10-Q 1 a10-q.txt FORM 10-Q -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q (MARK ONE) ~~/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 OR ~~/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

FOR THE TRANSITION PERIOD FROM ______________ TO ______________ COMMISSION FILE NUMBER 0-27401 ------------------------ INTERSPEED, INC. (Exact name of registrant as specified in its charter) DELAWARE 04-333365 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 39 HIGH STREET NORTH ANDOVER, MASSACHUSETTS 01845 (Address of principal executive (zip code) offices)

(978) 688-6164 (Registrant's telephone number, including area code) NOT APPLICABLE (Former name, former address and former fiscal year, if changed since last report) ------------------------ 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 / / APPLICABLE ONLY TO CORPORATE ISSUERS: As of July 31, 2000, 10,958,904 shares of $0.01 par value common stock of the registrant were outstanding. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- ~~PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS~~

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......................... 9-20 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK... 20 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................... 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 21 SIGNATURE PAGE........................................................ 22

2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERSPEED, INC. CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)

The Condensed Balance Sheet as of September 30, 1999 has been summarized from the Company's audited Balance Sheet as of that date. See notes to condensed financial statements. 3 INTERSPEED, INC. CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

See notes to condensed financial statements. 4 INTERSPEED, INC. CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

See notes to condensed financial statements. 5 INTERSPEED, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared by Interspeed, Inc. (the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. They should be read in conjunction with the audited financial statements included in the Company's Annual Report on Form 10-K/A for the year ended September 30, 1999. In the opinion of management, the accompanying unaudited condensed financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results which could be expected for the full year. NET LOSS PER SHARE Basic net loss per share is computed using the weighted average number of common shares outstanding during each period. Outstanding stock options have been excluded from the computation of diluted per share amounts since the effect would be antidilutive. Had the impact of stock options, using the treasury stock method, been included in the computation, weighted average shares would have increased by 804,000, 957,000, 1,233,000, and 1,205,000 for the three and nine months ended June 30, 2000 and 1999, respectively. INCOME TAXES The Company's quarterly effective tax rate is based on the estimated tax rate for the fiscal year. COMPREHENSIVE INCOME There was no difference between the Company's net loss and its total comprehensive loss for any of the periods presented. SEGMENT INFORMATION The Company currently operates in one business segment: designing, developing and marketing advanced communications products which enable service providers to deliver high speed data access to small and medium sized businesses, multi-tenant units ("MTUs"), and other organizations. CONCENTRATIONS OF CREDIT RISK Until the three months ended June 30, 2000, the Company's activities had been conducted primarily in the United States. The Company performs ongoing credit evaluations of its customers and generally requires no collateral. At June 30, 2000, approximately 92% of accounts receivable were comprised of balances due from three customers and approximately 67% of accounts receivable were denominated in a foreign currency. The Company relies on contract manufacturers and some single source suppliers of materials for certain product components. As a result, should the Company's current manufacturers or suppliers not produce and deliver inventory for the Company to sell on a timely basis, operating results could be adversely impacted. 6 INTERSPEED, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED) RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," effective for fiscal years beginning after June 15, 2000. The new standard requires that all companies record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for based on the use of the derivative and whether it qualifies for hedge accounting. Management is currently assessing the impact of SFAS No. 133 on the financial statements of the Company. The Company will adopt this accounting standard on October 1, 2000, as required. In December 1999, the Securities and Exchange Commission (the "SEC") released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements and will be effective for the Company in fiscal 2001. Management is currently evaluating the effect of adopting SAB No. 101 on the financial statements. INVENTORY Inventory consisted of the following (in thousands):

SIGNIFICANT CUSTOMER AND GEOGRAPHIC INFORMATION The Company currently targets its sales efforts to data communications service providers, MTUs, and other service organizations to both public and private network providers and users across four related market segments. For the three months and nine months ended June 30, 2000, gross sales to customers in the United States amounted to $400,000 and $7,200,000, and export sales for the same periods amounted to $6,600,000 and $6,900,000, respectively. For the three months ended June 30, 2000, one international customer accounted for approximately 92% of gross revenue. For the nine months ended June 30, 2000, three customers, two domestic and one international, accounted for approximately 15%, 25% and 46% of gross revenues, respectively. RELATED PARTY TRANSACTIONS From its inception through the completion of its initial public offering on September 24, 1999 ("IPO"), the Company's operations were funded through contributions of capital and loans from Brooktrout, Inc. ("Brooktrout"), its parent company. At September 24, 1999, in connection with the Company's IPO, Brooktrout contributed $13,598,000, the majority of the outstanding note balance, to the capital of the Company. The Company and Brooktrout entered into a Transition Services Agreement (the "Agreement") which expired on December 31, 1999. The Agreement outlined certain services that would continue to be performed on behalf of the Company by Brooktrout through December 31, 1999. The Agreement required that these services be phased out over a period beginning on October 1999 to December 1999. The services 7 INTERSPEED, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED) included payroll processing and administration, human resources, benefits, marketing, information technology and telecommunications, accounts receivable, accounting and finance and order entry. The fees for such services were on an "as used" basis and were included in the Agreement. During the three and nine months ended June 30, 2000 and 1999, fees for these services totaled $0, $43,000, $469,000 and $1,102,000, respectively WARRANTS During the three months ended March 31, 2000, in consideration for entering into certain long-term reseller agreements, the Company granted to the customers vested warrants to purchase 55,000 shares of the Company's common stock at the market price of the Company's common stock on the dates the warrants were granted. The value of the warrants was calculated by applying the Black-Scholes option pricing model using the fair market value of the Company's common stock on the date the agreements were executed. The value of the warrants has been charged to expense as a component of stock compensation and warrant charges in the condensed statement of operations. The Company, during the three months ended March 31, 2000, also granted to the customers warrants to purchase up to 150,000 shares of the Company's common stock that vest in installments as the customers attain certain revenue milestones over the terms of the agreements. The Company is accounting for these warrants as a sales discount. As revenue is recognized on sales to these customers, the Company is recording a sales discount based on the relationship of the customers' sales to date to the specified revenue milestone. The amount of the discount is being estimated by valuing the warrants using the Black- Scholes option pricing model at the end of each fiscal period. The value of the warrants is being adjusted in each fiscal period until the revenue levels are attained and the warrants vest. The exercise price of the warrants is the fair market value of the Company's common stock on the date that the warrants vest. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS QUARTERLY REPORT. THIS DOCUMENT CONTAINS CERTAIN STATEMENTS THAT ARE "FORWARD-LOOKING STATEMENTS" AS THAT TERM IS DEFINED UNDER THE PRIVATE SECURITIES LEGISLATION REFORM ACT OF 1995 AND RELEASES ISSUED BY THE SECURITIES AND EXCHANGE COMMISSION. THE WORDS "BELIEVE," EXPECT," "ANTICIPATE," "INTEND," "ESTIMATE," AND OTHER EXPRESSIONS, WHICH ARE PREDICTIONS OF OR INDICATE FUTURE EVENTS AND TRENDS AND WHICH DO NOT RELATE TO HISTORICAL MATTERS, IDENTIFY FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY TO DIFFER MATERIALLY FROM THE ANTICIPATED FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD LOOKING STATEMENTS. SOME OF THE FACTORS DESCRIBED UNDER "RISK FACTORS" MAY RESULT IN THESE DIFFERENCES. THE READER SHOULD CAREFULLY REVIEW ALL OF THESE FACTORS, AND SHOULD BE AWARE THAT THERE MAY BE OTHER FACTORS THAT COULD CAUSE THESE DIFFERENCES. WE DO NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT CHANGES IN UNDERLYING ASSUMPTIONS OR FACTORS, NEW INFORMATION, FUTURE EVENTS OR OTHER CHANGES. OVERVIEW REVENUE. Our revenue is generated primarily from sales of our products and related maintenance services to data communications service providers and their customers. Revenue from product sales is recognized upon shipment of the product. No revenue is recognized on products shipped on a trial basis. Our products generally carry a one year warranty from the date of purchase. We estimate sales returns and warranty costs at the time the product revenue is recognized and an accrual is recorded. Customers may contract for support services over and above that provided by our warranty policy. Revenue from such contracts and from the extended warranty contracts is recognized ratably over the service period. We do not recognize revenue on beta units until beta testing on such units is completed. SALES DISCOUNTS--WARRANTS. We have granted to the customers warrants to purchase up to 150,000 shares our common stock that vest in installments as the customers attain certain revenue milestones over the terms of the agreements, with an exercise price equal to the fair market value of the common stock at the time of vesting. We are accounting for these warrants as a sales discount. As revenue is recognized on sales to these customers, we are recording a sales discount based on the relationship of the customers' sales to date to the specified revenue milestone. The amount of the discount is being estimated by valuing the warrants using the Black-Scholes option pricing model at the end of each fiscal period. The value of the warrants is being adjusted in each fiscal period until the revenue levels are attained and the warrants vest. The exercise price of the warrants is the fair market value of the Company's common stock on the date that the warrants vest. COST OF REVENUE. Cost of revenue consists of direct product costs such as standard parts and components for our products and the cost of third party products purchased for resale, salaries and employee benefits for manufacturing personnel and overhead such as equipment and facility costs. GROSS PROFIT. We expect our gross profit to be affected by many factors including pricing, product mix, cost factors such as component prices, internal and external manufacturing costs as well as manufacturing efficiencies due to higher volume of product shipments which we believe will result in the improvement of overhead absorption. RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of salaries and employee benefits for engineering personnel and costs relating to prototypes including components, non-recurring engineering charges and tools. Product enhancements and new features are key objectives. We expect research and development expenses to increase in absolute dollars in the future. 9 SALES AND MARKETING. Sales and marketing expenses consist primarily of salaries, employee benefits, trade shows, public relations, marketing materials, travel and other marketing expenses. Future sales and marketing activities will involve additional costs related to the expansion of the sales and sales engineering organization, product branding, advertising and public relations costs. We expect sales and marketing expenses to increase in absolute dollars in the future. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of personnel costs for executive officers, administrative and support activities including payroll administration, workers' compensation and general liability insurance, accounting and finance, legal, tax, human resources and transaction processing. STOCK COMPENSATION AND WARRANT CHARGES. Stock options have been granted with exercise prices that were less than the estimated fair value of our common stock. Compensation cost associated with these options is the difference between the fair value of the stock and the exercise price. In consideration for entering into certain long-term reseller agreements, we granted to the customers vested warrants to purchase 55,000 shares of our common stock at the market value of our stock on the dates the warrants were granted The value of the warrants was calculated by applying the Black-Scholes option pricing model using the fair market value of our common stock on the date the agreements were executed. The value of the warrants has been charged to expense as a component of stock compensation and warrant charges in the condensed statement of operations. INCOME TAX EXPENSE. Prior to our IPO, we had been included in Brooktrout's consolidated income tax filings and these losses have been used to reduce the group's taxes payable. Brooktrout has not and does not intend to reimburse us for the value of the net losses used to reduce Brooktrout's consolidated taxable income. Accordingly, we have not recognized any benefit related to these losses. We are no longer to be included in Brooktrout's consolidated income tax filings. We do not anticipate recognizing any benefits from losses generated in the short term due to our limited operating history. We expect to continually evaluate the recoverability of net loss carryforwards. RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED JUNE 30, 2000 AND 1999 GROSS REVENUE. Gross revenue for the three and nine months ended June 30, 2000 was $7,007,000 and $14,162,000, compared to $950,000 and $1,341,000 for the same three and nine month periods in fiscal year 1999, which represented increases of $6,057,000 and $12,821,000, respectively. These increases are attributable to increased revenue shipments during the fiscal periods of 2000, including the sale of a significantly higher proportion of third-party equipment during the three months ended June 30, 2000, versus the comparatively low level of revenue during the first nine months in fiscal 1999. For the three months ended June 30, 2000, one international customer accounted for approximately 92% of gross revenue. We recognized our first sale in the quarter ended December 31, 1998 after our product successfully completed beta testing, and commenced commercial operations and the general release of our products in February 1999. We believe that the proportion of third-party equipment of revenue in future fiscal periods will revert to the lower levels recognized during the fiscal periods prior to the three months ended June 30, 2000. SALES DISCOUNTS--WARRANTS. During the nine months ended June 30, 2000, we recognized $439,000 of sales discounts related to warrants granted to certain customers. Since these equipment purchase contracts were executed during fiscal year 2000, no such sales discounts were recorded in the prior fiscal year. COST OF REVENUE. Cost of revenue was $4,596,000 and $8,558,000, or approximately 66% and 60% of gross revenue, for the three and nine months ended June 30, 2000, compared to $514,000 and $826,000 for the three and nine months ended June 30, 1999. The significantly higher cost of revenue in the fiscal 10 periods of 2000 is due to the increased revenue volume, including substantial sales of third party products at relatively low margin. GROSS PROFIT. Gross profit was $2,411,000 and $5,165,000, and gross profit percentage on gross revenue was approximately 34% and 36%, for the three months and nine months ended June 30, 2000, compared to gross profit of $436,000 and $515,000 for the three and nine months ended June 30, 1999. These increases in gross profit were due to the substantially greater revenue recognized during the fiscal periods of 2000. Gross profit percentage for the three and nine months ended June 30, 2000 declined from prior fiscal periods in fiscal year 2000 due to unfavorable product mix and the non-recurring sale of lower margin third-party equipment during the three months ended June 30, 2000. RESEARCH AND DEVELOPMENT. Research and development expenses increased by approximately 34% and 44% to $1,793,000 and $5,385,000, respectively, during the three months and nine months ended June 30, 2000 from $1,335,000 and $3,747,000 for the three and nine months ended June 30, 1999. These increases were due primarily to increases in payroll-related expenses from the year-to-year growth in the number of engineering employees, and to third-party consulting expenses for specific development projects during the three and nine months of fiscal 2000. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses for the three and nine months ended June 30, 2000 were $2,626,000 and $7,020,000, compared to $976,000 and $1,898,000 for the three and nine months ended June 30, 1999, increases of $1,650,000 and $5,122,000, respectively. These increases were due primarily to payroll-related expenses, travel, advertising/marketing and trade show expenses associated with the build-up in sales and marketing staff and activities, as well as expenses relating to the implementation of internal Year 2000 compliant systems. STOCK COMPENSATION AND WARRANT CHARGES. In prior fiscal years, stock options have been granted with exercise prices that were less than the estimated fair value of our common stock. Compensation cost associated with such options was determined as the difference between the fair value of the stock and the exercise price. Stock compensation costs were $285,000 and $988,000 for the three and nine months ended June 30, 2000, as compared to $1,850,000 and $1,944,000 for the three and nine months ended June 30, 1999, as the compensation cost is being charged to expenses over the option vesting period. During the nine months ended June 30, 2000, we recognized $849,000 in warrant charges related to certain long-term reseller agreements. Since the equipment purchase contracts containing the warrant grant provisions were executed during fiscal year 2000, no such charges were recorded in fiscal year 1999. INCOME TAX EXPENSE. Prior to our IPO, we had been included in Brooktrout's consolidated income tax filings and the losses associated with the Company have been used to reduce the group's taxes payable. Brooktrout has not and does not intend to reimburse us for the value of the net losses used to reduce Brooktrout's consolidated taxes. Accordingly, we have not recorded any benefit related to these prior losses. We have not recognized any for the losses generated for the three and nine months ended June 30, 2000 as we believe that it is more likely than not that such benefits will not be recoverable. We will continue to evaluate the recoverability of net loss carryforwards. NET LOSS. Net losses for the three and nine months ended June 30, 2000 were $2,182,000 and $8,580,000 compared to net losses of $3,725,000 and $7,074,000 for the three and nine months ended June 30, 1999. The increased net loss for the nine months ended June 30, 2000 is due primarily to the increases in operating expenses, and warrant-related charges, as described above, that more than offset the increase in gross profit from increased revenue resulting from the shipment of our product during the nine months ended June 30, 2000. 11 LIQUIDITY AND CAPITAL RESOURCES From inception through the IPO, our operations had been funded through contributions of capital and loans from Brooktrout. Subsequent to the IPO, our operations have been funded through the proceeds from the IPO. Cash decreased by $14,801,000 to $6,426,000 at June 30, 2000 from $21,227,000 at September 30, 1999. The decrease in cash is due primarily to a $9,425,000 increase in accounts receivable, an $839,000 increase in inventory, and the net loss for the nine months ended June 30, 2000, being partially offset by non-cash operating charges and a net increase in current liabilities. The increase in accounts receivable was due to substantially higher gross revenue billings during the first nine months of fiscal 2000, while the increase in inventory was due to the expectation of increased shipment volumes during subsequent quarters. For the nine months ended June 30, 2000 and 1999, we purchased fixed assets of approximately $1,413,000 and $588,000, respectively. We currently have no material commitments for additional capital expenditures. We believe that the remaining net proceeds will be sufficient to meet our anticipated cash needs for working capital and capital expenditures at least until September 30, 2000. Thereafter, if cash generated from operations is insufficient to satisfy our liquidity requirements, we may need to raise additional funds through public or private financing, strategic relationships or other arrangements. There can be no assurance that such additional funding, if needed, will be available on terms that we believe are attractive, or at all. If we fail to raise capital when needed, it could harm our business, operating results and financial condition. If we raise additional funds through the issuance of equity securities, the percentage ownership of our stockholders would be reduced. We do not believe that inflation has had a significant effect on our operations to date. 12 RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND THE OTHER INFORMATION IN THIS QUARTERLY REPORT. OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE HARMED BY ANY OF THE FOLLOWING RISKS. WE HAVE A HISTORY OF LOSSES AND ANTICIPATE FUTURE LOSSES We have accumulated losses of approximately $24.4 million since inception in October 1996 through June 30, 2000 and expect to incur net losses in the future. Losses were approximately $10.5 million for the year ended September 30, 1999 and approximately $8.6 million for the nine months ended June 30, 2000. We anticipate continuing to incur significant sales and marketing, research and development and general and administrative expenses and, as a result, we will need to generate higher revenues to achieve and sustain profitability. We cannot be certain we will realize sufficient revenues to achieve profitability. BECAUSE OF OUR LIMITED OPERATING HISTORY IT IS DIFFICULT FOR US TO PREDICT FUTURE RESULTS OF OPERATIONS We commenced operations in March 1997 and our first product became generally available in February 1999. Due to our limited operating history, it is difficult for us to predict future results of operations. You should consider our business and prospects in light of the risks typically encountered by companies in their early stages of development, particularly those in rapidly evolving markets such as the data communications equipment market. We cannot be certain that we will successfully address these risks. OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY AND CAUSE OUR STOCK PRICE TO BE VOLATILE WHICH COULD CAUSE THE VALUE OF YOUR INVESTMENT IN OUR COMPANY TO DECLINE Our quarterly or annual operating results are likely to fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. If our operating results do not meet the expectations of securities analysts, the trading price of our common stock could significantly decline which may cause the value of your investment in our company to decline. In addition, the value of your investment could be impacted by investor perception of the Internet and emerging data communications sectors generally, independent of the operating performance of our company or other similar companies. Some of the factors that could affect our quarterly or annual operating results or impact the market price of our common stock include: - our ability to develop, manufacture, market and support our products and product enhancements; - the timing and amount of, or cancellation or rescheduling of, orders for our products, particularly large orders from key customers; - our ability to retain key management, sales and marketing and engineering personnel; - announcements, new product introductions and price reductions in products offered by our competitors; - our ability to obtain sufficient supplies of sole or limited source components for our products; - a decrease in the average selling prices of our products; - changes in costs of components which we include in our products; and - the mix of products that we sell and the mix of distribution channels through which they are sold. Due to these and other factors, quarterly or annual revenues, expenses and results of operations could vary significantly in the future, and period-to-period comparisons should not be relied upon as indications of future performance. 13 THE LOSS OF ANY SIGNIFICANT CUSTOMER COULD CAUSE OUR REVENUE TO DECLINE The loss of any of our significant customers could cause our revenue to decline and thus have a material adverse effect on our business, financial condition and results of operations. Our products became generally available in February 1999 and to date we have only sold products to a limited number of customers. Unless and until we diversify and expand our customer base, our future success will significantly depend upon a limited number of customers. During the three months ended June 30, 2000, one international customer accounted for approximately 92% of gross revenue. FAILURE TO ADEQUATELY DEVELOP OUR SALES CHANNELS COULD CAUSE OUR REVENUE TO DECLINE We sell our products directly through our sales force and indirectly through original equipment manufacturers, value added resellers and system integrators. Our failure to adequately develop these sales channels may cause our revenue to decline and, thus, have a material adverse effect on our business, financial condition and results of operations. We are currently continuing to develop these sales channels and expect to expend significant resources in this area. As of July 31, 2000, we had a total of 24 employees responsible for direct sales, marketing and sales engineering in the United States and international markets. To the extent we are able to enter into agreements with additional original equipment manufacturers, value added resellers or systems integrators, the amount and timing of resources which they devote to the sale of our products may not be within our control, and they may not perform their obligations as expected. IF WE ARE UNABLE TO DEVELOP AND OPERATE AN EFFECTIVE CUSTOMER SUPPORT ORGANIZATION, SALES OF OUR PRODUCTS MAY BE REDUCED Purchasers of data communications equipment assign significant weight in their purchasing decisions to a vendor's capabilities and reputation in supporting its products. We will be required to expend significant resources and management attention on developing and operating a customer support organization. If our level of customer support does not satisfy customer expectations, our reputation and future sales could be adversely affected. Accordingly, we have emphasized customer support in our business strategy and marketing. Because our products were recently introduced for sale, we have limited experience in operating a customer support program. IF OUR TARGET CUSTOMERS DO NOT ACCEPT DSL TECHNOLOGY, WE MAY BE UNABLE TO SUSTAIN OR GROW OUR BUSINESS Our future success is substantially dependent upon whether digital subscriber line, or DSL, technology gains widespread market acceptance by data communications service providers and the small to medium sized business users to whom they market their services. In the event that our customers or potential customers adopt technologies other than digital subscriber line, or DSL, we may be unable to sustain or grow our business. Our business strategy and current products are focused on DSL technology. Various alternative technologies, including T-1, cable and broadband wireless, are currently available to deliver high speed data communications, and each of the alternatives has comparative advantages and disadvantages. Data communications service providers continually evaluate alternative high speed data access technologies and may at any time adopt technologies other than DSL. IF OUR PRODUCTS ARE NOT ACCEPTED BY THE MARKET, OUR REVENUES MAY DECLINE We have recently introduced our products to the market. Market acceptance of our products is critical to our future success. Factors that may affect the market acceptance of our products include: - market acceptance of DSL technology; - the features, performance, price and total cost of ownership of our products; 14 - the availability of competing products and technologies; - the success and development of our direct sales force and distribution channels; - the quality of our customer service and support of our products; and - the breadth and depth of our product offerings. Failure of our existing or future products to achieve and maintain meaningful levels of market acceptance would materially adversely affect our business, financial condition and results of operations. BECAUSE WE CURRENTLY DEPEND ON A SINGLE FAMILY OF PRODUCTS, ANY DECLINE IN DEMAND FOR THOSE PRODUCTS MAY HARM OUR OPERATING RESULTS We expect to derive substantially all of our revenues from our DSL access routers, or DSLARs, product family and related modules for the foreseeable future. The market may not continue to demand our current products, and we may not be successful in marketing any new or enhanced products. Any reduction in the demand for our current products or our failure to successfully develop or market and introduce new or enhanced products could materially adversely affect our business, financial condition and results of operations. UNLESS WE ARE ABLE TO KEEP PACE WITH THE EVOLUTION OF THE DATA COMMUNICATIONS EQUIPMENT MARKET WE WILL NOT BE ABLE TO GROW OR SUSTAIN OUR BUSINESS The data communications equipment market is characterized by: - rapid technological advances; - evolving industry standards; - changes in end-user requirements; - frequent new product introductions; and - evolving offerings by data communications service providers. We believe our future success will depend, in part, on our ability to anticipate or adapt to such changes and to offer, on a timely basis, products that meet customer demands. We intend to continue to invest significantly in product and technology development. The development of new or enhanced products is a complex and uncertain process requiring the anticipation of technological and market trends. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent our development, introduction or marketing of new products and enhancements and result in unexpected expenses. The introduction of new or enhanced products also requires that we manage the transition from older products in order to minimize disruption in customer ordering patterns and ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. Our inability to develop on a timely basis new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could have a material adverse effect our business, financial condition and results of operations. IF WE LOSE KEY PERSONNEL, WE MAY BE UNABLE TO SUCCESSFULLY OPERATE OUR BUSINESS Our success depends to a significant degree upon the continued contributions of our principal management, engineering and sales personnel, many of whom perform important management functions and would be difficult to replace. We do not have employment contracts with our key personnel. The loss of the services of any key personnel could materially adversely affect our business, financial condition and results of operations. 15 IF WE ARE UNABLE TO ATTRACT AND RETAIN ADDITIONAL QUALIFIED PERSONNEL, WE MAY BE UNABLE TO SATISFY CUSTOMER DEMANDS WHICH MAY CAUSE OUR REVENUES TO DECLINE Our business strategy will require us to attract and retain additional engineering, sales, customer support and administrative personnel. We have at times experienced, and continue to experience, difficulty in recruiting qualified personnel. Recruiting qualified personnel is an intensely competitive and time consuming process. We may not be able to attract and retain the necessary personnel to accomplish our business objectives, and we may experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion or to support our customers and operations. In addition, companies in the data communications industry whose employees accept positions with competitors frequently claim that such competitors have engaged in unfair hiring practices. We could incur substantial costs in defending ourselves against any such litigation, regardless of the merits or outcome of such litigation. FAILURE TO MANAGE OUR GROWTH EFFECTIVELY MAY PREVENT US FROM MAXIMIZING OUR EARNINGS We have expanded and plan to continue to expand our operations, including our sales and marketing activities, our accounting, billing and human resource departments and the establishment of additional sales offices. This expansion may place significant strains on our ability to manage our growth, including our ability to monitor operations, bill customers, control costs and maintain effective quality controls. Until the end of December 1999, we relied upon Brooktrout, our parent company, to provide us with administrative and support services, including accounting, human resources and computer systems. Since then, we have implemented systems that provide the functions and services that were previously provided by Brooktrout. If we fail to manage our growth effectively, it could have a material adverse effect on our business, financial condition and results of operations. INTENSE COMPETITION IN THE MARKET FOR HIGH SPEED DATA ACCESS EQUIPMENT MAY PREVENT US FROM ACHIEVING OR SUSTAINING PROFITABILITY The market for data communications equipment is highly competitive, particularly in the emerging DSL equipment market. If we are unable to compete effectively in the market for high speed data access equipment, our results of operations could be materially adversely affected. We compete directly with Ascend Communications, Inc., which was acquired by Lucent Technologies Inc.; Copper Mountain Networks, Inc.; Diamond Lane, which was acquired by Nokia, Inc.; Paradyne Networks, Inc.; and Tut Systems, Inc. Many of our current and potential competitors have significantly greater selling and marketing, technical, manufacturing, financial, and other resources. Moreover, our competitors may foresee the course of market developments more accurately than we do and could in the future develop new technologies that compete with our products. The strength and capabilities of our competitors may be increased as a result of the trend toward consolidation in the data communications market. Capitalizing on and maintaining our technological advantage will require a continued high level of investment in research and development, marketing and customer service and support. Due to the rapidly evolving markets in which we compete, additional competitors with significant market presence and financial resources may enter those markets, thereby further intensifying competition. We may not have sufficient resources to continue to make the investments or achieve the technological advances necessary to compete successfully with existing competitors or new competitors. IF WE ARE UNABLE TO DEVELOP INTERNATIONAL MARKETS FOR OUR PRODUCTS, WE MAY BE UNABLE TO GROW AS PLANNED Our strategy emphasizes the development of international markets for our products. We may be unsuccessful in marketing, selling and distributing our products in foreign markets. Conducting business outside of the United States is subject to risks, including: - longer accounts receivable collection cycles; 16 - possible foreign currency exchange risk and conversion issues; - difficulties in managing operations across disparate geographic areas; - difficulties associated with enforcing agreements and collecting receivables through foreign legal systems; - changes in a specific country's or region's political or economic conditions; - trade protection measures; - import or export licensing requirements; - potential adverse tax consequences; - unexpected changes in regulatory requirements; and - reduced or limited protection of our intellectual property rights in some countries. We cannot be certain that one or more of such factors will not have a material adverse effect on our future international operations, and consequently, our business, financial condition and results of operations. OUR DEPENDENCE ON SOLE AND SINGLE SOURCE SUPPLIERS AND INDEPENDENT MANUFACTURERS EXPOSES US TO SUPPLY INTERRUPTIONS THAT COULD RESULT IN PRODUCT DELIVERY DELAYS Although we generally use standard parts and components for our products, some key components are purchased from sole or single source vendors for which alternative sources are not currently available. Our inability to obtain sufficient quantities of these components may result in future delays or reductions in product shipments which could materially adversely affect our business, financial condition and results of operations. We currently purchase proprietary components from Conexant and Motorola for which there are no direct substitutes. These components could be replaced with alternatives from other suppliers, but that would involve redesign of our products. Such redesign would involve considerable time and expense. We currently enter into purchase orders with our suppliers for materials based on forecasts, but have no guaranteed supply arrangements with these suppliers. In addition, we currently use a small number of independent manufacturers to manufacture printed circuit boards, chassis and subassemblies to our design. Our reliance on independent manufacturers involves a number of risks, including the potential for inadequate capacity, unavailability of, or interruptions in access to, process technologies, and reduced control over delivery schedules, manufacturing yields and costs. If our manufacturers are unable or unwilling to continue manufacturing our components in required volumes, we will have to transfer manufacturing to acceptable alternative manufacturers whom we have identified, which could result in significant interruption of supply. Moreover, the manufacture of these components is extremely complex, and our reliance on the suppliers of these components exposes us to potential production difficulties and quality variations, which could negatively impact cost and timely delivery of our products. We currently enter into purchase orders with independent manufacturers of materials based on forecasts, but have no guaranteed arrangements with these manufacturers. Any significant interruption in the supply, or degradation in the quality, of any component would have a material adverse effect on our business, financial condition and results of operations. OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY MAY PREVENT US FROM RETAINING OUR COMPETITIVE ADVANTAGE Our success and our ability to compete are dependent, in part, upon our proprietary technology. Taken as a whole, we believe our intellectual property rights are significant and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenues. In addition, the laws of many foreign 17 countries do not protect our intellectual property to the same extent as the laws of the United States. Also, it may be possible for unauthorized third parties to copy or reverse engineer aspects of our products, develop similar technology independently or otherwise obtain and use information that we regard as proprietary. Furthermore, policing the unauthorized use of our products is difficult. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or patents that we may obtain, or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our future operating results. INTELLECTUAL PROPERTY CLAIMS AGAINST US CAN BE COSTLY AND RESTRICT OUR BUSINESS The data communications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants in our market increases and the functionality of our products is enhanced and overlaps with the products of other companies, we may become subject to claims of infringement or misappropriation of the intellectual property rights of others. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could have a material adverse effect on our business, financial condition or results of operations. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could have a material adverse effect upon our operating results. Legal action claiming patent infringement may be commenced against us. We cannot assure you that we would prevail in such litigation given the complex technical issues and inherent uncertainties in patent litigation. In the event a claim against us was successful, and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign to avoid infringement, this could have a material adverse effect on our business, financial condition and results of operations. CHANGES TO REGULATIONS AFFECTING THE TELECOMMUNICATIONS INDUSTRY COULD REDUCE DEMAND FOR OUR PRODUCTS Any changes to the legal requirements relating to the telecommunications industry, including the adoption of new regulations by federal or state regulatory authorities under current laws or any legal challenges to existing laws or regulations relating to the telecommunications industry, could have a material adverse effect upon the market for our products. Moreover, our distributors or customers may require, or we may otherwise deem it necessary or advisable, that we modify our products to address actual or anticipated changes in the regulatory environment. Our inability to modify our products or address any regulatory changes could have a material adverse effect on our business, financial condition or results of operations. CONTROL BY BROOKTROUT MAY LIMIT STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF MATTERS REQUIRING STOCKHOLDER APPROVAL At June 30, 2000, Brooktrout owned approximately 56% of the outstanding shares of common stock. Accordingly, Brooktrout will be able to control or significantly influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquiror from attempting to obtain control of us, which in turn could have a material adverse effect on the market price of our common stock or prevent our stockholders from realizing a premium over the market prices for their shares of common stock. 18 SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD CAUSE OUR STOCK PRICE TO FALL The market price of our common stock could fall as a result of future sales of a large number of shares of our common stock in the public market. As of July 31, 2000, we had approximately 10,958,904 shares of common stock outstanding, of which approximately 4,003,311 shares are freely transferable without restriction or registration under the Securities Act of 1933, unless such shares are held by our affiliates. The remaining 6,955,593 shares of common stock held by existing stockholders and 141,735 shares subject to outstanding options vested as of July 31, 2000 are restricted securities and may only be sold in the public market if registered or if they qualify for an exemption from registration under the Securities Act; 122,326 shares subject to outstanding options vested as of July 31, 2000 are freely transferable without restriction or registration under the Securities Act of 1933. Under specified circumstances and subject to customary conditions, Brooktrout has the right, with respect to 6,075,000 shares of common stock, to require us to register its shares of common stock under the Securities Act, and Brooktrout will have rights to participate in any future registrations of securities by us. PROVISIONS IN OUR CHARTER AND BYLAWS MAY DISCOURAGE TAKEOVER ATTEMPTS AND THUS DEPRESS THE MARKET PRICE OF OUR COMMON STOCK Provisions in our amended and restated Certificate of Incorporation may have the effect of delaying or preventing a change of control or changes in our management. These provisions include: - the right of the Board of Directors, without stockholder approval, to issue shares of preferred stock and to establish the voting rights, preferences, and other terms thereof; - the right of the Board of Directors to elect a director to fill a vacancy created by the expansion of the Board of Directors; - the ability of the Board of Directors to alter our bylaws without prior stockholder approval; - the election of three classes of directors to each serve three year staggered terms; - the elimination of stockholder voting by consent; - the removal of directors only for cause; - the vesting of exclusive authority in the Board of Directors (except as otherwise required by law) to call special meetings of stockholders; and - certain advance notice requirements for stockholder proposals and nominations for election to the Board of Directors. These provisions discourage potential takeover attempts and could adversely affect the market price of our common stock. BECAUSE WE HAVE NO SPECIFIC PLAN FOR ANY SIGNIFICANT PORTION OF THE NET PROCEEDS OF OUR IPO, OUR MANAGEMENT WILL HAVE THE DISCRETION TO ALLOCATE THE NET PROCEEDS OF OUR IPO TO USES THE STOCKHOLDERS MAY NOT DEEM DESIRABLE Although we expect to use the net proceeds of our IPO for general corporate purposes such as working capital, product development and sales and marketing, we currently have no other specific plan for any significant portion of the net proceeds of our IPO. As a consequence, our management will have the discretion to allocate the net proceeds of our IPO to uses the stockholders may not deem desirable. We may not be able to invest these net proceeds to yield a significant return. Substantially all of the net proceeds of our IPO will be invested in short-term, interest-bearing, investment grade securities or guaranteed obligations of the U.S. government for an indefinite period of time. 19 WE DO NOT INTEND TO PAY DIVIDENDS To date, we have never declared or paid any cash dividends on shares of our common stock. We currently intend to retain our earnings for future growth and development of our business and, therefore, do not anticipate declaring or paying any dividends in the foreseeable future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the potential change in a financial instrument's value caused by fluctuations in interest and currency exchange rates and equity and commodity prices. Our operating activities expose us to many risks that are continually monitored, evaluated, and managed. Proper management of these risks helps reduce the likelihood of earnings volatility. At June 30, 2000, approximately 67% of our accounts receivable were denominated in Australian dollars due to the sale of product to a foreign customer during the three months ended June 30, 2000. We are not a party to any derivative arrangement and we do not engage in trading, market-making or other speculative activities in the derivatives markets. At June 30, 2000, we had no outstanding foreign currency exchange contracts, and no short-term or long-term debt obligations. 20 PART II OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) We completed our IPO in September 1999. The IPO was made pursuant to a registration statement on Form S-1, originally filed with the Securities and Exchange Commission on June 18, 1999, as amended (Commission File No. 333-81071), which was declared effective on September 23, 1999. The IPO commenced on September 24, 1999 and terminated shortly thereafter after the sale into the public market of all of the registered shares of common stock. The shares of common stock sold in the IPO were offered for sale by a syndicate of underwriters represented by U.S. Bancorp Piper Jaffray, Warburg Dillon Read LLC, Tucker Anthony Cleary Gull and DLJdirect Inc. We registered an aggregate of 3,500,000 shares of common stock (including 1,500,000 sold by Brooktrout as a selling shareholder) in the IPO at a per share price of $12.00, for an aggregate offering price of $42,000,000. As of the date of the filing of this report, 3,925,000 registered shares (including 425,000 shares previously owned by Brooktrout that were sold upon the exercise of the underwriters' overallotment option) have been sold at an aggregate offering price of $47,100,000. Of the 3,925,000 shares sold in the IPO, 2,000,000 shares were registered for our account. We incurred the following expenses in connection with the IPO: Underwriting discounts and commissions...................... $1.68 million Other expenses.............................................. 1.53 million ------------- Total expenses.............................................. $3.21 million

After deducting the expenses set forth above, we received $20,790,000 in net proceeds for the IPO. From the period commencing on September 23, 1999 through June 30, 2000, we have used approximately $14.8 million of the net proceeds, of which approximately $13.7 million was used to fund operating activities including the net loss for the three months ended June 30, 2000, and approximately $1.4 million which was used to purchase equipment. (b) Recent Sales of Unregistered Securities (1) In January 2000, we granted a warrant to purchase 50,000 shares of the common stock to a customer at an exercise price of $18.75 per share in reliance upon the exemption from registration under Section 4(a) of the Securities Act of 1933. (2) In February 2000, we granted a warrant to purchase 5,000 shares of the common stock to a customer at an exercise price of $21.25 per share in reliance upon the exemption from registration under Section 4(a) of the Securities Act of 1933. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 The Amended and Restated Certificate of Incorporation of the Company is incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K, filed with the Securities and Exchange Commission on December 29, 1999 ("10-K"). 3.2 The Amended and Restated By-Laws of the Company are incorporated herein by reference to Exhibit 3.2 to the 10-K. 27.1 Financial Data Schedule (b) Reports on Form 8-K during the quarter ended June 30, 2000. The registrant filed no Reports on Form 8-K during the quarter ended June 30, 2000. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. INTERSPEED, INC. By: /s/ STEPHEN A. IDE ----------------------------------------- Stephen A. Ide PRESIDENT Dated: August 4, 2000 (Principal Executive Officer) By: /s/ WILLIAM J. BURKE ----------------------------------------- William J. Burke CHIEF FINANCIAL OFFICER, SENIOR VICE PRESIDENT-FINANCE, AND TREASURER Dated: August 4, 2000 (Principal Financial Officer)

INTERSPEED INC 10-Q