that set installation and equipment standards for communications systems. Our products are also required to meet certain safety requirements. For example, Underwriters Laboratories must certify certain of our products 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 certain of our customers may deploy them. Any delay in or failure to obtain these approvals could harm our business, financial condition or results of operations. Outside of the United States, our products are subject to the regulatory requirements of each country in which our products are manufactured or sold. These requirements are likely to vary widely. If we do not obtain timely domestic or foreign regulatory approvals or certificates, we would not be able to sell our products where these regulations apply, which could prevent us from maintaining or growing our revenue or achieving profitability. In addition, regulation of our customers may adversely impact our business, operating results and financial condition. For example, FCC regulatory policies affecting the availability of data and Internet services and other terms on which telecommunications companies conduct their business may impede our entry into 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 our sale of products to these customers.

If we lose key personnel or are unable to hire additional qualified personnel as necessary, we may not be able to manage our business successfully, which could materially and adversely affect our growth strategy, reputation and share price.

We depend on the performance of Salvatore D’Auria, our President, Chief Executive Officer and Chairman of the Board, and on other senior management and technical personnel with experience in the video and data communications, telecommunications and high-speed data access industries. The loss of any one of them could harm our ability to execute our business strategy, which could adversely affect our reputation and share price.

Additionally, we do not have employment contracts with any of our executive officers. We believe that our future success will depend in large part on our continued ability to identify, hire, retain and motivate highly skilled employees who are in great demand. We cannot assure you that we will be able to do so.

Our stock price is volatile, and, if you invest in Tut Systems, you may suffer a loss of some or all of your investment.

The market price and trading volume of our common stock has been subject to significant volatility, and this trend may continue. In particular, trading volume historically has been low and the market price of our common stock has increased dramatically in recent months. Since the announcement of our acquisition of VTC, the closing price of our common stock, as traded on The Nasdaq National Market, has fluctuated from a low of $1.23 to a high of $7.49 per share. The value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:

Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.

Future sales of shares of our common stock could cause our stock price to decline.

Substantially all of our common stock may be sold without restriction in the public markets, subject only in the case of shares held by our officers and directors and affiliates to volume and manner of sale restrictions (other than as described in the following sentence). The approximately 3.3 million shares of common stock that we issued to Tektronix in connection with our November 2002 acquisition of VTC were restricted securities, as that term is defined in Rule 144 under the Securities Act, and therefore subject to certain restrictions. However, we are contractually obligated to file and keep effective a registration statement in order to allow Tektronix to sell these shares to the public. Likewise, Tektronix has the right (subject to certain exceptions) to include these shares in certain registration statements pursuant to which we may sell shares of our common stock. During 2005, Tektronix sold 1.0 million shares of common stock. At December 31, 2005, Tektronix owns 2.3 million shares of common stock.

Sales of a substantial number of shares of common stock in the public market, whether or not in connection with this offering, or the perception that these sales could occur could materially and adversely affect our stock price and make it more difficult for us to sell equity securities in the future at a time and price we deem appropriate.

Our charter, bylaws, retention and change of control plans and Delaware law contain provisions that could delay or prevent a change in control.

Certain provisions of our charter and bylaws and our retention and change of control plans, referred to as the “Plans,” may have the effect of making it more difficult for a third-party to acquire, or of discouraging a third- party from attempting to acquire, control of us. The provisions of the charter and bylaws and the Plans could

limit the price that certain investors may be willing to pay in the future for shares of our common stock. Our charter and bylaws provide for a classified board of directors, eliminate cumulative voting in the election of directors, restrict our stockholders from acting by written consent and calling special meetings, and provide for procedures for advance notification of stockholder nominations and proposals. In addition, our board 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. The Plans provide for severance payments and accelerated stock option vesting in the event of termination of employment following a change of control. The provisions of the charter and bylaws, and the Plans, as well as Section 203 of the Delaware General Corporation Law, to which we are subject, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management.

Recent and proposed regulations related to equity compensation could adversely affect earnings, affect our ability to raise capital and affect our ability to attract and retain key personnel.

Since our inception, we have used stock options as a fundamental component of our employee compensation packages. We believe that our stock option plans are an essential tool to link the long-term interests of stockholders and employees, especially executive management, and serve to motivate our employees to make decisions that will, in the long run, give the best returns to stockholders. The Financial Accounting Standards Board (FASB) has announced changes to U.S. GAAP that will require us to record a charge to earnings for employee stock option grants and employee stock purchase plan rights for all future periods beginning on January 1, 2006. This standard will negatively impact our earnings and may affect our ability to raise capital on acceptable terms. To the extent that new accounting standards make it more difficult or expensive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.

We are exposed to additional costs and risks associated with complying with increasing and new regulation of corporate governance and disclosure standards.

We are spending an increased amount of management time and external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules. Particularly, Section 404 of the Sarbanes-Oxley Act, when it becomes applicable to us, will require management’s annual review and evaluation of our internal control over financial reporting, and attestation of the effectiveness of our internal control over financial reporting by management. We expect that our independent registered public accounting firm will be required to attest to the design and effectiveness of our internal controls over financial reporting beginning with the filing of the annual report on Form 10-K for the fiscal year ended December 31, 2006, and with each subsequently filed annual report on Form 10-K. We expect to incur significant additional accounting and legal expenses in the process of documenting and testing our internal control systems and procedures and in making improvements in order for us to comply with the requirements of Section 404. We cannot predict the outcome of our assessment of our internal control over financial reporting. If we conclude in future periods that our internal control over financial reporting is not effective or if our independent registered public accounting firm is unable to provide an unqualified opinion as of future year-ends, investors may lose confidence in our financial statements, and the price of our stock may suffer.

As a result of our November 2002 acquisition of VTC, our executive and principal administrative and engineering facility totaling approximately 22,450 square feet is located in Lake Oswego, Oregon. As a result of our June 2005 acquisition of Copper Mountain, we have a facility in San Diego, California. In January 2006, we entered into a new lease agreement for a facility in San Diego, totaling approximately 20,000 square feet. We also have a facility, totaling approximately 17,000 square feet, located in Pleasanton, California. The lease for the Lake Oswego facility expires in December 2007, the lease for the Pleasanton facility expires in June 2007 and the new lease for the San Diego facility expires in August 2009. In addition, we have a product staging and warehouse facility totaling approximately 7,500 square feet in Cary, Illinois. The lease for this facility expires in June 2007. Selling, marketing, operational and research and development activities are conducted at all of our facilities. We believe that our facilities will be suitable and adequate for the present purposes and that the productive capacity in such facilities is substantially being utilized.

On October 30, 2001, we and certain of our current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from our January 29, 1999 initial public offering and our March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against us and certain of our current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and alleges claims against certain of our current and former officers and directors under Sections 15 and 20(a) of the Securities Act. The complaint also names as defendants the underwriters for our initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public offerings and secondary offerings conducted in 1999 and 2000. Therefore, for pretrial purposes, the Whalen action is being coordinated with the approximately 300 other suits before United States District Court Judge Shira Scheindlin of the Southern District of New York under the matter In Re Initial Public Offering Securities Litigation. The individual defendants in the Whalen action, namely, Nelson Caldwell, Salvatore D’Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, approving the parties’ October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying our motion to dismiss.

In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including us, was submitted to the Court in the In Re Initial Public Offering Securities Litigation. On August 31, 2005, the Court granted preliminary approval of the settlement. The settlement is subject to a number of conditions, most of which are outside of our control, including final approval by the Court. The underwriters named as defendants in the In Re Initial Public Offering Securities Litigation (collectively, the “underwriter-defendants”), including the underwriters named in the Whalen suit, are not parties to the stipulation of settlement.

The stipulation of settlement provides that, in exchange for a release of claims against the settling issuer-defendants, the insurers of all of the settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the underwriter-defendants. The ultimate amount, if any, that may be paid on our behalf will therefore depend on the final terms of the settlement, including the number of issuer-defendants that ultimately participate in the final settlement, and the amounts, if any, recovered by the plaintiffs from the underwriter-defendants and other non-settling defendants.

In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation

Copper Mountain, which we acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities laws under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, we have inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and we are exposed to any liability that may come out of the claims. The Copper Mountain action described in this paragraph, like the Whalen action described above, has been coordinated for pretrial purposes under the matter In Re Initial Public Offering Securities Litigation. The individual defendants in the Copper Mountain action were also dismissed without prejudice pursuant to the October 9, 2002 Order of the Court approving the parties’ October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order granting in part and denying in part Copper Mountain’s motion to dismiss. Thereafter, Copper Mountain entered into the same stipulation of settlement as we did in the Whalen action described above. The Copper Mountain stipulation of settlement is subject to the same terms, conditions and contingencies as the stipulation of settlement we entered into with respect to the Whalen action described above.

In the event that all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on our behalf could range from zero to approximately $7.0 million, which consists of the approximately $3.5 million from the Copper Mountain action described above and approximately $3.5 million from the Whalen action described above, depending on plaintiffs’ recovery from the underwriter-defendants and from other non-settling parties and the amount of insurance available under our applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement payments would be made on our behalf under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, we believe that our insurance will likely cover some or all of our share of any payments towards satisfying its share of plaintiffs’ $1 billion recovery amount. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount we will ultimately be required to pay, if any, as of December 31, 2005, we have not accrued a liability for this matter.

We are subject to other legal proceedings, claims and litigation arising in the ordinary course of business. Our management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

No matters were submitted to a vote of security holders during the quarter ended December 31, 2005.

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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 low and high closing sales prices per share of the common stock by quarter for 2004 and 2005, as reported on The Nasdaq National Market. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.

On February 21, 2006 the last reported sale price of our common stock on the Nasdaq National Market was $2.92 per share. As of February 21, 2006, there were 33,561,514 shares of our common stock outstanding and approximately 427 holders of record of our common stock.

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

The following table presents our selected consolidated financial data for, and as of the end of, each of the periods indicated. The selected consolidated financial data for, and as of the end of, the fiscal years ended December 31, 2001, 2002, 2003, 2004 and 2005 are derived from our audited consolidated financial statements. The selected consolidated financial data are not necessarily indicative of the results that may be expected for any future period. The selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes included elsewhere in this report.

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

We design, develop, and sell digital video processing systems that enable telephony-based service providers to deliver broadcast quality digital video signals across their networks. We refer to these systems as digital TV headends or video content processing systems. We also offer digital video processing systems that enable private enterprise and government entities to transport video signals across satellite, fiber, radio, or copper facilities for surveillance, distance learning, and TV production applications.

Historically, we derived most of our sales from our broadband transport and service management products. In November 2002, we acquired VideoTele.com, referred to in this report as VTC, from Tektronix, Inc. to extend our product offerings to include digital video processing systems. On June 1, 2005, we acquired Copper Mountain Networks, Inc., referred to in this report as Copper Mountain, for its technology and engineering resources which we have refocused to further address our expanding video market opportunities for delivering advanced video services over coax and fiber networks.

During the years ended December 31, 2003, 2004 and 2005, international sales represented 18.4%, 23.3% and 22.6% of our total sales, respectively.

We pay close attention to and monitor various trends and uncertainties about our business. There is a growing demand by independent operating telephone companies to offer video services to their customer base. According to a recent release from Infonetics Research in November 2005, the number of IPTV subscribers worldwide is expected to grow to over 53.7 million by the end of 2009. While this growing market presents opportunities to serve a larger customer base, we are also encountering increasing competition as more companies compete to sell digital TV headend products. We expect this market space will continue to become more competitive in the future. Our immediate competitors in the digital TV headend markets have been primarily small private companies that were focused on a narrower product line than ours and thereby may have been able to devote substantially more targeted resources to developing, marketing and selling new products than we are able to. Certain of these companies have become targets for acquisition by larger companies, in which case we may face competitors with substantially greater name recognition, and technical, financial and marketing resources than we have. This increased competitive pressure may adversely affect the amount and timing of our revenue in future periods, thereby making it more difficult for us to accurately forecast our future revenue, and may also adversely affect our product margins.

The emergence of new technologies to serve the digital TV headend market means that we must continue to invest in these technologies to remain competitive. Digital subscriber line, or DSL, technologies use sophisticated signal blending techniques to transmit data through copper wires. The limitations on the amount of

data that can be transmitted in a fixed amount of time (such limitations are referred to as bandwidth) and the distance data may be transmitted using copper wire constrain both the number of video channels that may be delivered simultaneously and the number of customers that are reachable from a telco central office over a DSL network. Advancements in video compression technology are now enabling high quality video streams to be transported at lower data transfer rates than has been previously available. These compression advancements also allow for the delivery of high-definition television over bandwidth constrained asymmetric DSL, or ADSL, lines for the first time. ADSL is a technology that allows more data to be transmitted over existing copper telephone lines compared with standard DSL. Additionally, DSL advancements are emerging that expand the available bandwidth from the telco to the subscriber thereby supporting higher DSL data transfer rates over longer distances. As our products continue to incorporate new technological advancements, we expect the demand for our products will increase because our products will enable more telcos to reach more of their customers with a greater number of video channels and features over their DSL networks. However, because of the increasing competition in the markets in which we compete, regardless of our revenue and product margins in future periods, we will continue to devote significant resources to research and development in future periods in order to enable us to offer our customers competitive products that incorporate these emerging technologies. As a consequence, we expect our research and development expenses in 2006 to be comparable to the research and development expenditures we incurred in 2005.

As we continue to capitalize on the growing number of telcos deploying video services in the United States and abroad, we will continue to aggressively market our new and existing products and expand our marketing and sales efforts domestically and internationally. Nevertheless, our sales activities have been and will continue to be subject to competitive market pressure. We believe that in certain competitive markets, our prospective customer purchase decisions continue to be impacted by lengthening of the purchase decision because of several factors that are affecting the overall digital TV headend market. Such factors include, but are not limited to, the delays in the introduction of advanced compression technology set top boxes, the transition to more efficient data transmission technologies and the emergence of video signal encryption requirements. Nevertheless, given the opportunities offered by the growing number of our target customers deploying or enhancing video services and despite the length of the sales cycle, we expect our sales and marketing expenses to increase in 2006 compared to our spending in 2005.

Our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as of December 31, 2005. Based on this evaluation, they concluded as of December 31, 2005 that our disclosure controls and procedures were effective. There were no changes in our internal control over financial reporting which occurred during the fourth quarter of fiscal year 2005 and which have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

Our discussion of our results of operations focuses on the following items from our income statement: Total revenues consists of product sales, and license and royalty fees. Revenue consists of sales of our video processing systems, which includes both digital TV headend and video transmission systems. Revenue also consists of revenue from our broadband transport and service management products. Since our acquisition of VTC, a large part of our revenue has been associated with the sale of digital TV headends. Furthermore, each individual headend sale has represented a significant portion of our revenue. If we were to sell even one less system than our forecasted number of headend sales, our revenue would be materially impacted. As we did not enter into any new license or royalty agreements during 2003, 2004 or 2005, we expect minimal future license and royalty revenue. Cost of goods sold, or COGS, consists of costs related to raw materials, contract manufacturing, personnel, overhead, test and quality assurance for products, and the cost of licensed technology included in our

products. Raw materials, contract manufacturing and licensed technology are the principal elements of COGS and vary directly with product sales. Sales and marketing expense consists primarily of selling and marketing personnel costs, including sales commissions, facilities, travel, trade shows, promotions and outside services. Research and development expense consists primarily of personnel and facilities costs, contract consultants, outside testing services, and equipment and supplies associated with enhancing existing products and developing new products. General and administrative expense consists primarily of personnel costs for administrative officers and support personnel, facilities, professional services and insurance expenses. Amortization of intangible assets consists primarily of expenses associated with the amortization of technology and patents related to acquisitions.

Our acquisition of Copper Mountain has had a significant impact on every aspect of our financial statements since June 2005. This impact is reflected in the following discussion of our operating results. This should be considered when evaluating our period-to-period comparisons of 2005 relative to years prior to 2005.

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

Total Revenues. For the year ended December 31, 2005, our total revenue increased by 49.9% to $37.5 million from $25.0 million for the year ended December 31, 2004. We operate in a single business segment across two related markets. We measure our revenue by our two product lines only and therefore are unable to further quantify the impact of individual products on our revenue. During this same period, our revenue from video processing systems increased by 69.9% to $30.6 million from $18.0 million for the year ended December 31, 2004. During 2005, we experienced an increased demand for our video processing systems from independent operating telephone companies and international post, telephone and telegraph companies compared to 2004. We believe the increase in video processing systems revenue was due primarily to the increased market acceptance and the resulting increased demand for our products that address the IPTV market. In 2004, certain prospective customers indicated to us that they were delaying their purchase decisions for a variety of factors, including their anticipation of the introduction and general availability of advanced compression technologies. In 2005, we introduced our upgraded Astria video processing systems that

incorporates these anticipated technologies, known as Motion Pictures Experts Group (MPEG) advanced video compression technologies or MPEG-4 AVC. As a result, our upgraded Astria products enable our customers to address a larger percentage of their geographic market and deliver advanced video services. We expect our revenue from video processing systems to increase in 2006 when compared to 2005 as we continue to introduce additional features to our Astria products, including high definition products to new customers and as an upgrade option to our installed base. Revenue from the sale of our broadband transport and service management products decreased by 33.7% to $4.6 million in 2005 from $7.0 million in 2004. The decrease in broadband transport and service management revenue was primarily the result of customers choosing competing products that transmit data via wireless data transmission technologies instead of our products (which transmit data over telephone wires). The year-over-year decrease in our broadband transport and service management revenue is primarily due to the end of the product lifecycle for these products. Revenue from this product line is expected to increase in future quarters with the introduction of our next generation products expected late in the first quarter of 2006.

Legacy product sales from the June 2005 acquisition of Copper Mountain Networks were $2.3 million for the year ended December 31, 2005. We do not anticipate additional significant revenue from these products.

For the year ended December 31, 2004, our revenue decreased by 22.3% to $25.0 million from $32.2 million for the year ended December 31, 2003. During this same period, our revenue from video processing systems decreased by 24.7% to $18.0 million from $23.9 million for the year ended December 31, 2003. As discussed earlier, we experienced a slowing demand for our video processing systems from independent operating telephone companies during 2004 compared to 2003. We believe the decrease in video processing systems revenue was primarily due to the adverse effect of several digital TV headend sales not closing during the period as expected primarily as a result of prospective customers delaying their purchase decisions in anticipation of the introduction and general availability of advanced compression technologies. Revenue from the sale of our broadband transport and service management products decreased by 15.7% to $7.0 million in 2004 from $8.3 million in 2003.

Cost of Goods Sold. For the year ended December 31, 2005, our cost of goods sold increased by 41.0%, or $7.6 million, to $26.3 million from $18.6 million for the year ended December 31, 2004. Included in cost of goods are the effects of changes in our reserves for excess and obsolete inventories. These reserves were primarily related to lower of cost or market adjustments for raw materials and reserves for finished goods in excess of what we reasonably expected to sell in the foreseeable future. During both 2005 and 2004, cost of goods sold included a charge for increases in our reserves for excess and obsolete inventories of $1.0 million. These charges were primarily associated with our video processing systems products. The increase in cost of goods sold of $7.6 million from 2004 to 2005 included increases in materials costs of $6.7 million, outside contractor expenses of $0.3 million and amortization of $0.1 million. Also included in cost of goods sold during 2005 was a one time charge of $0.5 million to amortize the backlog acquired in the Copper Mountain acquisition. Our gross profit increased in 2005 compared to 2004 due to increased sales volume from our video processing systems.

For the year ended December 31, 2004, our cost of goods sold increased by 6.9%, or $1.2 million, to $18.7 million from $17.4 million for the year ended December 31, 2003. Included in cost of goods are the effects of changes in our reserves for excess and obsolete inventories. These reserves were primarily related to lower of cost or market adjustments for raw materials and reserves for finished goods in excess of what we reasonably expected to sell in the foreseeable future. During 2004, cost of goods sold included a charge for an increase in our reserves for excess and obsolete inventories of $1.0 million. This charge was primarily associated with our video processing systems products. In 2003, cost of goods sold was reduced as a result of a decrease in our reserves for excess and obsolete inventories of $1.5 million. The decrease in our reserves for excess and obsolete inventories in 2003 was because we were able to sell certain products for which we had originally set aside reserves in prior years. In addition to this $2.5 million increase included in costs of goods from the change in reserves for excess and obsolete inventories from 2003 to 2004, other significant increases in cost of goods sold

included increases in labor expenses of $0.5 million, outside contractor expenses of $0.2 million, freight costs of $0.2 million and amortization expenses of $0.2 million. Partially offsetting these increases was a decrease in materials cost of $2.4 million. Our gross profit declined in 2004 compared to 2003 due to decreased sales volume for both our video processing systems and our broadband transport and service management products. The cost increases previously mentioned, including the increase in our reserves for excess and obsolete inventories, also negatively affected our gross profit in 2004 when compared to 2003.

Sales and Marketing. For the year ended December 31, 2005, our sales and marketing expenses increased by 31.5% to $10.6 million from $8.1 million for the year ended December 31, 2004. The increase of $2.6 million in sales and marketing expense was due to a year-over-year increase in personnel related costs of $1.7 million due to additional headcount added during the year and additional headcount from our acquisition of Copper Mountain, $0.2 million for travel costs, $0.1 million for promotional and advertising costs, $0.4 million for purchases of supplies and $0.2 million for depreciation of equipment.

For the year ended December 31, 2004, our sales and marketing expenses increased by 8.2% to $8.1 million from $7.5 million for the year ended December 31, 2003. The increase of $0.6 million in sales and marketing expense was due to a year-over-year increase in personnel related costs of $0.2 million due to additional headcount added during the year, $0.1 million for promotional and advertising costs, $0.2 million for facilities and infrastructure expenses and $0.1 million in outside services expenses.

Research and Development. For the year ended December 31, 2005, our research and development expense increased by 70.5% to $12.4 million from $7.3 million for the year ended December 31, 2004. The $5.1 million increase in our research and development expense was due to a year-over-year increase in personnel related costs of $2.8 million from additional headcount added from our acquisition of Copper Mountain, $0.6 million from outside services, $0.2 million for facility costs, $1.3 million for the purchase of supplies relating to the development of our new product offerings and $0.2 million for travel costs. Our capital expenditures for research and development were $1.1 million in 2003, $0.1 million in 2004 and $0.6 million for 2005.

For the year ended December 31, 2004, our research and development expense decreased by 8.0% to $7.3 million from $7.9 million for the year ended December 31, 2003. The $0.6 million decrease in our research and development expense was due to a year-over-year decrease in personnel related costs.

General and Administrative. For the year ended December 31, 2005, our general and administrative expense increased by 21.1% to $5.3 million from $4.3 million for the year ended December 31, 2004. The $0.9 million increase in our general and administrative expense was primarily due to a $1.2 million one-time write off of costs relating to CoSine’s termination of the proposed merger offset by a decrease in outside services of $0.2 million and franchise taxes of $0.1 million.

For the year ended December 31, 2004, our general and administrative expense decreased by 3.1% to $4.3 million from $4.5 million for the year ended December 31, 2003. The $0.2 million decrease in our general and administrative expense was primarily due to a decrease in personnel related costs of $0.2 million, lower insurance costs of $0.3 million and contractors cost of $0.2 million offset by higher relocation costs of $0.1 million and outside service costs of $0.4 million.

Restructuring Costs. In September 2005, we announced a restructuring program that included a workforce reduction. As a result of this restructuring program, we recorded restructuring costs of $0.1 million consisting of severance payments. As of December 31, 2005, we have paid all of the costs relating to the restructuring. We did not incur any restructuring costs for the year ended December 31, 2004. We incurred restructuring costs of $0.3 million for the year ended December 31, 2003.

In August 2003, we implemented a restructuring program that included a workforce reduction and relocation. This restructuring program resulted in restructuring costs of $0.3 million in the third quarter of 2003.

The restructuring costs consisted of $0.2 million in workforce reduction charges related primarily to severance and fringe benefits and $0.1 million in relocation expenses. As a result of this 2003 restructuring, we reduced our workforce by approximately 11.0%.

Impairment of Assets. During the third quarter of 2005, we determined that certain of the technology acquired as part of the VTC acquisition had become impaired. As a result, we recorded an impairment charge of $0.2 million to write off the book value of the intangible assets associated with this technology. During the fourth quarter of 2005, we determined that certain assets in our UK office had become impaired. As a result, we recorded an impairment charge of $0.2 million to write off the book value of the assets. During the first quarter of 2004, we determined that certain of the technology acquired as part of the purchase of the ViaGate Technology assets had become impaired. As a result, we recorded an impairment charge of $0.2 million to write off the book value of the intangible assets associated with this technology. During the second quarter of 2003, we recorded an impairment charge of $0.1 million to write off the book value of certain technology acquired as part of the acquisition of the assets of ViaGate. The impairment costs have been included in cost of goods sold.

Amortization of Intangible Assets. Amortization of intangible assets is comprised of intangibles related to the acquisitions of FreeGate, OneWorld assets and Xstreamis in 2000, ActiveTelco in 2001, VTC in 2002 and Copper Mountain in 2005. The remaining intangible assets subject to amortization from these acquisitions consist primarily of completed technology and patents. Amortization expense was $1.6 million, $1.5 million and $1.8 million for the years ended December 31, 2005, 2004 and 2003, respectively. Amortization expense included in cost of goods sold was $1.6 million, $1.5 million and $1.7 million for the years ended December 31, 2005, 2004 and 2003, respectively. The $0.1 million increase in 2005 when compared with 2004 was the result of intangible assets acquired as part of the Copper Mountain acquisition. The $0.3 million decrease in 2004 when compared with 2003 was the result of an intangible asset becoming fully amortized in 2004.

Gain on sale of Investments. The gain on sale of investments for the year ended December 31, 2004, resulted from the sale of certain equity investments that had been written down to zero in a previous year.

Interest and Other Income, Net. Interest and other income, net consists primarily of interest income and expense. Interest and other income, net remained consistent at $0.1 million and $0.2 million for the years ended December 31, 2005 and 2004 respectively. For the year ended December 31, 2004, our interest and other income, net decreased to an expense of $0.2 million from an income of $30,000 for the year ended December 31, 2003. The decrease was due to interest expense associated with the $3.8 million note issued in connection with our purchase of VTC in November 2002.

Cash and cash equivalents totaled $12.1 million at December 31, 2005, compared with cash and cash equivalents of $12.4 million at December 31, 2004, reflecting a net reduction in cash and cash equivalents of $0.3 million.

Cash used in operating activities was $20.3 million for the year ended December 31, 2005, compared with $9.7 million for the year ended December 31, 2004. The increase in cash used in operating activities was primarily due to a higher net loss in 2005 compared with 2004, and a higher accounts receivable and inventory balance which was partially offset by higher accounts payable balances in 2005 compared with the same period in 2004.

Cash used in investing activities included additions to property and equipment for the year ended December 31, 2005 of $1.7 million compared with $1.4 million in 2004, and net cash acquired as part of the Copper Mountain acquisition of $1.5 million offset by net purchases of short-term investments of $1.7 million. In 2006, we expect capital expenditures to increase compared with 2005. We expect these capital expenditures to be funded from operations and borrowings from our existing credit facility.

Cash provided by financing activities in 2005 consisted of $14.1 million from the issuance of private equity financing, $0.5 million from the issuance of common stock related to the exercise of stock options and purchases made pursuant to the employee stock purchase plan and net proceeds from the line of credit of $7.1 million.

The net decrease in cash and cash equivalents of $2.0 million during the year ended December 31, 2004, resulted primarily from our use of $9.7 million for operating activities and the purchase of property and equipment of $1.4 million. The net decrease in cash and cash equivalents from these uses was offset by $8.7 million from the issuance of 4.6 million additional common shares in a secondary offering and $0.5 million in proceeds from the issuance of common stock related to the exercise of stock options and purchases made pursuant to the employee stock purchase plan.

As of December 31, 2005, we did not have any relationships with unconsolidated entities or financial partnerships such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

The following table sets forth our contractual obligations as of December 31, 2005:

On September 23, 2004, we entered into a revolving asset based credit facility (“credit facility”), with Silicon Valley Bank (“the Bank”) which was amended on December 29, 2005. As amended, this facility had an initial term of two years and expires on September 23, 2007. Borrowings under the credit facility are formula based and limited to the lesser of $10.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the bank’s prime rate, 7.25% as of December 31, 2005, plus 0.5%. The rate may increase by 1.0% if we do not meet certain financial covenants. All of our assets are pledged as collateral, and the credit facility contains various covenants. We were in compliance with these financial covenants as of December 31, 2005. Based on the maximum percentages of eligible accounts receivable and eligible inventory levels, available borrowings under this facility were $7.8 million as of December 31, 2005. In addition, this credit facility allows for long-term borrowings of up to $1.2 million for purchase of fixed assets. We had outstanding borrowings of $7.1 against the revolving credit facility and no long-term borrowings against the credit facility at December 31, 2005.

As part of our acquisition of VTC from Tektronix in November 2002, we issued a note payable to Tektronix for $3.2 million, with repayment in sixty months, or by November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is added to the principal balance of the note. Thereafter, we will pay accrued interest on this note commencing on January 31, 2006 and on each

April 30, July 31 and October 31 thereafter until the principal balance is paid in full. Principal and accrued interest on the note payable is $4.1 million at December 31, 2005.

In July 2005, we completed the sale of 5,535 shares of our common stock at a price of $2.70 per share for gross proceeds of $14.9 million. Net proceeds from the offering were approximately $14.1 million. Under the terms of the sale, we also issued warrants to purchase an additional 2.8 million shares of our common stock. The warrants expire in 2010 and, beginning in 2006, are exercisable at a per share price of $4.25. We also have the right to call the warrants in the event that the trading price of our common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would provide us an additional $11.8 million in cash.

We have incurred substantial losses and negative cash flows from operations since inception. For the year ended December 31, 2005, we incurred a net loss of $17.6 million, negative cash flows from operating activities of $20.3 million, and have an accumulated deficit of $313.2 million.

We believe that our cash and cash equivalents and availability under our credit facility as of December 31, 2005, are sufficient to fund our operating activities and capital expenditure needs for at least the next twelve months. In future periods, we generally anticipate that our cash flows from operations will begin to increase as a result of several factors, including our expectation that our revenue will increase and our net loss will decrease in 2006 as compared to 2005. Accordingly, we expect the amount of cash used to fund our operations to decrease in 2006. However, in the event that we do not meet our revenue and earnings expectations, we may require additional cash to fund our operations. Failure to generate positive cash flow in the future could have a material adverse effect on our ability to achieve our intended business objectives.

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We have identified the policies below as critical to our business operations and the understanding of our results of operations.

Revenue recognition. We generate revenue primarily from the sale of hardware products, including third-party products, through professional services, and through the sale of our software products. We sell products through direct sales channels and through distributors. Generally, revenue is generated from the sale of video processing systems and components and the sale of broadband transport and service management products.

Revenue is generated primarily from the sale of complete end-to-end video processing systems generally referred to as turnkey solutions. Turnkey solution revenue is principally generated by the sale of complete end-to-end video processing systems that are designed, developed and produced according to a buyer’s specifications. Turnkey solutions are multi-element arrangements, which consist of hardware products, software products, professional services and post contract support.

Revenue is also generated from the sale of video processing component products and the sale of broadband transport and service management products and the sale of certain legacy products related to the acquisition of Copper Mountain. We sell these products through our own direct sales channels and also through distributors.

Our revenue recognition policies for turnkey solutions are in accordance with SOP 97-2, Software Revenue Recognition, as amended, which is the authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP 97-2 requires that revenue recognized from software arrangements be allocated to each element of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or other elements. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2 and was amended again in December 1998 by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments deferred and then clarified, respectively, the specification of what was considered vendor specific objective evidence of fair value for the various elements in a multiple element arrangement.

In the case of software arrangements that require significant production, modification or customization of software, which encompasses all of our turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We recognize revenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the PCS element of the multi-element arrangement, for which we have established vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally recognized using the percentage-of- completion method, as stipulated by SOP 81-1. The percentage-of-completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. In connection with certain contracts, we may perform the work prior to when the revenue is billable pursuant to the contract. The termination clauses in most of our contracts provide for the payment for the fair value of products delivered and services performed in the event of an early termination. In connection with certain of our contracts, we have recorded unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. Management reviews unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are generally considered to be incidental to the arrangement in its entirety because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.

For direct sales of video processing systems component products not included as part of turnkey solutions and the direct sale of broadband transport products and service management products, and the sales of legacy products related to the acquisition of Copper Mountain, we recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured.

Significant management judgments and estimates must be made in connection with the measurement of revenue in a given period. We follow specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, we assess a number of factors, including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, we may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. In order to recognize revenue,

we must also make a judgment regarding collectibility. Management’s judgment of collectibility is applied on a customer-by-customer basis pursuant to our credit review policy. We sell to customers for which there is a history of successful collection and to new customers for which such history may not exist. New customers are subject to a credit review process, which evaluates the customers’ financial position and ability to pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are only increased after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility is not probable based upon our credit review process, no credit is extended and revenue is recognized on a cash-collected basis.

We also maintain accruals and allowances for all cooperative marketing and other programs, as necessary. Estimated sales returns and warranty costs are based on historical experience and are recorded at the time revenue is recognized, as necessary. Our products generally carry a one year warranty from the date of purchase. To date, warranty costs have been insignificant to the overall financial statements taken as a whole.

Unbilled Receivables. Unbilled receivables (costs and estimated profit in excess of billings) may be recorded in connection with certain turnkey solution contracts. Unbilled receivables are not billable at the balance sheet date but are recoverable over the remaining life of the contract through billings made in accordance with contractual agreements. Management reviews unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue.

Inventories. Inventories are stated at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. We record provisions to write down our inventory and related purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than we estimate, additional inventory provisions may be required.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R (revised 2004), “Share-Based Payment”, which amends FASB Statement No. 123 and will be effective for public companies for first fiscal years beginning after June 15, 2005. We will adopt SFAS 123R on January 1, 2006 on a prospective basis. The new standard will require us to expense employee stock options and other share-based payments. The FASB believes the use of a binomial lattice model for option valuation is capable of more fully reflecting certain characteristics of employee share options compared to the Black-Scholes options pricing model. The new standard may be adopted in one of three ways—the modified prospective transition method, a variation of the modified prospective transition method or the modified retrospective transition method. We will adopt SFAS No 123R using the Black-Scholes options pricing model under the modified prospective transition method. On December 29, 2005, the Board of Directors of approved full acceleration of unvested stock options with an exercise price of $3.02 or greater previously granted under our 1998 Stock Option Plan and 1999 Non-statutory Stock Option Plan held our officers and employees. Options to purchase approximately 876,550 shares of the Company’s common stock, including approximately 126,390 shares held by our named executive officers, are subject to acceleration effective as of December 29, 2005. Since we currently account for share based payments using the intrinsic value method under APB 25, we expect the adoption of SFAS 123R will have an adverse impact on our results of operations.

volatility and expected term), the accounting for certain redeemable financial instrument issues under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. We are currently evaluating the impact that SAB 107 will have on our results of operations when we adopt it in fiscal 2006.

In June 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB No. 20 and FAS No. 3”, which replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Its adoption is not expected to have a significant impact on our financial position or results of operations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs-An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the previously issued authoritative guidance to clarify those abnormal amounts of idle facility expense, freight, handling costs, and wasted material should be recognized as current-period charges. In addition, SFAS 151 requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005, and will be adopted by us beginning January 1, 2006. We do not expect the adoption of this statement to have a material effect on our financial condition or results of operations.

In November 2005, FASB issued FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“FSP 115-1”) which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. The adoption of FSP 115-1 will not have a material impact on the Company’s results of operations or financial condition.

As of December 31, 2005, we had $1.7 million in short-term investments. An immediate 10% change in interest rate would be immaterial to our financial condition or results of operations.

The principal amount of cash and cash equivalents at December 31, 2005, totaled $12.1 million with a related weighted average interest rate of 1.75%. We had $1.7 million in short-term investments with a related

weighted average interest rate of 3.8%. Our long-term debt of $4.1 million at December 31, 2005, carries a weighted average fixed interest rate of 8.0% per annum with principal payment of the entire note payable balance due in November 2007. We had $7.1 million in outstanding borrowings under our credit facility which carries an average interest rate of 7.75%.

The table below presents principal amounts and related weighted average interest rates by year for our cash and cash equivalents, and debt obligations.

The estimated fair value of our cash and cash equivalents approximates the principal amounts reflected above based on the maturities of these financial instruments.

Although payments under certain of our operating leases for our facilities are tied to market indices, we are not exposed to material interest rate risk associated with our operating leases.

We transact business primarily in the U.S. dollar. To date, the effect of changes in foreign currency exchange rates on revenue has not been material, as the majority of our revenue is earned in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, therefore, reduce demand for our product.

For our foreign subsidiaries whose functional currency is the local currency, we translate assets and liabilities to U.S. dollars using the period-end exchange rates and translate revenues and expenses to U.S. dollars using average exchange rates during the period. Foreign currency exchange gains and losses arising from translation of foreign subsidiary financial statements are reported as a separate component on our Statement of Stockholders’ Equity. To date, the effect of changes in foreign currency exchange rates on translation has not been material.

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Tut Systems, Inc. (the “Company”) and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

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

The Company designs, develops, and sells digital video processing systems that enable telephony-based service providers to deliver broadcast quality digital video signals over their networks. The Company also offers video processing systems that enable private enterprise and government entities to transport video signals over satellite, fiber, radio, or copper networks for surveillance, distance learning, and TV production applications. Additionally, the Company designs, develops and markets broadband transport and service management products that enable the provisioning of high speed Internet access and other broadband data services over existing copper networks within hotels and private campus facilities.

Historically, the Company derived most of its sales from its broadband transport and service management products. In November 2002, the Company acquired VideoTele.com, referred to in this report as VTC, from Tektronix, Inc. to extend its product offerings to include digital video processing systems. On June 1, 2005, the Company acquired Copper Mountain Networks, Inc., referred to in this report as Copper Mountain, for its additional product and engineering resources to further address the Company’s expanding video market opportunities. The Company does not expect significant future revenue from the sale of Copper Mountain’s historical product line. Video-based products now represent a majority of the Company’s sales.

The Company has incurred substantial losses and negative cash flows from operations since inception. For the year ended December 31, 2005, the Company incurred a net loss of $17,645 and negative cash flows from operating activities of $20,261, and has an accumulated deficit of $313,158 at December 31, 2005. Management believes that its cash and cash equivalents and availability under the credit facility as of December 31, 2005 are sufficient to fund its operating activities and capital expenditure needs at least for the next twelve months. However, in the event that the Company does not meet its revenue and earnings expectations, the Company at least may require additional cash to fund operations. Failure to generate positive cash flow in the future would have a material adverse effect on the Company’s ability to achieve its intended business objectives.

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

The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates include valuation of inventories and accounts receivable, estimation of loss on purchase commitments, estimation of percentage-of-completion on revenue contracts, the recoverability of long-lived assets and intangible assets, and estimation of range of losses under contingencies. Actual results could differ from those estimates.

The fair value of the Company’s cash and cash equivalents, short-term investments, accounts receivable, accounts payable, line of credit and note payable approximate their carrying value due to the short maturity or market rate structure of those instruments.

Cash equivalents are stated at cost or amortized cost, which approximates fair value. The Company includes in cash and cash equivalents all highly liquid investments that mature within three months of their purchase date. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates that designation as of each balance sheet date.

The Company’s short-term investments are stated at fair value, and are principally comprised of corporate debt securities. The Company classifies its investments as available for sale in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and states its investments at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss). The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in interest and other income (expense), net. A liquid market exists for these short-term investments.

Unbilled receivables (costs and estimated profit in excess of billings) may be recorded in connection with certain turnkey solution contracts. Unbilled receivables are not billable at the balance sheet date but are recoverable over the remaining life of the contract through billings made in accordance with contractual agreements. Management reviews unbilled receivables and related contract provisions to ensure the Company is justified in recognizing revenue prior to billing the customer and that there is objective evidence which allows the Company to recognize such revenue.

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make payments. These estimated allowances are periodically reviewed and take into account customers’ payment history and information regarding customers’ creditworthiness that is known to the Company. The Company assesses individual accounts receivable over a specific aging and amount. If the financial condition of any of the Company’s customers were to deteriorate, resulting in their inability to make payments, the Company would need to record an additional allowance.

Inventories are stated at the lower of cost or market. Cost is computed using standard cost which approximates actual cost on a first-in, first-out basis. The Company records provisions to write down its inventory and related purchase commitments for estimated obsolescence or unmarketable inventory equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about the future demand and market conditions. If actual future demand or market conditions are less favorable than those estimated by the Company, additional inventory provisions may be required.

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

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

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

Intangible assets are stated at cost less accumulated amortization. Intangible assets consist of completed technology and patents, customer lists, maintenance contract renewals and trademarks. These intangible assets are amortized on a straight line basis over the estimated periods of benefit, which are as follows:

The Company periodically assesses the impairment of long-lived assets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, significant negative industry or economic trends, a significant decline in the stock price for a sustained period and the Company’s market capitalization relative to net book value.

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

During 2003 and 2005, the Company determined that certain long-lived assets and certain intangible long-lived assets were impaired and recorded losses accordingly under SFAS No. 144. No such impairment was recorded in 2004. Future events could cause the Company to conclude that impairment indicators once again exist. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed. Management tests for impairment of goodwill on an annual basis and at any other time if events occur or circumstances change that would indicate that it is more likely than not that the fair value of the reporting unit has been reduced below its carrying amount.

industry or economic trends, a significant decline in the stock price for a sustained period and the Company’s market capitalization relative to net book value.

The impairment test for goodwill is a two-step process. Step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to the reporting unit. Measurement of the fair value of a reporting unit is based on one or more fair value measures including present value techniques of estimated future cash flows and estimated amounts at which the unit as a whole could be bought or sold in a current transaction between willing parties. If the carrying amount of the reporting unit exceeds the fair value, step two requires the fair value of the reporting unit to be allocated to the underlying assets and liabilities of that reporting unit, resulting in an implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss equal to the excess is recorded in net earnings (loss).

The Company generates revenue primarily from the sale of hardware products, including third-party products, through professional services, and through the sale of its software products. The Company sells products through direct sales channels and through distributors. Generally, revenue is generated from the sale of video processing systems and components and the sale of broadband transport and service management products.

Revenue is also generated from the sale of video processing component products, the sale of broadband transport and service management products, and the sale of certain legacy products acquired with the Copper Mountain merger. The Company sells these products through its own direct sales channels and also through distributors.

The Company’s revenue recognition policies for turnkey solutions are in accordance with SOP 97-2, Software Revenue Recognition, as amended, which is the authoritative guidance for recognizing revenue on software transactions and transactions in which software is more than incidental to the arrangement. SOP 97-2 requires that revenue recognized from software arrangements be allocated to each element of the arrangement based on the relative fair values of the elements, such as hardware, software products, maintenance services, installation, training or other elements. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for any undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered, subject to certain limited exceptions set forth in SOP 97-2, as amended. SOP 97-2 was amended in February 1998 by SOP 98-4, Deferral of the Effective Date of a Provision of SOP 97-2, and was amended again in December 1998 by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. Those amendments deferred and then clarified, respectively, the specification of what was considered vendor specific objective evidence of fair value for the various elements in a multiple element arrangement.

In the case of software arrangements which require significant production, modification or customization of software, which encompasses all of the Company’s turnkey arrangements, SOP 97-2 refers to the guidance in SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The Company recognizes revenue for all turnkey arrangements in accordance with SOP 97-2 and SOP 81-1. Excluding the post contract support (or PCS) element, for which the Company has established vendor specific objective evidence of fair value (as defined by SOP 97-2), revenue from turnkey solutions is generally

recognized using the percentage-of-completion method, as stipulated by SOP 81-1. The percentage-of- completion method reflects the portion of the anticipated contract revenue that has been earned that is equal to the ratio of labor effort expended to date to the anticipated final labor effort, based on current estimates of total labor effort necessary to complete the project. Revenue from the PCS element of the arrangement is deferred at the point of sale and recognized over the term of the PCS period. Generally, the terms of the turnkey solution sales provide for billing of approximately 90% of the contract value of the arrangement prior to the time of delivery to the customer site, with an additional approximately 9% of the contract value billed upon substantial completion of the project and the balance upon customer acceptance. In connection with certain contracts, the Company may perform the work prior to when the revenue is billable pursuant to the contract. The termination clauses in most of the Company’s contracts provide for the payment for the fair value of products delivered and services performed in the event of an early termination. In connection with certain of the Company’s contracts, it has recorded unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. Management reviews unbilled receivables and related contract provisions to ensure it is justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows it to recognize such revenue. The contractual arrangements relative to turnkey solutions include customer acceptance provisions. However, such provisions are generally considered to be incidental to the arrangement in its entirety because customers are fully obligated with respect to approximately 99% of the contract value irrespective of whether acceptance occurs or not.

For direct sales of video processing systems component products not included as part of turnkey solutions, direct sale of broadband transport products and service management products and the sales of legacy products acquired with the Copper Mountain merger, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured.

Management must make significant judgments and estimates in connection with the measurement of revenue in a given period. The Company follows specific and detailed guidelines for determining the timing of revenue recognition. At the time of the transaction, the Company assesses a number of factors, including specific contract and purchase order terms, completion and timing of delivery to the common-carrier, past transaction history with the customer, the creditworthiness of the customer, evidence of sell-through to the end user, and current payment terms. Based on the results of the assessment, the Company may recognize revenue when the products are shipped or defer recognition of revenue until evidence of sell-through occurs and cash is received. In order to recognize revenue, the Company must also make a judgment regarding collectibility of the arrangement fee. Management’s judgment of collectibility is applied on a customer-by-customer basis pursuant to the Company’s credit review policy. The Company sells to customers with whom the Company has a history of successful collection and to new customers for which no similar history may exist. New customers are subject to a credit review process, which evaluates the customers’ financial position and ability to pay. New customers are typically assigned a credit limit based on a review of their financial position. Such credit limits are increased only after a successful collection history with the customer has been established. If it is determined from the outset of an arrangement that collectibility is not probable based upon the Company’s credit review process, revenue is recognized on a cash-collected basis.

The Company also maintains accruals and allowances for cooperative marketing and other programs, as necessary. Estimated sales returns and warranty costs are based on historical experience and are recorded at the time revenue is recognized, as necessary. The Company’s products generally carry a one year warranty from the date of purchase. To date, warranty costs have been insignificant to the overall financial statements taken as a whole.

Should changes in conditions cause us to determine that the criteria for revenue recognition are not met for certain future transactions, revenue recognition for any reporting period could be adversely affected.

The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” Financial Accounting Standards Board Interpretation No. 44 (“FIN 44”) “Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB 25,” and complies with the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company’s stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 148 and the EITF Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.”

The Company amortizes stock-based compensation using the straight-line method over the remaining vesting periods of the related options, which is generally four years. Pro forma information regarding net loss and earnings per share is required to be determined as if we had accounted for employee stock options under the fair value method of SFAS No. 123, as amended by SFAS No. 123R.

The following table illustrates the effect on net loss and loss per share if the Company’s had applied the fair value recognition provisions of SFAS No. 123, as amended by SFAS No. 123R, to stock-based employee compensation:

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

The effects of applying pro forma disclosures of net loss and earnings/loss per share are not likely to be representative of the pro forma effects on net loss/income and earnings/loss per share in future years, as the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.

The fair value of each stock option grant has been estimated on the date of the grant using the Black-Scholes option pricing model. The Company has also estimated the fair value of the purchase rights issued from its

employee stock purchase plan, using the Black-Scholes option pricing model. The Company first issued purchase rights from the 1998 Purchase Plan in fiscal 1999. The following table outlines the weighted average assumptions for both the stock options granted and the purchase rights issued:

Generally, the Company grants options at a price equal to the fair market value of the Company’s stock on the date of the grant. The weighted-average estimated fair values of stock options granted during fiscal 2003, 2004 and 2005 as calculated using the Black-Scholes option pricing model were $1.82, $3.33 and $1.94 per share, respectively.

On December 29, 2005, the Board of Directors approved full acceleration of unvested stock options with an exercise price of $3.02 or greater, previously granted under the Company’s 1998 Stock Option Plan and 1999 Non-statutory Stock Option Plan held by Company officers and employees. Options to purchase approximately 876,550 shares of the Company’s common stock, including approximately 126,390 shares held by the Company’s named executive officers, were subject to acceleration effective as of December 29, 2005. As a condition of the acceleration, and to avoid any unintended personal benefits, the Company also imposed a holding period on shares underlying the accelerated options that will require all optionees to refrain from selling any shares acquired upon the exercise of the options until the date on which such shares would have vested under the options’ original vesting terms, or, if earlier, the optionee’s last day of employment or upon a “change in control” as defined in any termination agreement between the individual option holder and the Company.

The Board decided to accelerate vesting of these options based in part on the anticipated effects of Financial Accounting Standards Board Statement No. 123 (revised 2004), “Share Based Payment” (SFAS 123R), which becomes effective for the Company’s first quarter of fiscal 2006, commencing on January 1, 2006. The acceleration of the vesting of these options minimizes future compensation expense that the Company would recognize in its financial statements with respect to these options as a result of SFAS 123R. Absent the acceleration of these options, upon the effectiveness of SFAS 123R, the Company would have been required to recognize approximately $2.1 million in pre-tax compensation expense, including $0.4 million attributable to options held by executive officers, from these options over their remaining vesting terms. By accelerating the vesting of these previously unvested options, the share-based compensation expense under SFAS 123 is reflected in this footnote disclosure. Further, the Company believes that any potential future share-based compensation expense related to these options would be immaterial to the Company’s financial results. However, the Company makes no assurance that these actions will avoid the recognition of future compensation expense in connection with these options.

Employees and officers may benefit from the accelerated vesting of their stock options in the event they terminate their employment with or service to the Company prior the completion of the original vesting terms as they would have the ability to exercise certain options that would have otherwise been forfeited. No share-based compensation expense will be recorded with respect to these options unless an employee or officer actually benefits from this modification. For those employees and officers who do benefit from the accelerated vesting, the Company is required to record additional share-based compensation expense equal to the intrinsic value of the option on the date of modification (i.e., December 29, 2005). The closing market price per share of the Company’s common stock on December 29, 2005 was $3.10 and the exercise price of the approximately 876,550 in unvested options on that date ranged from $3.02 to $6.16, with a weighted exercise price of $3.95. The

Company estimates the potential additional share-based compensation expense that the Company may be required to record with respect to these options would be immaterial to the Company’s financial results.

Shipping and handling costs incurred for inventory purchases and product shipments are recorded in Cost of Sales in the Consolidated Statements of Operations.

The Company accounts for advertising costs as expense in the period in which they are incurred. Advertising expense for the years ended December 31, 2003, 2004 and 2005 was zero, $53 and $49, respectively.

Research and development expenditures are charged to expense as incurred. These costs include costs associated with salaries, contractors, supplies, facilities, utilities and administrative expenses.

Costs incurred in the research and development of new software products are expensed as incurred until technological feasibility has been established at which time such costs are capitalized, subject to a net realizable value evaluation. Technology feasibility is established upon the completion of an integrated working model. Costs incurred between completion of the working model and the point at which the product is ready for general release have not been significant. Accordingly, the Company has charged all costs to research and development expense in the period incurred.

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.

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

Basic and diluted net loss per share is computed using the weighted average number of common shares outstanding. Options were not included in the computation of diluted net loss per share because the effect would be antidilutive.

Other comprehensive (loss) income includes unrealized gains and losses on other assets and foreign currency translation adjustments that have been previously excluded from net loss and reflected instead in stockholders’ equity. The following table sets forth the components of other comprehensive (loss) income:

The Company operates in one business segment, designing, developing and selling video content processing systems optimized for the provisioning of public broadcast digital TV services across telephone company and cable company facilities, digital video trunking systems for applications across TV broadcast, government and education facilities, and broadband data transmission systems for application over existing private campus or building facilities.

The market for these products is characterized by rapid technological developments, frequent new product introductions, changes in end-user requirements and constantly evolving industry standards. The Company’s future success depends on its ability to develop, introduce and market enhancements to its existing products, to introduce new products in a timely manner that meet customer requirements and to respond effectively to competitive pressures and technological advances. Further, the emergence of new industry standards, whether formally adopted by official standards committees or informally through widespread use of such standards by telephone companies or other service providers, could require the Company to redesign its products.

Currently, the Company relies on contract manufacturers and certain single source suppliers of materials for certain product components. As a result, should the Company’s current manufacturers or suppliers not produce and deliver inventory for the Company to sell on a timely basis, operating results could be adversely impacted.

From time to time, the Company maintains a substantial portion of its cash and cash equivalents in money market accounts with one financial institution. The Company invests its excess cash in debt instruments of the U.S. Treasury, governmental agencies and corporations with strong credit ratings. The Company has established guidelines relating to diversification and maturities in order to maintain the safety and liquidity of these assets. To date, the Company has not experienced any significant losses on its cash equivalents or short-term investments.

As of December 31, 2005, two customers, FTC Management, Inc. and Al-Falak Systems Solutions and Consulting accounted for 19% and 12% respectively of the Company’s accounts receivable.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R (revised 2004), “Share-Based Payment”, which amends FASB Statement No. 123 and will be effective for public companies first fiscal year beginning after June 15, 2005. Thus, the Company will adopt SFAS No. 123R on January 1, 2006 on a prospective basis. The new standard will require the Company to expense employee stock options and other share-based payments. The FASB believes the use of a binomial lattice model for option valuation is capable of more fully reflecting certain characteristics of employee share options compared to the Black-Scholes options pricing model. The new standard may be adopted in one of three ways—the modified prospective transition method, a variation of the modified prospective transition method or the modified retrospective transition method. The Company will adopt SFAS No. 123R using the Black-Scholes option pricing model under the modified prospective transition method. On December 29, 2005, the Board of Directors approved full acceleration of unvested stock options with an exercise price of $3.02 or greater previously granted under the Company’s 1998 Stock Option Plan and 1999 Non-statutory Stock Option Plan held by Company officers and employees. Options to purchase approximately 876,550 shares of the Company’s common stock, including approximately 126,390 shares held by the Company’s named executive officers, are subject to acceleration effective as of December 29, 2005. Since the Company currently accounts for share based payments using the intrinsic value method under APB 25, the Company expects the adoption of FAS 123R will have an adverse impact on its results of operations.

On March 29, 2005, the SEC issued Staff Accounting Bulletin 107, or SAB 107, which expresses the views of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provides the SEC’s views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with non-employees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instrument issues under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in an interim period, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R, and disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. The Company is currently evaluating the impact that SAB 107 will have on its results of operations when it is adopted in fiscal 2006.

In June 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections—a replacement of APB No. 20 and FAS No. 3”, which replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. When it is impracticable to determine the period-specific effects of an accounting change, this Statement requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. When it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. This Statement shall be effective for accounting changes and corrections of

errors made in fiscal years beginning after December 15, 2005. Its adoption is not expected to have a significant impact on the Company’s financial position or results of operations.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs-An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the previously issued authoritative guidance to clarify those abnormal amounts of idle facility expense, freight, handling costs, and wasted material should be recognized as current-period charges. In addition, SFAS 151 requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005, and will be adopted by the Company beginning January 1, 2006. The Company does not expect the adoption of this statement to have a material effect on its financial condition or results of operations.

In November 2005, FASB issued FASB Staff Position (“FSP”) FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“FSP 115-1”) which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether that impairment is other-than-temporary, and on measuring such impairment loss. FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 is effective for reporting periods beginning after December 15, 2005. Our adoption of FSP 115-1 will not have a material impact on our results of operations or financial condition.

Certain reclassifications have been made to prior year balances in order to conform to the current year presentation. Amortization of intangible assets relating to completed technology and patents have been reclassified from operating expenses to cost of goods sold. This reclassification did not affect cash flows, financial position or net loss.

At December 31, 2004 and 2005, cash, cash equivalents and short term investments are summarized as follows:

On January 7, 2005, the Company entered into an Agreement and Plan of Merger with CoSine Communications, Inc., referred to in this report as CoSine. The Company received formal notice from CoSine on May 17, 2005, to terminate the merger agreement. In May 2005, the Company incurred a one time charge of $1,209 to write off the related transaction costs, reflected in the statement of operations for the second quarter of 2005. The Company included this charge in General and Administrative expenses.

On June 1, 2005, the Company acquired 100% of the outstanding common stock of Copper Mountain for approximately $11,729. The purchase price consisted of 2,467 shares of the Company’s common stock valued in aggregate at $9,787, warrants to purchase the Company’s common stock valued at $58, acquisition related expenses consisting of legal, insurance and other professional fees of $1,503 and employee severance costs of $351. The value of the Company’s common stock was determined based on the average market price over the two day period before and after the acquisition was announced on February 11, 2005. The results of operations of Copper Mountain have been included in the consolidated statement of operations from June 1, 2005. The Company acquired Copper Mountain for its additional product and engineering resources, which are being refocused to address the Company’s expanding video market opportunities. The Company believes that the acquisition of Copper Mountain is accelerating the Company’s plans to address the growing number of opportunities in the market for video processing systems. During the year ended December 31, 2005, the Company recognized revenue of $2,226 from the sale of legacy Copper Mountain’s products. The Company will honor Copper Mountain’s existing customer support agreements but does not expect significant future revenue from the sale of Copper Mountain’s historical product lines.

The Company determined the fair value of the acquired intangibles using established valuation techniques. The purchase price of $11,729 exceeded the fair value of the net assets acquired of $10,057, thereby resulting in goodwill of $1,672. The allocation of the purchase price was as follows:

Completed technology and patents are being amortized over a weighted average life of five years. Amortization of $795 has been included in cost of goods sold. The goodwill of $1,672 will not be deductible for tax purposes.

The following unaudited pro forma consolidated information gives effect to the acquisition of Copper Mountain as if it had occurred on January 1, 2004 and 2005 by consolidating the results of operations of Copper Mountain with the results of operations of the Company for the year ended December 31, 2004 and 2005.

The aggregate amortization expense for the years ended December 31, 2003, 2004 and 2005 was $1,809, $1,524 and $1,647 respectively.

On September 23, 2004, the Company entered into a revolving asset based credit facility (“credit facility”), with Silicon Valley Bank (“the Bank”) which was amended on December 29, 2005. As amended, this facility had an initial term of two years and expires on September 23, 2007. Borrowings under the credit facility are formula based and limited to the lesser of $10.0 million or an amount based on a percentage of eligible accounts receivable and eligible inventories. The interest rate on outstanding borrowings is equal to the bank’s prime rate, 7.25% as of December 31, 2005, plus 0.5%. The rate may increase by 1.0% if the Company does not meet certain financial covenants. All of the Company’s assets are pledged as collateral and the credit facility contains various covenants. The Company was in compliance with these financial covenants as of December 31, 2005. Based on the maximum percentages of eligible accounts receivable and eligible inventory levels, available borrowings under this facility were $7,787 as of December 31, 2005. In addition, this credit facility allows for long-term borrowings of up to $1.2 million for purchase of fixed assets. The Company had outstanding borrowings under this facility of $7,080 against the revolving credit facility and no long-term borrowings against the credit facility at December 31, 2005.

As part of the Company’s acquisition of VTC from Tektronix, Inc. in November 2002, the Company issued a note payable to Tektronix, Inc. for $3,232, with repayment in sixty months, or November 2007. The interest rate on this note is 8% and is compounded annually. Through January 31, 2006, the accrued interest is added to the principal balance of the note. Thereafter, the Company will pay accrued interest on this note commencing on January 31, 2006 and on each April 30, July 31 and October 31 thereafter until the principal balance is paid in full. As of December 31, 2004 and 2005, this note payable balance, including accrued interest, was $3,816 and $4,122, respectively.

NOTE 7—RESTRUCTURING COSTS, IMPAIRMENT OF CERTAIN ASSETS AND PROVISION FOR INVENTORY:

In August 2003, the Company implemented a restructuring program that included a workforce reduction and relocation. As a result of this restructuring program, the Company recorded restructuring costs of $292. The workforce reduction was approximately 11% of the Company’s employees, resulting in severance and fringe benefit expenses of approximately $192 along with relocation costs of $100. As of December 31, 2003, the Company had paid all the costs relating to this restructuring program.

In September 2005, the Company announced a restructuring program that included a workforce reduction. As a result of this restructuring program, the Company recorded restructuring costs of $130 consisting of severance payments. As of December 31, 2005, all the restructuring costs have been paid.

During the second quarter of 2003 and first quarter of 2004, the Company determined that certain of the technology acquired as part of the purchase of the ViaGate assets had become impaired. As a result, the Company recorded an impairment charge of $128 in 2003 and $202 in 2004. During the third quarter of 2005, the Company determined that certain of its technology acquired as part of the VTC acquisition in November 2002, had become impaired. As a result, the Company incurred a loss of $192 to write-off the technology. These impairment charges are included in Cost of Goods Sold.

During the fourth quarter of 2005, the Company determined that certain long lived assets in the UK office had become impaired. As a result, the Company recorded an impairment charge of $206 in 2005. There was no such impairment charge in 2003 and 2004.

The Company recorded a provision, within costs of goods sold, for inventory totaling $225 in 2003, $1,542 in 2004 and $1,022 in 2005. These provisions relate to the net realizable value of raw materials and reserves for finished goods in excess of what the Company reasonably expected to sell in the foreseeable future, based on the continued decline in the telecommunications market and current economic conditions. The Company sold $539 and $76 in 2004 and 2005, respectively of inventory that had been previously reserved for.

The components of net deferred tax assets and liabilities as of December 31, 2004 and 2005 are as follows:

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

At December 31, 2005, the Company has approximately $302,901 in federal and $150,842 in state net operating loss, or NOL, carryforwards to reduce future taxable income. Of these amounts, $28,642 and $12,156 represent federal and state tax deductions, respectively, from stock option compensation. The tax benefit from these deductions will be recorded as an adjustment to additional paid-in capital in the year in which the benefit is realized.

At December 31, 2005, the Company also has research and experimentation tax credit carryforwards of approximately $3,736 and $2,230 for federal and state income tax purposes, respectively. The NOL and credit carryforwards expire in 2007 to 2025.

The Company’s ability to use its federal and state net operating loss carryforwards and federal and state tax credit carryforwards to reduce future taxable income and future taxes, respectively, may be subject to restrictions attributable to equity transactions that may have resulted in a change of ownership as defined by Internal Revenue Code Section 382. In the event the Company has had such a change in ownership, utilization of these carryforwards could be severely restricted and could result in significant amounts of these carryforwards expiring prior to benefiting the Company. The Company is currently assessing whether such a change in ownership has occurred.

The Company’s effective tax rate of zero is a result of the tax benefit calculated at the statutory tax rate completely offset by the deferred tax asset valuation allowance.

The Company leases office, manufacturing and warehouse space under noncancelable operating leases that expire in 2006 and 2010. In connection with the business combination in 2002, the Company assumed an operating lease that expires in December 2007. In December 2005, the Company entered into a lease agreement for a facility in Pleasanton, California that expires in June 2007. The Company also leases certain office equipment under capitalized lease obligations that expire in 2008.

Minimum future lease payments under operating and capital leases at December 31, 2005 are as follows:

Rent expense for the years ended December 31, 2003, 2004 and 2005 was $1,233 $1,189 and $1,426 respectively. At December 31, 2005, the cost of the leased capital assets were $168 with accumulated amortization of $14 resulting in a net book value of leased capital assets of $154.

The Company had noncancelable commitments to purchase finished goods inventory totaling $469 and $450 in aggregate at December 31, 2004 and 2005, respectively. These purchase commitments represent outstanding purchase orders submitted to the Company’s third party manufacturers for goods to be produced and delivered to the Company in 2005 and 2006.

On October 30, 2001, the Company and certain of its current and former officers and directors were named as defendants in Whalen v. Tut Systems, Inc. et al., Case No. 01-CV-9563, a purported securities class action lawsuit filed in the United States District Court for the Southern District of New York. An amended complaint was filed on December 5, 2001. A consolidated amended complaint was filed on April 19, 2002. The consolidated amended complaint asserts that the prospectuses from the Company’s January 29, 1999 initial public offering and its March 23, 2000 secondary offering failed to disclose certain alleged actions by the underwriters for the offerings. The complaint alleges claims against the Company and certain of its current and former officers and directors under Section 11 of the Securities Act of 1933, as amended, and under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and alleges claims against certain of its current and former officers and directors under Sections 15 and 20(a) of the Securities Act. The complaint also names as defendants the underwriters for the Company’s initial public offering and secondary offering. Similar suits were filed in the Southern District of New York challenging over 300 other initial public offerings and secondary offerings conducted in 1999 and 2000. Therefore, for pretrial purposes, the Whalen action is being coordinated with the approximately 300 other suits before United States District Court Judge Shira Scheindlin of the Southern District of New York under the matter In Re Initial Public Offering Securities Litigation. The individual defendants in the Whalen action, namely, Nelson Caldwell, Salvatore D ‘Auria and Matthew Taylor, were dismissed without prejudice by an October 9, 2002 Order of the Court, approving the parties’ October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order denying the Company’s motion to dismiss.

In June 2004, a stipulation of settlement for the claims against the issuer-defendants, including the Company, was submitted to the Court in the In Re Initial Public Offering Securities Litigation. On August 31, 2005, the Court granted preliminary approval of the settlement. The settlement is subject to a number of conditions, most of which are outside of the Company’s control, including final approval by the Court. The underwriters named as defendants in the In Re Initial Public Offering Securities Litigation (collectively, the “underwriter-defendants”), including the underwriters named in the Whalen suit, are not parties to the stipulation of settlement.

The stipulation of settlement provides that, in exchange for a release of claims against the settling issuer-defendants, the insurers of all of the settling issuer-defendants will provide a surety undertaking to guarantee plaintiffs a $1 billion recovery from the non-settling defendants, including the underwriter-defendants. The ultimate amount, if any, that may be paid on behalf of the Company will therefore depend on the final terms of the settlement, including the number of issuer-defendants that ultimately participate in the final settlement, and the amounts, if any, recovered by the plaintiffs from the underwriter-defendants and other non-settling defendants.

In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation

Copper Mountain, which the Company acquired on June 1, 2005, was in December 2001, along with certain of its officers and directors, named as defendants in a class action shareholder complaint filed in the United States District Court for the Southern District of New York, now captioned In re Copper Mountain Networks, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-10943 alleging violations of securities law under Section 11 of the Securities Act of 1933, as amended, and Section 10(b) and Rule 10b-5 of the Exchange Act. As a result of the acquisition, the Company has inherited the responsibility and obligations of Copper Mountain to defend the claims in that case and the Company is exposed to any liability that may come out of the

claims. The Copper Mountain action described in this paragraph like the Whalen action described above has been coordinated for pretrial purposes under the matter In Re Initial Public Offering Securities Litigation. The individual defendants in the Copper Mountain action were also dismissed without prejudice pursuant to the October 9, 2002 Order of the Court approving the parties’ October 1, 2002 Stipulation of Dismissal. On February 19, 2003, the Court issued an Opinion and Order granting in part and denying in part Copper Mountain’s motion to dismiss. Thereafter, Copper Mountain entered into the same stipulation of settlement as the Company did in the Whalen action described above. The Copper Mountain stipulation of settlement is subject to the same terms, conditions and contingencies as the stipulation of settlement the Company entered into with respect to the Whalen action described above.

In the event that all or substantially all of the issuer-defendants participate in the final settlement, the amount that may be paid to the plaintiffs on behalf of the Company could range from zero to approximately $7.0 million which consists of the approximately $3.5 million from the Copper Mountain action described above and approximately $3.5 million from the Whalen action described above, depending on plaintiffs’ recovery from the underwriter-defendants and from other non-settling parties and the amount of insurance available under the Company’s applicable insurance policies. If the plaintiffs recover at least $1 billion from the underwriter-defendants, no settlement payments would be made on behalf of the Company under the proposed terms of the settlement. If the plaintiffs recover less than $1 billion, the Company believes that its insurance will likely cover some or its entire share of any payments towards satisfying its share of plaintiffs’ $1 billion recovery amount. Management estimates that its range of loss relative to this matter is zero to $7.0 million. Presently there is no more likely point estimate of loss within this range. As a consequence of the uncertainties described above regarding the amount the Company will ultimately be required to pay, if any, as of December 31, 2005, the Company has not accrued a liability for this matter.

The Company is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. The Company’s management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

The Company has 5,000 shares of undesignated preferred stock, $0.001 par value, authorized for issuance. The Board of Directors can issue, in one or more series, this preferred stock and fix the voting rights, liquidation preferences, dividend rights, repurchase rights, conversion rights, redemption rights and terms and certain other rights and preferences with stockholder action. There was no preferred stock issued and outstanding at December 31, 2004 or 2005.

In October 2004, the Company completed the sale of 4,600 shares of its common stock at a price of $2.25 per share for gross proceeds of $10,350. Net proceeds from the offering were approximately $8,711.

On July 22, 2005, the Company completed the private sale of 5,535 shares of its common stock at a price of $2.70 per share for gross proceeds of $14,945. Net proceeds from the offering after issuance costs of $888 were approximately $14,057. Under the terms of the financing, the Company also issued warrants to purchase an additional 2,767 shares of its common stock. The warrants expire in 2010 and, beginning in 2006, are exercisable at a per share price of $4.25. The Company has the right to call the warrants in the event that the trading price of its common stock exceeds $7.44 per share for twenty consecutive trading days. If exercised in full, the warrants would provide an additional $11,760 in proceeds to the Company. Of the net proceeds of $14,057, $6 was recorded as common stock and $14,051 was recorded as additional paid in capital. This additional paid in capital consists of $7,949 additional paid in capital for common stock and $6,102 additional paid in capital for warrants.

In November 1993, the Company adopted the 1992 Stock Plan (the “1992 Plan”), under which the Company may grant both incentive stock options and nonstatutory stock options to employees, consultants and directors. Options issued under the 1992 Plan can have an exercise price of no less than 85% of the fair market value, as defined under the 1992 Plan, of the stock at the date of grant. The 1992 Plan, including amendments, allows for the issuance of a maximum of 178 shares of the Company’s common stock. This number of shares of common stock has been reserved for issuance under the 1992 Plan. The Company is no longer granting stock options from the 1992 Plan. As stock options are terminated or cancelled from the 1992 Plan, the stock options are being retired and are no longer available for future grant.

The Company’s 1998 Stock Plan (the “1998 Plan”) was adopted by the Board of Directors in July 1998 and was approved by the stockholders in September 1998 and has rights and privileges similar to the 1992 Plan. The 1998 Plan allows for the issuance of a maximum of 1,000 shares of the Company’s common stock with annual increases starting in 2000, subject to certain limitations. In January 2000, the 1998 Plan was amended to increase the maximum number of shares that may be issued to 1,358. In January 2001, the 1998 Plan was amended to increase the maximum number of shares that may be issued by 375 to 1,733. In January 2002, the 1998 Plan was amended to increase the maximum number of shares by 375 to 2,108. In January 2005, the 1998 Plan was amended to increase the maximum number of shares by 375 to 2,483. In August 2005, the 1998 Plan was amended to increase the maximum number of shares by 500 to 2,983.

The Company’s 1999 Nonstatutory Stock Option Plan (the “1999 Plan”) was adopted by the Board of Directors in December 1999. The 1999 Plan allows for the issuance of a maximum of 1,000 shares of the Company’s common stock. Additions to the Plan may be approved by the Board of Directors. The 1999 Plan has rights and privileges similar to the 1998 Plan. In April 2000, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 1,425. In October 2000, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 1,825. In October 2002, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 2,625. In August 2005, the 1999 Plan was amended to increase the maximum number of shares that may be issued to 3,125.

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

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

The Company uses the Black-Scholes option pricing model to value options granted to consultants. The total estimated fair value of these grants during the periods presented was not significant and was expensed over the applicable vesting periods. No options were granted to consultants during 2004 or 2005.

At December 31, 2003, 2004 and 2005 vested options to purchase 2,432, 3,126 and 4,453 shares of common stock, respectively were unexercised. The weighted average exercise price of these options $8.29, $7.10 and $5.08 per share for 2003, 2004 and 2005 respectively.

The following table summarizes information about stock options outstanding at December 31, 2005:

On December 29, 2005, the Board of Directors of approved full acceleration of unvested stock options with an exercise price of $3.02 or greater previously granted under the Company’s 1998 Stock Option Plan and 1999 Non-statutory Stock Option Plan held by Company officers and employees. Options to purchase approximately 876,550 shares of the Company’s common stock, including approximately 126,390 shares held by the Company’s named executive officers, are subject to acceleration effective as of December 29, 2005. As a condition of the acceleration, and to avoid any unintended personal benefits, the Company also imposed a holding period on shares underlying the accelerated options that will require all optionees to refrain from selling any shares acquired upon the exercise of the options until the date on which such shares would have vested under the options’ original vesting terms, or, if earlier, the optionee’s last day of employment or upon a “change in control” as defined in any termination agreement between the individual option holder and the Company. The closing market price per share of the Company’s common stock on December 29, 2005 was $3.10 and the exercise price of the approximately 876,550 in unvested options on that date ranged from $3.02 to $6.16, with a weighted exercise price of $3.95.

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 ending on the last trading day of the period six (6) months later. In 1998, the Company reserved 250 shares of common stock for issuance under the 1998 Purchase Plan. In 2001, the Company allocated an additional 250 shares of common stock, increasing the number of shares reserved for issuance under the 1998 Purchase Plan to 500 and in January 2005, the Company increased the number of shares reserved for issuance by 250 to 750, of which 420 have been issued, leaving 330 for future issuances under the 1998 Purchase Plan as of December 31, 2005. The 1998 Purchase Plan is subject to annual increases, subject to certain limitations.

In April 1995, the Company adopted the Tut Systems’ Inc. 401(k) Plan (the “401(k) Plan”) covering all eligible employees. Through December 31, 2001, contributions were limited to 15% of each employee’s annual compensation, and further limited by IRS annual contribution limitations. Effective January 1, 2002, contributions are allowed up to 100% of each employee’s annual compensation, but are still limited by IRS annual contribution limitations, depending on the age of the eligible employee. Contributions to the 401(k) Plan by the Company are discretionary. The Company did not make any contributions for the years ended December 31, 2003, 2004 and 2005.

The Company currently targets its sales and marketing efforts to both public and private service providers and users across two related markets. The Company currently operates in a single business segment as there is only one measurement of profitability for its operations. Revenue relating to the broadband transport and service management products was $8,263, $6,962 and $4,613 for the years ended December 31, 2003, 2004 and 2005, respectively. Revenue related to video processing systems was $23,929, $18,030 and $30,626 for the years ended December 31, 2003, 2004 and 2005, respectively. Revenue related to legacy product sales from the recently completed Copper Mountain merger was $2,226 for the year ended December 31, 2005. Revenues are attributed to the following countries based on the location of customers:

No individual customer accounted for greater than 10% of the Company’s revenue for the years ended December 31, 2003, 2004 and 2005.

The Company designs, develops, and sells video processing systems and broadband transport and service management products. Video processing systems include both digital TV headend systems and video systems. The digital TV headend system enables telephony-based service providers to transport broadcast quality digital video signals across their networks and our digital video transmission systems optimize the delivery of video signals across enterprise, government and education networks. The broadband transport and service management products enable the transmission of broadband data over existing hotels and private campus networks.

The Company has long-lived assets, which consist of property and equipment, and other assets. Long-lived assets are located in the following countries:

The Company generally warrants its products for a specific period of time against material defects. The Company provides for the estimated future costs of warranty obligations in costs of goods sold when the related revenue is recognized. The accrued warranty costs represents the best estimate at the time of sale of the total costs that the Company expects to incur to repair or replace product parts, which fail while still under warranty. The amount of accrued estimated warranty costs are primarily based on historical experience as to product failure as well as current information on repair costs. On a quarterly basis, the Company reviews the accrued balances and updates the historical warranty cost trends. Warranty costs and accrued warranty cost for the years ended December 31, 2003, 2004 and 2005 were immaterial to the overall financial statements.

The following table presents certain unaudited consolidated quarterly financial information for each of the eight quarters ended December 31, 2005. In the opinion of management, this quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments necessary to state fairly the information for the periods presented. The results of operations for any quarter are not necessarily indicative of results for the full year or for any future period.

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

There has been no change in our independent registered public accounting firm during the past two fiscal years. There have been no disagreements with our independent registered public accounting firm on our accounting or financial reporting or auditing scope of procedure that would require our registered public accounting firm to make reference to such disagreement in their report on our consolidated financial statements and financial statement schedule, or otherwise require disclosure in this Annual Report on Form 10-K.

Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting which occurred during the fourth quarter of fiscal year 2005 and which have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

On December 30, 2005, our board of directors approved the terms of compensation to be paid to the non-management directors. Compensation for non-management directors includes an annual retainer of $25,000 for serving as a director and a meeting bonus retainer of $12,500 for attendance at all regularly scheduled quarterly board meetings. Directors may voluntarily elect to receive up to 100% of their cash retainers in the form of the Company’s common stock with a 10% value premium, subject to holding requirements and our stock ownership guidelines, when adopted by the board of directors. Our board of directors also approved an increase in the initial stock grant that directors would receive upon their first election to the board from 15,000 shares of common stock to 30,000 shares of common stock. A summary of the Non-management Director Compensation Plan is provided in Exhibit 10.23 of this Annual Report on Form 10-K.

The Company’s Proxy Statement for its 2006 Annual Meeting of Stockholders, filed pursuant to Regulation 14A under the Securities and Exchange Act of 1934, as amended, or the Exchange Act, is incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) and provides the information required in Item 10.

With respect to Section 16(a) compliance, the Company’s Proxy Statement for its 2006 Annual Meeting of Stockholders, filed pursuant to Regulation 14A under the Exchange Act, is incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) and provides the information required in Item 10.

The Company’s Proxy Statement for its 2006 Annual Meeting of Stockholders, filed pursuant to Regulation 14A under the Exchange Act, is incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) and provides the information required in Item 11.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

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

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

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

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


TUT SYSTEMS, INC.

By:		/s/ SALVATORE D’AURIA
		Salvatore D’Auria President and Chief Executive Officer (Principal Executive Officer)

By:		/s/ RANDALL K. GAUSMAN
		Randall K. Gausman Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

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

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this 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:


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

6000 SW Meadows Drive, Suite 200 Lake Oswego, Oregon		97035
(address of principal executive offices)		(zip code)


	High		Low
2004
First Quarter	$	7.49	$	3.83
Second Quarter		4.66		2.41
Third Quarter		3.54		1.69
Fourth Quarter		4.25		2.46

2005
First Quarter	$	4.55	$	2.41
Second Quarter		3.19		2.38
Third Quarter		3.77		2.93
Fourth Quarter		3.42		2.84


	Fiscal Year Ended December 31,
	2001			2002 (4)			2003			2004			2005 (5)
	(in thousands, except per share data)
Statement of Operations Data:
Total revenues	$	13,748		$	9,371		$	32,192		$	24,992		$	37,465
Cost of goods sold (3)		41,420	(2)		15,167	(1)		17,432			18,642			26,281

Gross profit (loss)		(27,672	)		(5,796	)		14,760			6,350			11,184

Operating expenses
Sales and marketing		12,413			8,695			7,479			8,096			10,649
Research and development		15,044			12,337			7,909			7,278			12,412
General and administrative		10,148			5,060			4,476			4,336			5,250
Restructuring costs		2,311			9,147			292			—			130
In-process research and development		1,160			562			—			—			—
Impairment of assets		32,551			—			—			—			206
Amortization of intangible assets		7,154			46			151			64			68

Total operating expenses		80,781			35,847			20,307			19,774			28,715

Loss from operations		(108,453	)		(41,643	)		(5,547	)		(13,424	)		(17,531	)
Impairment of certain equity investments		—			(592	)		—			—			—
Gain on sale of investments		—			—			—			125			—
Interest and other income (expense), net		4,127			610			30			(161	)		(114	)

Net loss	$	(104,326	)	$	(41,625	)	$	(5,517	)	$	(13,460	)	$	(17,645	)

Net loss per common share attributable to common stockholders, basic and diluted	$	(6.39	)	$	(2.45	)	$	(0.28	)	$	(0.63	)	$	(0.60	)

Shares used in computing net loss per share attributable to common stockholders, basic and diluted		16,326			16,957			19,996			21,392			29,200


	December 31,
	2001			2002			2003			2004			2005
	(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents	$	49,367		$	25,571		$	14,370		$	12,440		$	12,111
Working capital		51,484			24,396			21,815			19,385			19,820
Total assets		78,992			39,729			42,771			27,965			47,183
Long-term debt		—			3,262			3,523			3,816			4,122
Total stockholders’ equity		66,096			28,231			23,655			19,378			26,402


	Year Ended December 31,
	2003		2004		2005
Total revenues	100.0	%	100.0	%	100.0	%
Cost of goods sold	54.2		74.6		70.1

Gross profit	45.8		25.4		29.9

Operating expenses:
Sales and marketing	23.2		32.4		28.4
Research and development	24.6		29.1		33.1
General and administrative	13.9		17.3		14.0
Restructuring costs	0.9		—		0.3
Impairment of assets	—		—		0.5
Amortization of intangible assets	0.5		0.3		0.2

Total operating expenses	63.1		79.1		76.6

Loss from operations	(17.2	)	(53.7	)	(46.8	)
Gain on sale of investments	—		0.5		—
Interest and other income (expense), net	0.1		(0.6	)	(0.3	)

Net loss	(17.1	)%	(53.9	)%	(47.1	)%


		Page
Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm		40
Consolidated Balance Sheets as of December 31, 2004 and December 31, 2005		41
Consolidated Statements of Operations for the Years Ended December 31, 2003, December 31, 2004 and December 31, 2005		42
Consolidated Statements of Stockholders’ Equity as of December 31, 2003, December 31, 2004 and December 31, 2005		43
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, December 31, 2004 and December 31, 2005		44
Notes to Consolidated Financial Statements		45
Financial Statement Schedule		72


ITEM NO.		Page
PART I
1.	BUSINESS	4
1A.	RISK FACTORS	13
1B.	UNRESOLVED STAFF COMMENTS	23
2.	PROPERTIES	23
3.	LEGAL PROCEEDINGS	23
4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	24

PART II
5.	MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	25
6.	SELECTED FINANCIAL DATA	26
7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	27
7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	37
8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	39
9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	67
9A.	CONTROLS AND PROCEDURES	67
9B.	OTHER INFORMATION	68

PART III
10.	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	69
11.	EXECUTIVE COMPENSATION	69
12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	69
13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	69
14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	69

PART IV
15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	70
	SIGNATURES	71


	Payments due by period
Contractual Obligations (thousands)	Total		Less than 1 year		1 - 3 years		3 - 5 years		Thereafter
Line of credit	$	7,080	$	7,080	$	—	$	—	$	—
Long-Term debt obligations		4,122		—		4,122		—		—
Interest on long-term debt obligations		504		252		252
Capital lease commitments		150		50		100		—		—
Operating lease commitments		1,792		960		816		16		—
Purchase obligations		450		450		—		—		—

Total	$	14,098	$	8,792	$	5,290	$	16	$	—


	Maturity Fiscal Year
	2006			2007			2008		2009		Thereafter		Total
	(dollars in thousands)
Assets:
Cash and cash equivalents	$	12,111		$	—		$	—	$	—	$	—	$	12,111
Average interest rate		1.75	%		—			—		—		—		1.75	%
Short-term investments	$	1,693		$	—		$	—	$	—	$	—	$	1,693
Average interest rate		3.8	%		—			—		—		—		3.8	%

Liabilities:
Line of credit	$	7,080		$	—		$	—	$	—	$	—	$	7,080
Average interest rate		7.75	%		—			—		—		—		7.75	%
Long-term debt	$	—		$	4,122		$	—	$	—	$	—	$	4,122
Average interest rate		8.0	%		8.0	%		—		—		—		8.0	%


	Years Ended December 31,
	2003			2004			2005
Revenue	$	32,192		$	24,992		$	37,465
Cost of goods sold		17,432			18,642			26,281

Gross profit		14,760			6,350			11,184

Operating expenses:
Sales and marketing		7,479			8,096			10,649
Research and development		7,909			7,278			12,412
General and administrative		4,476			4,336			5,250
Restructuring costs		292			—			130
Impairment of assets		—			—			206
Amortization of intangible assets		151			64			68

Total operating expenses		20,307			19,774			28,715

Loss from operations		(5,547	)		(13,424	)		(17,531	)
Gain on sale of investments		—			125			—
Interest and other income (expense), net		30			(161	)		(114	)

Net loss	$	(5,517	)	$	(13,460	)	$	(17,645	)

Net loss per share, basic and diluted (Note 2)	$	(0.28	)	$	(0.63	)	$	(0.60	)

Shares used in computing net loss per share, basic and diluted (Note 2)		19,996			21,392			29,200


	Common Stock			Additional Paid-in Capital					Deferred Compensation			Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Total Stockholders’ Equity
	Shares	Amount		Stock			Warrants		Deferred Compensation						Accumulated Deficit			Total Stockholders’ Equity
Balance, January 1, 2003	19,796	$	20	$	304,888		$	—	$	—		$	(141	)	$	(276,536	)	$	28,231
Components of comprehensive loss:
Unrealized gain on other investments	—		—		—			—		—			74			—			74
Foreign currency translation adjustment	—		—		—			—		—			(22	)		—			(22	)
Net loss	—		—		—			—		—			—			(5,517	)		(5,517	)

Total comprehensive loss	—		—		—			—		—			—			—			(5,465	)
Common stock issued for cash upon exercise of stock options	440		—		831			—		—			—			—			831
Common stock issued under employee stock purchase plan	38		—		58			—		—			—			—			58

Balance, December 31, 2003	20,274	$	20	$	305,777		$	—	$	—		$	(89	)	$	(282,053	)	$	23,655

Components of comprehensive loss:
Unrealized gain (loss) on other investments	—		—		—			—		—			(23	)		—			(23	)
Foreign currency translation adjustment	—		—		—			—		—			(28	)		—			(28	)
Net loss	—		—		—			—		—			—			(13,460	)		(13,460	)

Total comprehensive loss	—		—		—			—		—			—			—			(13,511	)
Common stock issued in secondary offering, net	4,600		5		8,706														8,711
Common stock issued for cash upon exercise of stock options	226		—		323			—		—			—			—			323
Common stock issued under employee stock purchase plan	80		—		200			—		—			—			—			200

Balance, December 31, 2004	25,180	$	25	$	315,006		$	—	$	—		$	(140	)	$	(295,513	)	$	19,378

Components of comprehensive loss:
Unrealized gain (loss) on other investments	—		—		—			—		—			(12	)		—			(12	)
Foreign currency translation adjustment	—		—		—			—		—			(13	)		—			(13	)
Net loss	—		—		—			—		—			—			(17,645	)		(17,645	)

Total comprehensive loss	—		—		—			—		—			—			—			(17,670	)
Common stock issued in private placement, net	5,535		6		7,949			6,102		—			—			—			14,057
Common stock issued in conjunction with Copper Mountain acquisition	2,467		2		9,845			—		—			—			—			9,847
Compensation charge related to the issuance of stock options	—		—		193			—		—			—			—			193
Unearned compensation related to issuance of restricted stock	—		—		102			—		(102	)		—			—			—
Amortization related to unearned compensation	—		—		—			—		64			—			—			64
Reversal of deferred compensation related to work force reduction	—		—		(19	)		—		19			—			—			—
Common stock issued for cash upon exercise of stock options	217		—		346			—		—			—			—			346
Common stock issued under employee stock purchase plan	75		—		187			—		—			—			—			187

Balance, December 31, 2005	33,474	$	33	$	333,609		$	6,102	$	(19	)	$	(165	)	$	(313,158	)	$	26,402


Office equipment		3-5 years
Computers and software		3-7 years
Test equipment		3-5 years
Leasehold improvements		1-7 years


Completed technology and patents		3-5 years
Customer lists		7 years
Maintenance contract renewals		5 years
Trademarks		7 years


	Stock Option Plans Year Ended December 31,						Employee Stock Purchase Plan Year Ended December 31,
	2003		2004		2005		2003		2004		2005
Expected dividend yield	0.0	%	0.0	%	0.0	%	0.0	%	0.0	%	0.0	%
Risk-free interest rate	2.5	%	2.8	%	3.7	%	1.26	%	1.16	%	3.19	%
Expected volatility	80.7	%	88.0	%	87.0	%	80.7	%	88.0	%	87.0	%
Expected life (in years)	4.0		4.0		4.0		0.5		0.5		0.5


	Years Ended December 31,
	2003			2004			2005
Unrealized gains (losses) on investments	$	74		$	(23	)	$	(12	)
Foreign currency translation adjustment		(22	)		(28	)		(13	)

Total	$	52		$	(51	)	$	(25	)


	As of December 31, 2005
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Corporate debt securities	$	1,693	$	—	$	—	$	1,693

	As of December 31, 2004
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Corporate debt securities	$	—	$	—	$	—	$	—


Current assets	$	4,285
Property and equipment		706
Completed technology and patents		6,221
Goodwill		1,672

Total assets acquired		12,884
Total liabilities assumed		1,155

Net assets acquired	$	11,729


	Year Ended December 31,
Proforma Results of Operations (unaudited)	2004			2005
Revenue	$	32,835		$	37,930
Net loss		(33,740	)		(25,970	)
Basic and diluted net loss per share		(1.41	)		(0.86	)


	As of December 31, 2004
	Gross Carrying Amount		Accumulated Amortization			Net Intangibles
Amortized intangible assets:
Completed technology and patents	$	7,922	$	(6,460	)	$	1,462
Customer list		86		(27	)		59
Maintenance contract renewals		50		(22	)		28
Trademarks		315		(97	)		218

	$	8,373	$	(6,606	)		1,767

Other non-current assets							168

						$	1,935


	Operating Leases		Capital Leases
2006	$	960	$	59
2007		790		59
2008		26		44
2009		8
2010		8

	$	1,792		162

Less amount representing interest				(12	)

				150
Less current portion				(50	)

			$	100


				Outstanding Options
	Shares Available For Grant		Options Exercised	Number of Shares		Price Per Share		Aggregate Price			Weighted Average Exercise Price
Balance, January 1, 2003	556		1,132	4,204		$	0.11-68.25	$	24,152		$	5.75
Options authorized	375
Options granted	(604	)		604			1.25-5.77		1,405			2.33
Options exercised			440	(440	)		0.11-3.75		(833	)		1.89
Options terminated	719			(719	)		1.21-54.88		(1,364	)		1.89

Balance, December 31, 2003	1,046		1,572	3,649		$	0.11-68.25	$	23,360		$	6.40
Options authorized	375
Options granted	(969	)		969			1.95-6.16		5,019			5.18
Options exercised			226	(226	)		0.36-3.75		(324	)		1.43
Options terminated	138			(138	)		1.21-41.75		(1,439	)		10.35

Balance, December 31, 2004	590		1,798	4,254		$	0.11-68.25	$	26,616		$	6.26
Options authorized	1,375
Options granted	(1,179	)		1,179			2.41-3.02		3,574			3.02
Options exercised			217	(217	)		2.74-4.50		(346	)		1.56
Options expired	(81	)
Options terminated	463			(463	)		1.21-57.44		(6,440	)		13.90

Balance, December 31, 2005	1,168		2,015	4,753		$	0.52-68.25	$	23,404		$	4.92


	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life (years)	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$0.52 - 1.21	556	6.65	$	1.14	556	$	1.14
1.25 - 1.45	538	6.75		1.41	517		1.42
1.47 - 1.47	150	7.04		1.47	146		1.47
1.49 - 1.49	500	5.48		1.49	500		1.49
1.55 - 2.15	483	6.72		1.99	441		2.00
2.19 - 3.01	395	7.89		2.78	162		2.64
3.02 - 3.02	637	9.42		3.02	637		3.02
3.04 - 5.01	741	7.86		4.39	741		4.39
5.07 - 22.94	539	7.09		9.65	539		9.65
22.94 - 68.25	214	4.35		40.25	214		40.25

	4,753				4,453


	Quarter Ended
	Mar. 31, 2004			Jun. 30, 2004			Sep. 30, 2004			Dec. 31, 2004			Mar. 31, 2005			Jun. 30, 2005			Sep. 30, 2005			Dec. 31, 2005
	(in thousands, except per share data)
	(unaudited)
Total revenues	$	6,177		$	5,123		$	6,672		$	7,020		$	7,053		$	9,674		$	10,039		$	10,699
Gross profit (loss)		466			1,316			2,210			2,358			2,538			3,480			2,176			2,990
Net loss		(4,450	)		(3,635	)		(2,743	)		(2,632	)		(3,320	)		(4,517	)		(5,600	)		(4,208	)
Net loss per share, basic and diluted	$	(0.22	)	$	(0.18	)	$	(0.13	)	$	(0.11	)	$	(0.13	)	$	(0.17	)	$	(0.17	)	$	(0.13	)
Shares used in computing net loss per share, basic and diluted		20,297			20,396			20,453			24,499			25,187			26,013			32,042			33,409


Signature	Title	Date

/S/ SALVATORE D’AURIA Salvatore D’Auria	President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)	February 23, 2006

/S/ RANDALL K. GAUSMAN Randall K. Gausman	Vice President, Finance and Administration, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)	February 23, 2006

Neal Douglas	Director

/S/ CLIFFORD H. HIGGERSON Clifford H. Higgerson	Director	February 23, 2006

/S/ STEVEN LEVY Steven Levy	Director	February 23, 2006

/S/ ROGER H. MOORE Roger H. Moore	Director	February 23, 2006


	Balance at Beginning of Period		Additions (reductions) to Costs and Expenses			Write-offs			Reclasses from Other Accounts		Balance at End of Period
Allowance for doubtful accounts:
Year ended December 31, 2003	$	10	$	37		$	—		$	—	$	47
Year ended December 31, 2004		47		106			(14	)		—		139
Year ended December 31, 2005		139		(29	)		(54	)		—		56

Valuation allowance for deferred tax assets:
Year ended December 31, 2003	$	105,055	$	2,604		$	—		$	—	$	107,659
Year ended December 31, 2004		107,659		13,293			—			—		120,952
Year ended December 31, 2005		120,952		2,906			—			—		123,858

Allowance for excess and obsolete inventory and abandoned product:
Year ended December 31, 2003	$	37,718	$	(1,266	)(1)	$	(36,227	)	$	—	$	225
Year ended December 31, 2004		225		1,003	(2)		—			—		1,228
Year ended December 31, 2005		1,228		946	(3)		(256	)		—		1,918


Exhibit Number		Description
2.1		Agreement and Plan of Merger by and among Tut Systems, Inc., Tiger Acquisition Corporation, Tektronix, Inc. and VideoTele.com, Inc. dated as of October 28, 2002.(1)

2.3		Agreement and plan of Merger and Reorganization by and among the Company, Wolf Acquisition Corp and Copper Mountain Networks, Inc. dated February 11, 2005 (2)

3.1		Second Amended and Restated Certificate of Incorporation of the Company.(3)

3.2		Bylaws of the Company, as currently in effect. (4)

4.1		Specimen Common Stock Certificate.(3)

10.1*		1992 Stock Plan, as amended, and form of Stock Option Agreement thereunder.(3)

10.2*		1998 Stock Plan and forms of Stock Option Agreement and Stock Purchase Agreement thereunder.(3)

10.3*		1998 Employee Stock Purchase Plan, as amended.(5)

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

10.5		American Capital Marketing, Inc. 401(k) Plan.(3)

10.6		Form of Indemnification Agreement entered into between the Company and each director and officer.(3)

10.8		Home Phoneline Promoters Agreement by and between the Company and IBM Corporation, Hewlett-Packard Company, Compaq Computer Corporation, Advanced Micro Devices, Inc., Intel Corporation, Epigram, Inc., AT&T Wireless Services Inc., 3Com Corporation, Rockwell Semiconductor Systems, Inc. and Lucent Technologies Inc. dated June 1, 1998.(3)

10.9		Master Agreement between the Company and Compaq Computer Corporation dated April 21, 1998 including supplements thereto.(3)

10.12*		Executive Retention and Change of Control Plan.(7)

10.13*		Non-Executive Retention and Change of Control Plan and Summary Plan Description.(7)

10.14*		Non-Qualified Stock Option Agreement issued to Mark Carpenter on March 3, 2000.(7)

10.15*		1999 Non-Statutory Stock Option Plan(8)

10.16		Office Lease Agreement between Kruse Way Office Associates Limited Partnership and VideoTele.com dated April 28, 2000 and amended August, 2005.(9)

10.17		Office Lease Agreement between The Richard Oppenheimer Living Trust, The Maurice Oppenheimer Living Trust, The Helene Oppenheimer Living Trust, and Tut Systems Inc. dated November 2002 and amended May 2005.(10)

10.18		Agreement for the sale and purchase of the entire share capital of Xstreamis plc, by and among the Company, the shareholders of Xstreamis plc and Philip Corbishley dated May 26, 2000.(11)

10.19		Purchase Agreement by and among the Company and the Investors names therein, dated July 19, 2005. (12)

10.20		Registration Rights Agreement by and among the Company and the Investors named therein, dated July 19, 2005. (12)

10.21		Silicon Valley Bank Loan and Security Agreement dated September 23, 2004 and amended December 29, 2005 (13)

10.22		Form of Acknowledgement of Amendment to Option Agreements dated December 29, 2005 (14)

10.23*		Summary of Non-Management Director Compensation Plan


Exhibit Number		Description
11.1		Calculation of net loss per share (contained in Note 1 of Notes to Audited Consolidated Financial Statements).

21.1		Subsidiaries of the Company

23.1		Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm

31.1		Certification of Chief Executive Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


Date: February 23, 2006

	By:	/s/ SALVATORE D’AURIA
		Salvatore D’Auria
		President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer)