10-K 1 a2035023z10-k.txt 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NUMBER 0-27401 ------------------------ INTERSPEED, INC. (Exact name of registrant as specified in its charter) DELAWARE 04-3333365 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 39 HIGH STREET NORTH ANDOVER, MASSACHUSETTS 01845 (Address of Principal Executive Offices) (Zip Code) (Registrant's Telephone Number, Including Area Code) (978) 688-6164 Securities Registered Pursuant to Section 12(b) of the Act: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- None N/A Securities Registered Pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE (Title of Class) -------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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. [ ] As of December 31, 2000, 11,049,172 shares of $0.01 par value Common Stock of the registrant were outstanding. The approximate aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing price of $0.28 per share for the registrant's Common Stock, as reported on the NASDAQ National Market System as of December 31, 2000, was $1,329,000. PART I ITEM 1. BUSINESS OVERVIEW Interspeed, Inc. (the "Company" or "Interspeed") (www.interspeed.com) designs, develops and markets advanced high-speed broadband communications equipment based on Digital Subscriber Line (DSL) technology. Interspeed offers a highly scalable family of DSL Access Routers - the EdgeSpeed 1000, EdgeSpeed 800, EdgeSpeed 500, and the EdgeSpeed DART. The Company's EdgeSpeed(TM) products are designed for use by communications service providers that deploy Internet services "in-building," or in Multi-Tenant Units (MTU's), to their business customers. All four products include complete DSL aggregation; Layer 2 switching, IP Routing (Layer 3), and VPN functions in a single device. The Company was incorporated as a Massachusetts corporation and a wholly owned subsidiary of Brooktrout, Inc. ("Brooktrout") in 1996. It commenced operations in March 1997, and was reincorporated as a Delaware corporation in June 1999. Interspeed, Inc. became a public company in September 1999 through its initial public offering. INDUSTRY OVERVIEW CURRENT DATA COMMUNICATIONS INFRASTRUCTURE--THE LAST MILE BOTTLENECK DSL technology represents one approach to providing high speed data transmission capabilities to end users. While telecommunications network backbones can support data speeds up to 10 gigabits per second, communication speeds over the last mile connection between the service providers' central office and the end user are often limited because data must travel over existing copper wire infrastructure equipment that was built to handle analog voice rather than bandwidth intensive data. This last mile connection often results in significant bottlenecks that limit high-speed data transmission. Over 140 million copper lines are installed in businesses and homes in the United States and over 700 million copper lines are installed worldwide. HIGH SPEED DATA ACCESS ALTERNATIVES A number of options are used to provide last mile connectivity, including analog modems and Integrated Services Digital Network (ISDN), cable modems and T-1. However, each of these alternatives suffers from significant drawbacks, particularly for small to medium sized businesses and MTUs. Analog modems and ISDN operate at speeds of 56 Kilobits per second, or Kbps, and 128 Kbps, respectively, which Interspeed believes are inadequate for many business users. Cable, operating at an average speed of 1,000 Kbps, offers higher speed but is not generally available to business users. In addition, cable is inherently susceptible to security breaches. T-1 service, operating at 1,500 Kbps, offers higher speed and security but requires expensive infrastructure modification resulting in high monthly charges. DSL TECHNOLOGY DSL technology, which was specifically developed to take advantage of existing copper infrastructure, provides dedicated high speed data access up to 2,320 Kbps at a competitive cost to end users. The two dominant forms of DSL technology are asymmetric DSL, or ADSL, and symmetric DSL, or SDSL. ADSL transmits data at high speeds only downstream to the subscriber and is best suited for the residential market where consumers typically download large quantities of data but send limited data upstream. In contrast, SDSL supports the two-way exchange of data at high speeds, and is better suited to business users. DSL TECHNOLOGY - IMPORTANT BENEFITS - HIGH SPEED. DSL technology offers high-speed data access at speeds ranging from 150 Kbps to several million bits per second at distances up to 23,000 feet, or approximately 4.3 miles, dependent upon several line characteristics. - LOW COST. DSL is relatively inexpensive to deploy because it takes advantage of the widely available existing copper wire infrastructure. - SECURE DEDICATED CONNECTIONS. Service providers can maintain high levels of performance and security even as new subscribers are added to the system because DSL connections are dedicated to each individual user. CURRENT STATUS OF DSL MARKET The DSL equipment industry, in general, has been experiencing a slowdown of overall sales and significant devaluation in the financial markets. We believe that this slowdown is not indicative of the relative demand for DSL and other broadband services. We believe that the combination of multiple factors are currently being felt in the marketplace including: - Service providers have had difficulty provisioning services to the level of customer demand. - Service providers have had difficulty deploying critical and more profitable value added IP services in addition to basic network connectivity. - Not anticipating these and other problems, service providers have generally purchased equipment in excess of their current capacity needs. Although we believe that these issues are barriers that will be overcome by the industry and that the overall consumer and business demand for broadband services remains strong, a continuation of this slowdown will jeopardize our ability to execute on our business plan. DSL TECHNOLOGY--IMPLEMENTATION Implementation of DSL involves the installation of specialized equipment at the point where the copper wire interfaces with the data communications backbone. This point may be at the service provider central office or another communications hub such as the equipment room of a building or a campus. This specialized equipment performs several important functions, including: - SIGNAL CONCENTRATION. The concentrator receives the data signals from many DSL lines and consolidates them into single higher bandwidth signal for uplink over high-speed transmission lines. - ROUTING. Routers are required to process the data signals from the concentrator and direct them to their appropriate destinations. Routers or other equipment may also support additional functions such as authentication, encryption and firewall. - SYSTEM MANAGEMENT. Typically, each piece of equipment contains a software controlled management system enabling the user to manage system functionality and coordinate with other network equipment. Historically, performance of these functions has been accomplished by purchasing, installing and managing individual equipment components, including DSL access multiplexors, or DSLAMs, routers and switches. A DSLAM is a device that aggregates data from multiple sources into a single signal for output. A complete DSL system is comprised of the aforementioned equipment in conjunction with customer premise equipment, or CPE. CPE is a DSL modem, which connects to the central office equipment. This configuration can have some significant drawbacks, including additional capital and operating costs, space requirements and interoperability issues. In a typical configuration based on current technology, DSL central office products are essentially concentrators, combined with a separate but compatible router and/or switch to provide security and authentication functions and to process the data and forward it to its destination. This multiple product configuration is not only expensive to install, but also must undergo complicated interoperability testing to ensure that all combinations and configurations work. The necessary maintenance and training associated with this multiple product configuration can be costly and time consuming, thus increasing the service providers' total cost of ownership. THE INTERSPEED TECHNOLOGY Interspeed provides a scalable "single-box" solution with integrated IP functionality. INTEGRATED DSLIP(TM) SOFTWARE ARCHITECTURE. Interspeed's DSLip architecture combines the necessary functional elements to deliver DSL network functionality -- DSL Access Multiplexing (traditional DSLAM functionality), Layer 3 IP Routing, Layer 2 Switching-Bridging, and Virtual Private Networking -- in a single unit. SUPPORT FOR VIRTUAL PRIVATE NETWORKS. Interspeed's DSLip Architecture offers the ability to provide completely independent virtual private networks (VPNs). Each VPN can have its own distinct mode of operation (i.e. router, bridge, DSLAM, or mixed mode), its own policy management and its own privacy. ADVANCED NETWORK MANAGEMENT. Interspeed's EdgeSpeed(TM) Access Routers include Interspeed Speedview(TM), a powerful, graphical tool that enables remote administration and management via a standard Web browser. Speedview enables the user to configure routing destinations on a port-to-port basis and fine tune and monitor system wide-configuration parameters, port configuration, transmission speed selection and more. Speedview(TM) provides detailed, user-specific configuration information, displays module types within the chassis, and provides status information for each port in the system. The EdgeSpeed(TM) platform also supports management via Simple Network Management Protocol (SNMP) and Command Line Interface (CLI). EDGESPEED(TM) PRODUCT FAMILY EDGESPEED DART The EdgeSpeed DART is Interspeed's most compact and lowest-cost access router. It is targeted at low-density MTU deployments, including retail strip malls, small commercial office and residential buildings. EDGESPEED 500 The EdgeSpeed 500 is specifically designed and engineered for DSL network deployments to provide high-speed data and voice services. It is targeted at Building Service Providers (BSPs) and Internet Service Providers (ISPs) seeking to install DSL in MTU buildings, retail malls, residential and hospitality properties, and campus environments. EDGESPEED 800 The EdgeSpeed 800 is specifically designed and engineered for DSL network deployments worldwide requiring high port densities in a standard 19-inch rack mount chassis. It is targeted at BSPs, ISPs, Competitive Local Exchange Carriers (CLECs), and Independent telephone companies seeking to deploy DSL in high-density MTU buildings, including residential buildings, offices and hotels, as well as Central Office co-location. EDGESPEED 1000 The EdgeSpeed 1000 is specifically designed and engineered for demanding high-density networks, where DSL service offerings are delivered to large number of subscribers. It is targeted at BSPs, ISPs, and Independent telephone companies seeking to deploy DSL in high-density MTU buildings, including residential buildings, offices and hotels, as well as Central Office co-location. CURRENTLY AVAILABLE HARDWARE MODULES - LM21. A subscriber line concentration module supporting twenty-four G.Lite ADSL ports for both data and analog voice applications. Supports speeds of up to 1.5 Mbps downstream and 512 Kbps upstream. - LM02. A subscriber line concentration module supporting up to sixteen SDSL ports. Each port can be individually configured to operate at one of several speeds ranging from 192 Kbps to 2.3 Mbps. - MM01. The Media Module provides enhanced serviceability by allowing customers to replace line modules without disturbing the DSL wiring. - SM01. An Ethernet switch/router module with five Ethernet ports. This module operates as a full-featured IP router and supports industry standard protocols including RIP1, RIP2, and OSPF. Alternatively, it can be configured to operate as a Layer 2 switch. - SM02. Similar to the SM01 except it has one multi-mode fiber optic Ethernet port. - SM11. An ATM switch/router module with one DS3 port over dual coaxial cable and an Ethernet port. This module operates as a full-featured IP router or Layer 2 switch and supports industry standard ATM protocols. - SM12. Similar to the SM11 except it has one OC-3 fiber optic port and an Ethernet port. - SM21. A T1/E1 switch/router module with three WAN ports with built in CSU/DSU and an Ethernet port. This module operates as a full featured IP router or Layer 2 switch and supports industry standard protocols such as PPP and Frame Relay. CUSTOMERS Our customers consist of service providers, value added resellers and system integrators. Sales to our three largest customers accounted for approximately 61%, 16% and 13%, respectively, of our total revenues for the year ended September 30, 2000. We do not expect revenues from our largest customer, Cabletron Systems, Inc. to be significant in the future, which will have a significant negative impact on our future results of operations. SALES AND MARKETING Our primary sales strategy will incorporate the establishment of indirect strategic sales channels. These channels are and will continue to be selected by their strength and reputation in the industry and their general alignment in the DSL marketplace. These sales channels are value added resellers, original equipment manufactures, and system integrators. Additionally, we have a direct sales force headquartered in North Andover, Massachusetts. The direct sales force is responsible for establishing relationships with key accounts. Key accounts are generally classified as data service providers, such as the RBOCs/ ILECs, CLECs, ISPs, or more strategic indirect sales channels discussed above. We have also initiated limited channel and marketing activities in Europe and the Pacific. In addition to our customer specific efforts, our marketing activities include attendance at industry trade shows and conferences, advertising of our products in industry trade journals, operating a web site, and ongoing communications with potential customers, industry analysts and the trade press. CUSTOMER SERVICE AND SUPPORT Our technical support staff provides pre- and post-sales support including installation and technical assistance. Additionally, they participate in and provide support for joint sales presentations and cooperative trade show activities with our customers, channels, and, partners. Our support services are available to our customers both on site and by telephone and remote access seven days a week on a 24-hour a day basis. Our sales and support staff provide customer feedback to our product design engineers with regard to our customers' evolving requirements. To supplement the efforts of our technical support staff, we have entered into partnership agreements with multiple professional services organizations capable of providing extensive installation maintenance services on an outsourced or referral basis. Warranties on our products extend for 12 months. We have a variety of hardware maintenance and support programs tailored to our customers' specific requirements that are available for products no longer under warranty. These programs vary from agreements to provide service on a time and materials basis to annual service contracts based on a percentage of the cost of the product. To date, revenues attributable to customer service and support services have been immaterial. BACKLOG At September 30, 2000, the Company does not have a significant backlog of unshipped orders. RESEARCH AND DEVELOPMENT Our research and development team includes qualified engineers with data communication industry experience that transitioned the Interspeed EdgeSpeed 1000/500 products from the product definition stage to final beta testing in only 18 months and continues to develop enhancements to, and extensions of, that product family, including the EdgeSpeed DART and EdgeSpeed 800. During the fiscal years ended September 30, 2000, 1999 and 1998, we spent approximately $7.5 million, $5.3 million and $3.2 million, respectively, on research and development. COMPETITION Our competitors are generally divided into two segments. One segment focuses on selling equipment to data communications service providers that target the business user end market. The other segment focuses on selling equipment to data communications service providers that target the MTU market. Generally, customers must purchase and interconnect individual equipment components from numerous suppliers to achieve the functionality of our DSL access router or DSLAR products. We compete directly with Lucent Technologies Inc.; Copper Mountain Networks, Inc., Paradyne Networks, Inc.; and Tut Systems, Inc. The principal competitive factors in our market include: - system reliability, performance and features; - technical support and customer service; - ease of installation and use; - total cost of ownership; - size and stability of operations; - brand recognition; and, - price per port. Our current financial position has had a material adverse effect on our ability to compete. MANUFACTURING We currently outsource the majority of our manufacturing to contract manufacturers. We currently perform final test, assembly and packaging of our products at our facility in North Andover, Massachusetts. We use a small number of independent manufacturers to manufacture printed circuit boards, chassis and subassemblies for our products. In addition, we use a combination of standard parts and components in our products, which are generally available from more than one vendor. Some components are obtained from a sole or single source and, should supply of these components cease, would require redesign of our products. While we work closely with some well-established vendors, we have no supply commitments from our vendors and we generally purchase components on a purchase order basis, rather than entering into long-term agreements with our vendors. To date, we have generally been able to obtain adequate supplies in a timely manner from our current suppliers. We have identified alternate vendors should current vendors be unable to fulfill our needs. However, a reduction or interruption in supply or a significant increase in the price of components would materially and adversely affect our business, financial condition and results of operations. We have a non-cancelable inventory purchase commitment for raw materials and finished goods with our principal contract manufacturer, which at September 30, 2000, totaled approximately $2.8 million. We expect that we will be required to purchase this inventory during the first six months of fiscal 2001. During the fourth quarter of fiscal 2000, we recorded a provision of $1 million for expected losses related to this commitment. There can be no assurance that additional provisions will not be necessary if the Company's sales plans are not achieved. Our manufacturing floor follows industry standard electro-static discharge procedures and we use a materials resource system to control product flow. Our product is built to meet or exceed current Institute for Interconnecting and Packaging Electronic Circuits, or IPC, standards. Quality control and quality assurance are carefully monitored. Key metrics, which we measure, include supplier on-time delivery, inventory level, order to delivery time and customer installation failure rate. All metrics are measured, tracked and improved through root cause failure analysis, containment and corrective action implementation. INTELLECTUAL PROPERTY We rely on a combination of copyright, trademark, trade secret and other intellectual property laws, nondisclosure agreements with our employees and third parties and other protective measures to protect our proprietary rights. We have filed a patent application covering aspects of the design of our single platform DSL hardware solution. We do not yet have any issued patents, and it is unclear whether any patents will be issued in the future. Although we employ a variety of intellectual property assets in the development and manufacturing of our products, we believe that none of such intellectual property is individually critical to our current operations. Although we are not aware that our products infringe on the proprietary rights of third parties, there can be no assurance that others will not assert claims of infringement in the future or that, if made, such claims will not be successful. Litigation to determine the validity of any claims, whether or not such litigation is determined in favor of us, could result in significant expense and divert our efforts from daily operations. In the event of any adverse ruling, we may be required to pay substantial damages, discontinue the sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to use infringing or substituted technology. From time to time, we may desire or be required to renew or to obtain licenses from others in order to further develop and market our products effectively. There can be no assurance that any necessary licenses will be available on commercially reasonable terms. EMPLOYEES As of December 31, 2000, we had 53 full time employees. The Company's value, continuation and success will depend, to a considerable extent, on the contributions of our employees, and on the Company's ability to retain and attract qualified employees. In light of our cash liquidity issues, we have emphasized the award of stock options as a means to retain our talented personnel. There is considerable uncertainty if this incentive will be successful. ITEM 2. PROPERTY We are headquartered in a facility consisting of approximately 36,000 square feet in North Andover, Massachusetts, under a lease expiring in 2004. ITEM 3. LEGAL PROCEEDINGS Shareholder class action suits have been filed against us, which if determined or settled in a manner adverse to us could adversely affect us. The shareholder class action suits, all of which are pending in the United States District Court for the District of Massachusetts, each arise out of the same alleged conduct and pertain to disclosures made by the Company in a press release dated October 6, 2000. Each of the actions alleges that the defendants, which include Interspeed, our former President and Chief Financial Officer, as well as two of our former Vice Presidents, violated Section 10(b) of the Securities Exchange Act of 1934, or the 1934 Act, in connection with our historical recognition of our revenues. In addition, each complaint alleges that the individual defendants are controlling persons of the Company under Section 20(a) of the 1934 Act, and as such caused the Company to engage in conduct which purportedly violated Section 10(b) of the 1934 Act. The plaintiffs seek damages in an undisclosed amount. We are currently reviewing the allegations in these lawsuits. The defense of these lawsuits could involve significant litigation-related expenses. In the event that any of the claims set forth in the class action complaints are determined or settled in a manner adverse to us, then such determinations or settlements could adversely affect our financial position, results of operations or ability to continue as a going concern. The outcome of these lawsuits cannot presently be determined. Accordingly, no provision for any loss that might result therefrom has been made in the financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY The Company's Common Stock is traded on the NASDAQ National Market System under the symbol "ISPD." The following table sets forth for the periods indicated the high and low sale prices per share of the Common Stock on the NASDAQ National Market System, as reported by NASDAQ. The Company's initial public offering (the "IPO") of its Common Stock at $12.00 per share occurred on September 24, 1999. HIGH LOW -------------------- FISCAL YEAR ENDED SEPTEMBER 30, 1999 Quarter ended September 30, 1999 $24.88 $16.88 FISCAL YEAR ENDED SEPTEMBER 30, 2000 Quarter ended December 31, 1999 $25.13 $10.00 Quarter ended March 31, 2000 $39.94 $15.63 Quarter ended June 30, 2000 $23.25 $10.25 Quarter ended September 30, 2000 $22.63 $ 6.50 The Company has never paid cash dividends on its Common Stock. The Company presently intends to retain earnings for use in the operation and expansion of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future. On December 18, 2000, there were 85 holders of record of the Company's Common Stock. RECENT SALES OF UNREGISTERED SECURITIES Set forth in chronological order below is information regarding the number of shares of capital stock issued by Interspeed during the past three years. Further included is the consideration, if any, received by Interspeed for such shares. We believe that the transactions described below with respect to option grants to our employees are exempt from the registration requirements of the Securities Act by reason of Section 4(2) and Rule 701 promulgated thereunder. (1) In October, 1998, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 36,000 shares of common stock to employees at an exercise price of $.13 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (2) In December, 1998, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 68,000 shares of common stock to employees at an exercise price of $.13 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (3) In January, 1999, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 20,000 shares of common stock to employees at an exercise price of $.13 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (4) In February, 1999, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 26,000 shares of common stock to employees at an exercise price of $.13 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (5) In March, 1999, pursuant to an incentive stock option agreement, we granted options to purchase up to an aggregate of 20,000 shares of common stock to employees at an exercise price of $.67 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (6) In April, 1999, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 20,000 shares of common stock to employees at an exercise price of $.80 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (7) In May, 1999, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 147,000 shares of common stock to employees at an exercise price of $.80 per share and pursuant to a non-qualified stock option agreement, options to purchase up to an aggregate of 300,000 shares of common stock to an employee at an exercise price of $.13 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. (8) In June, 1999, pursuant to incentive stock option agreements, we granted options to purchase up to an aggregate of 24,000 shares of common stock to employees at an exercise price of $.80 per share in reliance upon the exemption from registration under Rule 701 promulgated under the Securities Act. In addition, pursuant to non-qualified stock option agreements, we granted options to purchase an aggregate of 80,000 shares of common stock to directors at an exercise price of $2.50 per share. (9) In January, 2000, we granted a warrant to purchase up to 50,000 shares of 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. (10) In February, 2000, we granted a warrant to purchase up to 5,000 shares of 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 SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA (in thousands, except per share data) The selected financial data should be read in conjunction with, and is qualified in its entirety by, "Management's Discussion and Analysis of Financial Condition and Results of Operations," the Financial Statements of Interspeed and the Notes to those statements and the other financial data included elsewhere in this report.

(1) Excludes non-cash amortization of stock-based compensation and warrant charges as follows: Cost of revenue................ $ 3 $ 24 $ 36 Research and development....... 14 184 213 Sales and marketing............ 2 80 953 General and administrative..... - 2,057 883 ---------- --------- -------- Totals...................... $ 19 $ 2,345 $ 2,085 ========== ========= ========

SEPTEMBER 30, -------------------------------------- 1997 1998 1999 2000 -------------------------------------- Balance Sheet: Cash .................................. $ 21 $ 132 $ 21,227 $ 612 Working capital......................... (155) 213 21,042 2,578 Total assets............................ 348 1,227 25,880 12,891 Long term note payable-due Brooktrout... 206 5,038 -- -- Total stockholders' equity (deficit).... (42) (4,336) 22,170 4,482 ITEM 7. 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 FINANCIAL STATEMENTS AND NOTES TO THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS ANNUAL 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. THESE RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHER THINGS, RISKS RELATED TO MARKET GROWTH, PRODUCT ACCEPTANCE AND PRODUCT DEMAND, RAPID CHANGES IN TECHNOLOGY, THE IMPACT OF COMPETITION, RISKS RELATED TO THE COMPANY'S FINANCIAL POSITION AND LIQUIDITY, THE IMPACT, IF ANY, OF THE ANNOUNCED RESTATEMENT ON INTERSPEED'S STOCK PRICE, THE OUTCOME OF THE STRATEGIC ALTERNATIVE PROCESS AND THE ABILITY OF THE COMPANY TO CLOSE A STRATEGIC TRANSACTION OR RAISE ADDITIONAL CAPITAL, THE UNCERTAINTIES ASSOCIATED WITH THE RECENTLY FILED LITIGATION, THE IMPACT OF SUBSEQUENT MANAGEMENT REVIEWS AND OTHER RISKS AND UNCERTAINTIES, INCLUDING, WITHOUT LIMITATION, THOSE FACTORS DESCRIBED UNDER "RISK FACTORS." 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 THE UNDERLYING ASSUMPTIONS OR FACTORS, NEW INFORMATION, FUTURE EVENTS OR OTHER MATERIAL CHANGES. OVERVIEW We design, develop, and market advanced high speed data communication solutions based on DSL technology. Our products enable data communications service providers such as competitive local exchange carriers, Internet service providers, and owners of multi-tenant units, to utilize the existing copper wire infrastructure to deliver high speed data access to their customers. We believe we offer the only single platform system that integrates the principal components required to offer DSL service, including signal concentration, routing, switching and network management. Unlike traditional DSL products, our DSLAR offers a highly scalable and flexible solution to our customers, at a lower total cost of ownership. Since we commenced operations in March 1997, we have focused our efforts and resources on research and development and the formation of a corporate infrastructure. We announced general availability of our Interspeed 1000 and Interspeed 500 DSLARs in February 1999, and of our Interspeed DART in October 1999. Our continuation as a going concern is dependent upon our ability to generate sufficient cash flow to meet our obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain successful operations. We are continuing our efforts to obtain additional funds and reduce cash outflows, by among other things, reducing headcount and curtailing certain marketing activities. Subsequent to September 30, 2000, our majority stockholder, Brooktrout, agreed to provide us a revolving line of credit under which we may request advances up to $2.5 million. Advances under this line of credit are at Brooktrout's sole discretion . We have engaged Broadview International, LLC to assist with the review of strategic alternatives, including a possible sale of the Company. If we are unable to complete a strategic transaction, secure additional sources of financing, or achieve positive cash flow from operations, we may be required to significantly curtail operations or cease doing business as a going concern. REVENUE BEFORE SALES DISCOUNTS - WARRANTS. 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 when the product has been shipped, the customer's obligation is fixed and collectibility is considered probable. No revenue is recognized on either products shipped on a trial basis or products shipped under consignment type arrangements. 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. 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 complete and all other requirements for revenue recognition are met. SALES DISCOUNTS - WARRANTS. We have granted to certain customers warrants to purchase up to 150,000 shares of 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 quarter. The value of the warrants is being adjusted in each quarter 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, overhead such as equipment and facility costs, provisions for excess and obsolete inventory, and losses on noncancelable purchase commitments. GROSS PROFIT. Our gross profit is affected by many factors including pricing, product mix, cost factors such as component prices, internal and external manufacturing costs. Gross profit is also impacted by provisions for excess and obsolete inventory, and losses on noncancelable purchase commitments. 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. 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. 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 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 recorded any benefit related to these losses. We are no longer 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. RESULTS OF OPERATIONS YEAR ENDED SEPTEMBER 30, 2000 COMPARED TO YEAR ENDED SEPTEMBER 30, 1999 REVENUE BEFORE SALES DISCOUNTS - WARRANTS. Gross revenue for the year ended September 30, 2000 was $6,419,000, an increase of $4,441,000 from gross revenue of $1,978,000 for the year ended September 30, 1999. This increase was due to significantly greater shipments to a major customer during fiscal year 2000. This customer accounted for 61% and 75% and of revenue in the years ended September 30, 2000 and 1999, respectively. We do not expect revenues from this customer to be significant in the future. Sales for the first quarter of fiscal 2001 totaled less than $50,000. See additional discussion in Recent Developments. SALES DISCOUNTS-WARRANTS. During the year ended September 30, 2000, we recognized $99,000 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 prior fiscal years. COST OF REVENUE. Cost of Revenue increased to $7,183,000 for the year ended September 30, 2000, from $1,365,000 for the year ended September 30, 1999, due to increased revenue volumes during fiscal year 2000, a $2 million provision for excess and obsolete inventory, and a $1 million provision for loss on a noncancelable purchase commitment, both recorded in, and due to events occurring in, the fourth quarter of fiscal 2000. GROSS PROFIT. Gross Profit decreased to a loss of $863,000 for the year ended September 30, 2000, from gross profit of $613,000 for the year ended September 30, 1999. This decrease in gross profit was primarily due to the $2 million provision for excess and obsolete inventory and the $1 million provision for loss on a noncancelable purchase commitment, as described above. RESEARCH AND DEVELOPMENT. Research and development expenses increased by 41% in fiscal year 2000 from $5,329,000 for the year ended September 30, 1999 to $7,491,000 for the year ended September 30, 2000. This increase was 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 fiscal 2000. We expect that research and development expenses will decrease in fiscal year 2001 as a result of a decrease in the number of our engineering employees caused by our financial condition. SALES AND MARKETING. Sales and marketing expenses increased by 350% in fiscal year 2000 from $1,673,000 for the year ended September 30, 1999 to $7,530,000 for the year ended September 30, 2000. This increase was 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. We expect that sales and marketing expenses will decrease in fiscal year 2001 as a result of our financial condition. GENERAL AND ADMINISTRATIVE. Prior to our IPO, we had relied on Brooktrout to provide the majority of general and administrative services. Upon the effective date of our IPO on September 24, 1999, we entered into a transition services agreement with Brooktrout, pursuant to which Brooktrout continued to provide us with certain services during the transitional period. The agreement called for fees to be paid in connection with the continuation of administrative and support services. Such services were phased out by December 31, 1999. General and administrative expenses, including the cost of services provided by Brooktrout, increased by 74% in fiscal year 2000 from $1,738,000 for the year ended September 30, 1999 to $3,023,000 for the year ended September 30, 2000. This increase was due primarily to costs associated with building a stand-alone general and administrative function, including expenses relating to the implementation of our financial systems. We expect that general and administrative expenses will decrease in fiscal year 2001 as a result of our financial condition. STOCK COMPENSATION AND WARRANT CHARGES. In prior fiscal years, stock options were granted with exercise prices that were less than the estimated fair value of our common stock. Compensation cost associated with these options was determined as the difference between the fair value of the stock and the exercise price. Stock compensation costs decreased to $1,236,000 in fiscal year 2000, from $2,345,000 for the year ended September 30, 1999. Compensation cost for the year ended September 30, 1999 included $548,000 related to grants to two directors that were 100% vested on the date of grant and $1,186,000 related to a grant to the Company's former president that vested 40% on June 18, 1999 upon the initial filing of a registration statement with the Securities and Exchange Commission. The unvested options under this grant were canceled in October 2000 upon the resignation of the former president. During the year ended September 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 were 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 taxes. Accordingly, we have not recorded any benefit related to these losses. We are no longer included in Brooktrout's consolidated tax filings. We do not anticipate recognizing any benefits from losses generated in the short term due to our limited operating history. NET LOSS. Net loss increased by $9,972,000 in fiscal year 2000 from $10,469,000 for the year ended September 30, 1999, to $20,441,000 for the year ended September 30, 2000. This increase is due to the provisions for excess and obsolete inventory and loss on a noncancelable purchase commitment, and increases in operating expenses, offset by a decrease in stock compensation and warrant charges, as described above. YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO YEAR ENDED SEPTEMBER 30, 1998 REVENUE. Revenue for the year ended September 30, 1999 was $1,978,000, as compared to $0 for the year ended September 30, 1998. This increase was due to the transition from the development stage to the commencement of commercial operations and the general release of our first products, the Interspeed 1000 and Interspeed 500, in February 1999. COST OF REVENUE. Cost of Revenue increased to $1,365,000 for the year ended September 30, 1999 from $0 for the year ended September 30, 1998, due to direct manufacturing costs and expenses coinciding with the general availability of product and initial shipments during fiscal year 1999. GROSS PROFIT. Gross Profit increased to $613,000 for the year ended September 30, 1999, from $0 for the year ended September 30, 1998. Gross margin percentage for fiscal year 1999 was 31%. This increase in gross profit was due to the recognition of revenues for the year ended September 30, 1999. RESEARCH AND DEVELOPMENT. Research and development expenses increased by 66% in fiscal year 1999 from $3,204,000 for the year ended September 30, 1998 to $5,329,000 for the year ended September 30, 1999. This increase was due primarily to increases in payroll related expenses from headcount growth, increasing from 16 engineers at September 30, 1998 to 36 engineers at September 30, 1999, and consulting expenses for specific development projects. SALES AND MARKETING. Sales and marketing expenses increased by 317% in fiscal year 1999 from $401,000 for the year ended September 30, 1998 to $1,673,000 for the year ended September 30, 1999. This increase was due to payroll, travel and trade show expenses associated with year-to-year increases in sales and marketing headcount from 4 at September 30, 1998 to 15 at September 30, 1999. GENERAL AND ADMINISTRATIVE. Prior to our IPO, we had relied on Brooktrout to provide the majority of general and administrative services. Upon the effective date of our IPO on September 24, 1999, we entered into a transition services agreement with Brooktrout, pursuant to which Brooktrout will continue to provide us with certain services during the transitional period. The agreement calls for fees to be paid in connection with the continuation of administrative and support services, with such services to be phased out by December 31, 1999. General and administrative expenses, including the cost of services provided by Brooktrout, increased by 152% in fiscal year 1999 from $689,000 for the year ended September 30, 1998 to $1,738,000 for the year ended September 30, 1999. This increase was due primarily to costs allocated to us using methodologies primarily based on headcount and services rendered. These cost allocations amounted to $1,078,000 for the year ended September 30, 1999 compared to $668,000 for the year ended September 30, 1998. STOCK COMPENSATION. 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 was determined as the difference between the fair value of the stock and the exercise price. Stock compensation costs increased $2,326,000 in fiscal year 1999, from $19,000 for the year ended September 30, 1998 to $2,345,000 for the year ended September 30, 1999. INCOME TAX EXPENSE. Prior to our IPO, we were 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 taxes. Accordingly, we have not recorded any benefit related to these losses. We are no longer included in Brooktrout's consolidated tax filings. We do not anticipate recognizing any benefits from losses generated in the short term due to our limited operating history. NET LOSS. Net loss increased by $6,156,000 in fiscal year 1999 from $4,313,000 for the year ended September 30, 1998 to $10,469,000 for the year ended September 30, 1999. This increase is due to the increases in operating expenses and stock compensation charges, as described above, more than offsetting gross profit from revenue resulting from the commencement of commercial operations during the fiscal year. 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 $20,615,000 from $21,227,000 at September 30, 1999 to $612,000 at September 30, 2000. The decrease in cash is due primarily to a $7,118,000 increase in inventory and the net loss for the year ended September 30, 2000, being partially offset by non-cash operating charges and a net increase of $4,629,000 in current liabilities. The increase in inventory was due to the increased inventory under consignment type arrangements and the expectation of increased shipment volumes during subsequent quarters. We anticipate that a significant portion of our inventory under consignment type arrangements will be returned to us. We have had limited sales during the first quarter of fiscal 2001. Further, during the fourth quarter of fiscal 2000 we recorded a provision of $2 million for excess and obsolete inventory. We believe that this provision reduces the inventory to its net realizable value; however, there can be no assurance that additional provisions will not be necessary if our sales plans are not achieved. For the years ended September 30, 2000 and 1999, we purchased fixed assets of approximately $1,657,000 and $1,014,000, respectively. We currently have no material commitments for additional capital expenditures. We have non-cancelable inventory purchase commitments for raw materials and finished goods with our principal contract manufacturer, which at September 30, 2000, totaled approximately $2.8 million. During the fourth quarter of fiscal 2000, the Company recorded a provision of $1 million for expected losses related to this commitment. We believe that this provision provides for the expected losses on this commitment; however, there can be no assurance that additional provisions will not be necessary if our sales plans are not achieved. We expect that we will be required to purchase this inventory during the first six months of fiscal 2001. For the year ended September 30, 2000, our cash decreased by $20,615,000, resulting in a cash balance of approximately $612,000 as of September 30, 2000. Subsequent to September 30, 2000, we have continued to use significant amounts of cash in operations. We have taken actions to reduce cash outflows by, among other things, reducing headcount and curtailing certain marketing activities. Subsequent to September 30, 2000, the Company's majority stockholder, Brooktrout, Inc. ("Brooktrout"), agreed to provide the Company with a revolving line of credit under which the Company may request advances up to $2.5 million. Advances under this line of credit are at Brooktrout's sole discretion and as of December 31, 2000, the Company has drawn down approximately $1.7 million. There can be no assurance that Brooktrout will continue to fund up to the maximum. We have engaged Broadview International LLC to assist us with the review of strategic alternatives, including a possible sale of the Company. We are actively considering all of our strategic alternatives, including a sale or merger of the Company, sales of certain of our assets, or a potential restructuring, recapitalization or bankruptcy reorganization of the Company. At this time, however, we cannot predict the success of any of these alternatives. If we are unable to complete one of the above mentioned strategic transactions or secure additional sources of financing, we may have to significantly curtail our operations or cease doing business. Shareholder class action suits have been filed against us, which if determined or settled in a manner adverse to us could adversely affect us. The shareholder class action suits, all of which are pending in the United States District Court for the District of Massachusetts, each arise out of the same alleged conduct and pertain to disclosures made by the Company in a press release dated October 6, 2000. Each of the actions alleges that the defendants, which include Interspeed, our former President and Chief Financial Officer, as well as two of our former Vice Presidents, violated Section 10(b) of the Securities Exchange Act of 1934, or the 1934 Act, in connection with our historical recognition of our revenues. In addition, each complaint alleges that the individual defendants are controlling persons of the Company under Section 20(a) of the 1934 Act, and as such caused the Company to engage in conduct which purportedly violated Section 10(b) of the 1934 Act. The plaintiffs seek damages in an undisclosed amount. We are currently reviewing the allegations in these lawsuits. The defense of these lawsuits could involve significant litigation-related expenses. In the event that any of the claims set forth in the class action complaints are determined or settled in a manner adverse to us, then such determinations or settlements could adversely affect our financial position, results of operations or our ability to continue as a going concern. The outcome of these lawsuits cannot presently be determined. Accordingly, no provision for any loss that might result therefrom has been made in the financial statements. We do not believe that inflation has had a significant effect on our operations to date. RECENT DEVELOPMENTS For the quarter ended December 31, 2000, our sales totaled less than $50,000, and we expect to report a significant loss for the quarter. We have taken significant additional steps to reduce cash outflows, including a reduction in headcount of 39 employees, or 42% of the workforce, from 93 employees at September 30, 2000 to 53 employees at December 31, 2000. As discussed above, we are continuing to explore strategic alternatives. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board released Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, establishes new standards of accounting and reporting for derivative instruments and hedging activities and will be effective for the Company in fiscal 2001. Management has evaluated the effect of adopting SFAS No. 133 on the financial statements and does not believe that the adoption will be material to the financial statements. In December 1999, the Securities and Exchange Commission (the "SEC") released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." It has subsequently issued implementation guidance in the form of a "Frequently Asked Questions" (FAQ) document. SAB No. 101 and the FAQ 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 the fourth quarter of fiscal 2001 and will be applied retroactively to the first quarter of fiscal 2001. Management does not believe that the adoption of SAB No. 101 will be material to the financial statements. RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND THE OTHER INFORMATION IN THIS ANNUAL REPORT. OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE HARMED BY ANY OF THE FOLLOWING RISKS. WE MAY NOT HAVE SUFFICIENT LIQUIDITY TO CONTINUE AS A GOING CONCERN For the year ended September 30, 2000, our cash decreased by $20,615,000, resulting in a cash balance of approximately $612,000 as of September 30, 2000. Subsequent to September 30, 2000, we have continued to use significant amounts of cash in operations. We have taken actions to reduce cash outflows by, among other things, reducing headcount and curtailing certain marketing activities. Subsequent to September 30, 2000, the Company's majority stockholder, Brooktrout, Inc. ("Brooktrout"), agreed to provide the Company with a revolving line of credit under which the Company may request advances up to $2.5 million. Advances under this line of credit are at Brooktrout's sole discretion and as of December 31, 2000, the Company has drawn down approximately $1.7 million. We have engaged Broadview International, LLC, a global merger and acquisition advisor, to assist us with the review of strategic alternatives, including a possible sale of the Company. If we are unable to sell the Company, secure additional sources of financing, or achieve positive cash flow from our operations, we may be required to significantly curtail our operations or cease doing business. IF CLASS ACTION LAWSUITS RECENTLY FILED AGAINST US ARE DETERMINED OR SETTLED IN A MANNER ADVERSE TO US, IT MAY ADVERSELY AFFECT OUR FINANCIAL CONDITION, RESULTS OF OPERATIONS OR ABILITY TO CONTINUE AS A GOING CONCERN Shareholder class action suits have been filed against Interspeed, which if determined or settled in a manner adverse to us could adversely affect us. The shareholder class action suits, all of which are pending in the United States District Court for the District of Massachusetts, each arise out of the same alleged conduct and pertain to disclosures made by the Company in a press release dated October 6, 2000. Each of the actions alleges that the defendants, which include Interspeed, our former President and Chief Financial Officer, as well as two of our former Vice Presidents, violated Section 10(b) of the Securities Exchange Act of 1934, or the 1934 Act, in connection with our historical recognition of our revenues. In addition, each complaint alleges that the individual defendants are controlling persons of the Company under Section 20(a) of the 1934 Act, and as such caused the Company to engage in conduct which purportedly violated Section 10(b) of the 1934 Act. The plaintiffs seek damages in an undisclosed amount. We are currently reviewing the allegations in those lawsuits. The defense of these lawsuits could involve significant litigation-related expenses. In the event that any of the claims set forth in the class action complaints are determined or settled in a manner adverse to us, then such determinations or settlements could adversely affect our financial position, results of operations or ability to continue as a going concern. IF WE ARE UNABLE TO COMPLETE A STRATEGIC TRANSACTION, IT MAY HAVE A MATERIAL ADVERSE AFFECT ON OUR FINANCIAL CONDITION OR OUR ABILITY TO CONTINUE DOING BUSINESS. We have engaged Broadview International LLC to assist us with the review of strategic alternatives, including a possible sale of the Company. We are actively considering all of our strategic alternatives, including a sale or merger of the Company, sales of certain of our assets, or a potential restructuring, recapitalization or bankruptcy reorganization of the Company. At this time, however, we cannot predict the success of any of these alternatives. If we are unable to complete one of the above mentioned strategic transactions or secure additional sources of financing, we may have to significantly curtail our operations or cease doing business. WE HAVE A HISTORY OF LOSSES AND ANTICIPATE FUTURE LOSSES We have accumulated losses of approximately $36.3 million since inception in October 1996 through September 30, 2000 and expect to incur net losses in the future. Losses were approximately $20.4 million and $10.5 million for the years ended September 30, 2000 and 1999, respectively. 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. THE LOSS OF ANY SIGNIFICANT CUSTOMER COULD CAUSE OUR REVENUE TO DECLINE If we are unable to replace our major customer, our revenue will 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 results will significantly depend upon a limited number of customers. 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. 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 THE SLOWDOWN IN THE DSL EQUIPMENT INDUSTRY CONTINUES, WE MAY NOT BE ABLE TO CONTINUE OUR OPERATIONS The DSL equipment industry has generally been experiencing a slowdown of overall sales and significant devaluation in the financial markets. We believe that the combination of multiple factors are currently being felt in the marketplace including: - Service providers have had difficulty provisioning services to the level of customer demand. - Service providers have had difficulty deploying critical and more profitable value added IP services in addition to basic network connectivity. - Not anticipating these and other problems, service providers have generally purchased equipment in excess of their current capacity needs. If the slowdown in the DSL equipment industry continues, we may not be able to continue our operations. IF OUR TARGET CUSTOMERS DO NOT ACCEPT DSL TECHNOLOGY, WE MAY BE UNABLE TO SUSTAIN OR GROW OUR BUSINESS Our future results are 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 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 results. 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; - 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 prospects 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 prospects depend 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. Because of recent business reversals, retention of our employees has been more difficult. The loss of the services of any key personnel could materially adversely affect our business, financial condition and results of operations. 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 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. Because of recent business reversals, retention of our employees has been more difficult. We have lost a number of personnel, particularly in engineering, due to our uncertain future, and continue to experience resignations. 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. 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 Lucent Technologies Inc.; Copper Mountain Networks, 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, OUR SALES MAY BE ADVERSELY AFFECTED 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; - 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 ARRANGEMENT WITH OUR PRINCIPAL CONTRACT MANUFACTURER MAY REQUIRE US TO PURCHASE INVENTORY IN EXCESS OF OUR CURRENT REQUIREMENTS. We have non-cancelable inventory purchase commitments for raw materials and finished goods with our principal contract manufacturer, which at September 30, 2000, totaled approximately $2.8 million. We expect that we will be required to purchase this inventory during the first six months of fiscal 2001. We have no current need for this inventory. OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY MAY PREVENT US FROM RETAINING OUR COMPETITIVE ADVANTAGE Our results 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 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. STOCK OWNED BY BROOKTROUT MAY LIMIT STOCKHOLDERS' ABILITY TO INFLUENCE THE OUTCOME OF MATTERS REQUIRING STOCKHOLDER APPROVAL At September 30, 2000, Brooktrout owned approximately 55% of the outstanding shares of our 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. 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 December 31, 2000, we had approximately 11,049,172 shares of common stock outstanding, and of which approximately 4,724,140 shares are freely transferable without restriction or registration under the Securities Act of 1933, unless such shares are held by our affiliates. The remaining 6,325,032 shares of common stock held by existing stockholders and 154,367 shares subject to outstanding options vested as of December 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; 126,928 shares subject to outstanding options vested as of December 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. 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 7A. 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 September 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 September 30, 2000, we had no outstanding foreign currency exchange contracts, and no short-term or long-term debt obligations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INTERSPEED, INC. INDEX TO FINANCIAL STATEMENTS PAGE Independent Auditors' Report................................ 29 Balance Sheets.............................................. 30 Statements of Operations.................................... 31 Statements of Stockholders' Equity (Deficit)................ 32 Statements of Cash Flows.................................... 33 Notes to Financial Statements............................... 34 Schedule II................................................. 44 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Interspeed, Inc. North Andover, MA We have audited the accompanying balance sheets of Interspeed, Inc., a subsidiary of Brooktrout, Inc., as of September 30, 2000 and 1999 and the related statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended September 30, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14. 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 in accordance with auditing standards generally accepted in the United States of America. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 1999 financial statements present fairly, in all material respects, the financial position of the Company at September 30, 1999, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 1999 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule for the two years ended September 30, 1999, when considered in relation to the related basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. The accompanying financial statements and the financial statement schedule for the year ended September 30, 2000 have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations and difficulty in generating sufficient cash flows to meet its obligations and sustain its operations and, as discussed in Note 13, certain class action complaints filed against the Company and certain other parties, raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are described in Note 1. The financial statements and the financial statement schedule do not include any adjustments that may result from the outcome of this uncertainty. Because of the possible material effects of the uncertainty referred to in the preceding paragraph, we are unable to express, and we do not express, an opinion on the financial statements and the financial statement schedule for 2000. Deloitte & Touche LLP Boston, Massachusetts November 10, 2000 INTERSPEED, INC. BALANCE SHEETS (in thousands, except share data) AS OF SEPTEMBER 30, ------------------------ 2000 1999 ------------------------ Assets Current assets: Cash................................................ $ 612 $ 21,227 Accounts receivable (less allowances of $497 and $49 in 2000 and 1999, respectively)........... 555 808 Inventory........................................... 5,058 2,445 Inventory consigned to others....................... 4,505 -- Prepaid expenses and other.......................... 83 168 ---------- ----------- Total current assets................................ 10,813 24,648 Property and equipment, net......................... 2,078 1,178 Other assets........................................ -- 54 ---------- ----------- Total assets........................................ $ 12,891 $ 25,880 ========== =========== Liabilities and Stockholders' Equity Current Liabilities: Accounts payable.................................... $ 6,146 $ 2,789 Accrued expenses.................................... 2,017 662 Short-term note payable - due Brooktrout............ -- 129 Deferred revenue.................................... 72 26 ---------- ----------- Total current liabilities........................... 8,235 3,606 Deferred rent....................................... 174 104 Commitments and contingencies (Notes 1, 5, 12 and 13) Stockholders' equity: Preferred Stock, $0.01 par value per share; 1,000,000 shares authorized, no shares issued or outstanding............................. -- -- Common stock, $.01 par value, 30,000,000 shares authorized, 10,998,926 and 10,702,658 shares issued and outstanding in 2000 and 1999, respectively ........................... 110 107 Additional paid-in capital.......................... 42,256 41,995 Accumulated deficit................................. (36,266) (15,825) Deferred compensation............................... (1,618) (4,107) --------- ---------- Total stockholders' equity.......................... 4,482 22,170 ---------- ----------- Total liabilities and stockholders' equity.......... $ 12,891 $ 25,880 ========== =========== See notes to financial statements. INTERSPEED, INC. STATEMENTS OF OPERATIONS (in thousands, except per share data) YEAR ENDED SEPTEMBER 30, ------------------------------ 2000 1999 1998 ------------------------------ Revenue before sales discounts - warrants.. $ 6,419 $ 1,978 $ -- Sales discounts-warrants................... (99) -- -- ------------------------------ Net revenue................................ 6,320 1,978 -- Cost of revenue (1)........................ 7,183 1,365 -- ------------------------------ Gross profit (loss)........................ (863) 613 -- ------------------------------ Operating expenses: Research and development (1)............... 7,491 5,329 3,204 Sales and marketing (1).................... 7,530 1,673 401 General and administrative (1)............. 3,023 1,738 689 Stock compensation and warrant charges..... 2,085 2,345 19 ------------------------------ Total operating expenses................... 20,129 11,085 4,313 ------------------------------ Loss from operations....................... (20,992) (10,472) (4,313) Interest income............................ 551 3 -- ------------------------------ Loss before income taxes................... (20,441) (10,469) (4,313) Income tax expense......................... -- -- -- ------------------------------ Net loss................................... $(20,441) $(10,469) $(4,313) ============================== Net loss per share-basic and diluted....... $ (1.89) $ (1.29) $ (0.54) ============================== Shares used to compute net loss per share-basic and diluted.................. 10,838 8,141 8,000 ============================== (1) Excludes non-cash amortization of stock-based compensation and warrant charges as follows: Cost of revenue...................... $ 36 $ 24 $ 3 Research and development............. 213 184 14 Sales and marketing.................. 953 80 2 General and administrative........... 883 2,057 -- ------------------------------ Totals............................ $ 2,085 $ 2,345 $ 19 ============================== See notes to financial statements. INTERSPEED, INC. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (in thousands)

See notes to financial statements INTERSPEED, INC. STATEMENTS OF CASH FLOWS (in thousands)

See notes to financial statements. INTERSPEED, INC. NOTES TO FINANCIAL STATEMENTS 1. NATURE OF THE BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF THE BUSINESS Interspeed, Inc. (the "Company" or "Interspeed") was founded in October 1996 and began operations in March 1997. At September 30, 2000, the Company is a 55% owned subsidiary of Brooktrout, Inc. ("Brooktrout"). The Company designs, develops, and markets advanced high-speed data communications solutions based on digital subscriber line, or DSL, technology. The Company's products enable data communication service providers such as competitive local exchange carriers, Internet service providers, and owners of multi-tenant units ("MTUs") to deliver high speed data access solutions to their customers utilizing existing copper wire infrastructure. BASIS OF PRESENTATION The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during the years ended September 30, 2000, 1999 and 1998, the Company incurred net losses of $20,441,000, $10,469,000, and $4,313,000, respectively, and used cash for operating activities of $19,155,000, $5,506,000 and $4,352,000, respectively. At September 30, 2000, the Company's cash balance was $612,000. The Company has non-cancelable inventory purchase commitments for raw materials and finished goods with its principal contract manufacturer, which at September 30, 2000, totaled approximately $2.8 million. The Company expects that it will be required to purchase this inventory during the first six months of fiscal 2001. Also, as discussed in Note 13, certain class action complaints have been filed against the Company and certain other parties, including certain former officers and directors of the Company. These factors, among others, may indicate that the Company will be unable to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded assets amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain recurring profitability from operations. Management is continuing its efforts to obtain additional funds and reduce cash outflows by, among other things, reducing headcount and curtailing certain marketing activities. Subsequent to September 30, 2000, the Company's majority stockholder, Brooktrout, agreed to provide the Company with a revolving line of credit under which the Company may request advances up to $2.5 million. Advances under this line of credit are at Brooktrout's sole discretion. The Company has engaged Broadview International LLC to assist with the review of strategic alternatives, including a possible sale of the Company. The Company is actively considering all of the strategic alternatives, including a sale or merger of the Company, sales of certain of the assets, or a potential restructuring, recapitalization or bankruptcy reorganization of the Company. At this time, however, management cannot predict the success of any of these alternatives. If the Company is unable to complete a strategic transaction, secure additional sources of financing, or achieve positive cash flow from operations, the Company may be required to significantly curtail operations or cease doing business. Prior to fiscal 2000, the Company's operating expenses included allocations of general corporate overhead expenses related to Brooktrout's corporate headquarters and common support activities, including payroll administration, workers' compensation and general liability insurance, accounting and finance, legal, tax and human resources. These costs amounted to $668,000 and $1,077,800 for the years ended September 30, 1999 and 1998, respectively, and were allocated to the Company using methodologies primarily based on headcount and usage. Although the Company believes the allocations were reasonable, the costs of these services to the Company may not have been indicative of the costs that would have been incurred if Interspeed had been a stand-alone entity. The Company entered into a Transition Services Agreement with Brooktrout, pursuant to which Brooktrout continued to provide certain services to the Company during a transition period that ended December 31, 1999. See Note 11. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. REVENUE Revenue from product sales is recognized when the product has been shipped, the customer's obligation is fixed and collectibility is considered probable. No revenue is recognized on products shipped on a trial basis or on products shipped under consignment type arrangements. Products generally carry a one-year warranty from the date of purchase. Estimated sales returns and warranty costs are recorded at the time product revenue is recognized. Customers may contract for support services over and above that provided by the warranty policy. Revenue from such contracts and from extended warranty contracts is recognized ratably over the service period. Revenue on beta units is not recognized until beta testing is complete and all other requirements for revenue recognition are met. INVENTORY AND INVENTORY CONSIGNED TO OTHERS Inventory and inventory consigned to others is stated at the lower of cost (first-in, first-out basis) or market. ADVERTISING EXPENSES The Company expenses advertising costs in the period in which they are incurred. Advertising cost for the years ended September 30, 2000, 1999 and 1998 was $802,000, $89,000 and $2,000, respectively. PROPERTY AND EQUIPMENT Property and equipment is carried at cost and depreciation is provided over the estimated useful lives of the related assets using the straight-line basis. Leasehold improvements are depreciated over the lesser of the lease term or the estimated useful life of the improvement. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. RESEARCH AND DEVELOPMENT Research and development costs, other than software development costs, are expensed as incurred. Software development costs are capitalized following attainment of technological feasibility. To date, no development costs that qualify for capitalization have been incurred. INCOME TAX EXPENSE Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established to reduce deferred tax assets to the amounts that are expected to be realized. Through the completion of the initial public offering on September 24, 1999 (the "offering"), the Company was included in the consolidated tax returns of Brooktrout and Brooktrout has realized or will realize the tax benefits associated with the Company's operating losses through that date. 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 804,236, 1,099,343 and 1,126,385 for the years ended September 30, 2000, 1999 and 1998, respectively. STOCK-BASED COMPENSATION Compensation expense associated with awards of stock options to employees is measured using the intrinsic value method described in Accounting Principles Board Opinion No. 25. WARRANTS Warrants granted to customers are accounted for in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" and Emerging Issues Task Force Consensus 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 fair value of the options is determined using the Black-Scholes model. CASH FLOWS There were no cash payments of interest or taxes for any of the years presented. COMPREHENSIVE INCOME There was no difference between the Company's net loss and its total comprehensive loss for any of the years presented and there was no accumulated other comprehensive income (loss). 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 RISK The Company performs ongoing credit evaluations of its customers and generally requires no collateral. At September 30, 2000, 95% of the receivable balance was comprised of balances due from three customers. 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. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments, including cash, accounts receivable and accounts payable, are carried at cost, which approximates their fair value because of the short-term nature of these instruments. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") released Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133, as amended, establishes new standards for accounting and reporting for derivative instruments and hedging activities and will be effective for the Company in fiscal year 2001. Management has evaluated the effect of adopting SFAS No. 133 on the financial statements and does not believe that the adoption will be material to the financial statements. In December 1999, the Securities and Exchange Commission (the "SEC") released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." It has subsequently issued implementation guidance in the form of a "Frequently Asked Questions" (FAQ) document. SAB No. 101 and the FAQ summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB No. 101 will be effective for the Company in the fourth quarter of fiscal 2001 and will be applied retroactively to the first quarter of fiscal 2001. Management does not believe that the adoption of SAB No. 101 will be material to the financial statements. 2. INVENTORY Inventory consisted of the following (in thousands): SEPTEMBER 30, ------------------------ 2000 1999 ------------------------ Raw material....................... $ 2,201 $ 1,622 Work in process.................... 117 5 Finished goods..................... 2,740 818 ---------------------------- Total.............................. $ 5,058 $ 2,445 ============================ Inventory consigned to others...... $ 4,505 $ -- ============================ During the fourth quarter of fiscal 2000, the Company recorded a provision of $2 million for excess and obsolete inventory. In addition, the Company recorded a provision of $1 million for expected losses related to a noncancelable purchase commitment for additional inventory (see Notes 4 and 5). The Company believes that these provisions reduce the inventory to its net realizable value and provide for losses on outstanding inventory purchase commitments; however, there can be no assurance that additional provisions will not be necessary if the Company's sales plans are not achieved. 3. PROPERTY AND EQUIPMENT Property and equipment consisted of the following (in thousands): SEPTEMBER 30, ESTIMATED ------------------ USEFUL LIFE 2000 1999 -------------------------------- Office equipment.................. 5 years $ 638 $ 342 Computers and software............ 3 years 1,544 786 Test equipment.................... 5 years 992 513 Leasehold improvements............ up to 5 years 238 114 --------------------- Total............................. 3,412 1,755 Less accumulated depreciation..... 1,334 577 --------------------- Total............................. $ 2,078 $ 1,178 ===================== 4. ACCRUED EXPENSES Accrued expenses consisted of the following (in thousands): SEPTEMBER 30, -------------------- 2000 1999 -------------------- Compensation.......................... $ 346 $ 580 Estimated loss on purchase commitment (Notes 2 and 5).......... 1,000 -- Other................................. 1,671 82 -------------------- Total................................. $ 2,017 $ 662 ==================== 5. COMMITMENTS The Company has non-cancelable operating leases for office, manufacturing and warehouse space which expire in March 2004. Minimum future lease payments under all non-cancelable operating leases at September 30, 2000 are as follows (in thousands): Fiscal Year: 2001......................................... $ 495 2002......................................... 519 2003......................................... 544 2004......................................... 235 2005 and thereafter.......................... -- -------- $ 1,793 ======== Rent expense for the years ended September 30, 2000, 1999 and 1998 was $656,000, $360,000 and $80,000, respectively. The Company has non-cancelable inventory purchase commitments for raw materials and finished goods with its principal contract manufacturer, which at September 30, 2000, totaled approximately $2.8 million. The Company expects that it will be required to purchase this inventory during the first six months of fiscal 2001 (see Note 2). 6. INCOME TAXES Through September 24, 1999, the Company was included in the consolidated tax returns of Brooktrout and Brooktrout has realized or will realize the tax benefits associated with the Company's operating losses through that date. Accordingly, the Company does not have available any net operating loss carryforwards nor has it recognized any tax benefits afforded Brooktrout by these net operating losses. Subsequent to September 24, 1999, the Company is no longer included in the consolidated return of Brooktrout and any taxes due will be the responsibility of the Company and any benefits associated with losses will inure to the Company. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets at September 30, 2000 are as follows: 2000 ----------- Net operating loss carryforwards................... $ 5,505 State net operating loss carryforwards............. 1,523 Research and other tax credit carrforwards......... 314 Accrued expenses................................... 624 Warrant expenses not currently deductible.......... 422 Reserves not currently deductible.................. 1,129 ------- Total......................................... 9,517 Less valuation allowance........................... (9,517) ------- Deferred tax assets, net...................... $ -- ======= A reconciliation of the U.S federal statutory rate to the effective tax rate is as follows:

Management of the Company has evaluated the positive and negative evidence affecting the realizability of its deferred taxes. Based on the weight of the available evidence, it is more likely than not that all of the deferred tax assets will not be realized, and accordingly, the deferred tax assets have been fully reserved. Management re-evaluates the positive and negative evidence on a quarterly basis. At September 30, 2000, the Company has federal net operating loss carryforwards of approximately $15,900,000, which expire in 2014, and federal research and development credit carryforwards of approximately $200,000, which expire in 2014. At September 30, 2000, the Company also has available state net operating loss carryforwards of approximately $15,860,000, which begin to expire in 2005, and state research and development and investment tax credit carrforwards of approximately $140,000, which expire in 2005. Of the total net operating loss carryforwards, approximately $1,400,000 is attributable to the exercise of stock options and the tax benefit from these items will be credited to additional paid-in capital, if realized 7. STOCK OPTION PLANS In April 1997, the Company's Board of Directors adopted and the stockholders approved the 1997 Stock Option Plan (the "1997 Stock Plan"), under which the Company may grant both incentive stock options and non-qualified options to employees. The 1997 Stock Plan allows for the granting of options to purchase up to 1,988,000 shares of common stock. The stock options are generally granted with vesting periods of five years and have an expiration date of ten years from the date of grant. At September 30, 2000, 972,179 shares had been exercised, and 695,637 shares are outstanding. 7. STOCK OPTIONS PLANS (continued) In June 1999, the Company adopted, and the stockholders approved, the Interspeed 1999 Stock Option and Grant Plan (the "1999 Stock Plan"), under which the Company may grant both incentive stock options and nonstatutory stock options to employees, consultants and directors. Options issued under the 1999 Stock Plan can have an exercise price of not less than 85% of the fair market value, as defined under the 1999 Stock Plan, of the stock at the date of grant. The 1999 Stock Plan provides for the issuance of up to 1,012,868 shares of the Company's common stock. At September 30, 2000, 686,846 shares have been granted, of which 12,765 shares had been exercised, and 326,022 shares were available for future grant. In May 2000, the Company's Board of Directors adopted and approved the Interspeed 2000 Non-Qualified Stock Option and Grant Plan (the "2000 Stock Plan"), under which the Company may grant non-statutory stock options to non-officer employees. Options issued under the 2000 Stock Plan can have an exercise price of not less than the fair market value, as defined under the 2000 Stock Plan, of the stock at the date of grant. The 2000 Stock Plan provides for the issuance of up to 500,000 shares of the Company's common stock. At September 30, 2000, 100 shares had been exercised, 230,633 shares have been granted and are outstanding, and 269,267 shares were available for future grant. Prior to fiscal 2000, certain options were granted with exercise prices which were less than the estimated fair value of the Company's common stock at the date of grant. Compensation cost associated with these options, determined as the difference between the fair value of the stock and the exercise price, totaled $6.5 million. This cost was recorded as deferred compensation and is being charged to expense over the vesting period. Compensation expense was $1,236,000, $2,345,000 and $19,000 for the years ended September 30, 2000, 1999 and 1998, respectively. During fiscal 2000, the deferred compensation balance was reduced by $1,253,000 to reflect the unearned compensation on stock options that were forfeited during fiscal year 2000. Compensation cost for the year ended September 30, 1999 included $548,000 related to grants to two directors that were 100% vested on the date of grant and $1,186,000 related to a grant to the Company's former president that vested 40% of the shares on June 18, 1999 upon the initial filing of a registration statement with the Securities and Exchange Commission. The unvested options under this grant were canceled in October 2000 upon the resignation of the former president. Activity under the 1997 Stock Plan, 1999 Stock Plan and 2000 Stock Plan is summarized as follows: WEIGHTED AVERAGE NUMBER OF EXERCISE SHARES PRICE --------------------------- Outstanding at September 30, 1997.......... 962,400 $ 0.13 Granted.................................... 381,600 $ 0.13 Exercised.................................. -- -- Forfeited.................................. (52,000) $ 0.13 ---------- Outstanding at September 30, 1998.......... 1,292,000 $ 0.13 Granted.................................... 946,000 $ 2.57 Exercised.................................. (702,658) $ 0.34 Forfeited.................................. (70,135) $ .13 ---------- Outstanding at September 30, 1999.......... 1,465,207 $ 1.60 Granted.................................... 858,170 $17.28 Exercised.................................. (282,386) $ 0.65 Forfeited.................................. (440,640) $ 5.26 ---------- Outstanding at September 30, 2000.......... 1,600,351 $ 9.17 ========= 7. STOCK OPTION PLANS (continued) The following table sets forth information regarding stock options outstanding at September 30, 2000: WEIGHTED WEIGHTED RANGE OF AVERAGE AVERAGE EXERCISE NUMBER EXERCISE REMAINING NUMBER PRICES OF SHARES PRICE LIFE (YEARS) EXERCISABLE --------- ------------------------------------------------ $0.13..................... 618,503 $ 0.13 7.40 109,882 $0.67 - $2.50............. 77,134 $ 1.21 8.60 36,234 $9.35 - $ 12.88........... 464,825 $ 11.07 9.31 88,181 $13.25 - $33.00........... 439,889 $ 21.27 9.28 57,736 ---------- -------- 1,600,351 292,033 ========= ======= The following information concerning the Company's stock option plan is provided in accordance with SFAS 123. The fair value of each option grant has been estimated on the date of grant using the Black-Scholes option pricing model. Weighted average assumptions used in determining the fair value of grants for the years ended September 30, 2000, 1999 and 1998 include risk-free interest rates of 5.9%, 4.75% and 5.5%, respectively, expected volatility of underlying stock of 138%, 89% and 0%, respectively and an expected life of 5 years. Dividend yields are not considered in the minimum value calculation. The weighted average fair value of options granted for the years ended September 30, 2000, 1999 and 1998 was $15.53, $6.38 and $1.20 per share, respectively. Had compensation expense for stock options been determined based on fair value at the grant date in accordance with the provisions of SFAS No. 123, pro forma net loss and pro forma net loss per share would have been as follows (in thousands except per share data): FOR THE YEAR ENDED SEPTEMBER 30, 2000 1999 1998 --------------------------------------------- Pro forma net loss............... $(22,749) $(10,484) $ (4,340) Pro forma net loss per share-basic and diluted........ $ (2.10) $ (1.29) $ (0.54) 8. EMPLOYEE STOCK PURCHASE PLAN The Company has an Employee Stock Purchase Plan (the "ESPP"), under which all eligible employees are entitled, through payroll deductions of amounts up to 10% of their total compensation, to purchase shares of the Company's common stock at 85% of the lesser of the market price at the offering commencement date or the offering termination date. The ESPP provides that up to 200,000 shares are available for purchase. At September 30, 2000, 13,882 shares had been purchased under the ESPP. 9. RETIREMENT PLANS The Company has a 401(k) retirement plan available to qualified employees. Employees are allowed to contribute up to 18% of their salary to the plan. The Company, at its discretion, matches contributions equal to $.25 per dollar contributed up to a maximum of 6% of a participant's salary. The Company contributed $0, $53,000 and $18,000 to the plan for the years ended September 30, 2000, 1999 and 1998, respectively. 10. SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION For the years ended September 30, 2000 and 1999, sales to United States customers amounted to $5,927,000 and $1,873,000, and export sales amounted to $492,000 and $105,000, respectively. One customer accounted for 61% and 75% of revenue for the years ended September 30, 2000 and 1999, respectively. Two customers accounted for 13% and 16%, respectively, of revenue for the year ended September 30, 2000, and another customer accounted for 15% of revenue for the year ended September 30, 1999. At September 30, 2000 and 1999, the Company had no significant long-lived assets located outside of the United States. 11. RELATED PARTY TRANSACTIONS The following is an analysis of the intercompany accounts with Brooktrout: YEARS ENDED SEPTEMBER 30, --------------------------------- 2000 1999 1998 --------------------------------- Beginning balance...................... $ (129) $ (5,038) $ (206) Expenses allocated from Brooktrout..... (43) (1,078) (668) Cash transfers......................... 172 (6,582) (3,775) Expenses paid by Brooktrout on behalf of the Company....................... -- (1,020) (389) Capital contribution................... -- 13,589 -- ---------------------------------- Ending balance......................... $ -- $ (129) $ (5,038) ================================== At the time of the offering, the Company and Brooktrout entered into a Transition Services Agreement (the "Agreement"). The Agreement outlined certain services that would be performed on behalf of the Company by Brooktrout through December 31, 1999. The Agreement called for these services to be phased out over the period from October 1, 1999 through December 31, 1999. The services called for in the Agreement 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 months ended December 31, 1999, fees for such services totaled $43,000. 12. WARRANTS During fiscal year 2000, in consideration for entering into certain long-term reseller agreements, the Company granted to the customers fully 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, $849,000, has been charged to expense as a component of stock compensation and warrant charges in the statement of operations. The Company 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. The value of the warrants is being adjusted at the end of each quarter 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. At September 30, 2000, none of the revenue milestones had been achieved and accordingly, none of the warrants had vested. 13. CONTINGENCIES Shareholder class action suits have been filed against the Company, which if determined or settled in a manner adverse to the Company could adversely affect the Company. The shareholder class action suits, all of which are pending in the United States District Court for the District of Massachusetts, each arise out of the same alleged conduct and pertain to disclosures made by the Company in a press release dated October 6, 2000. Each of the actions alleges that the defendants, which include Interspeed, the former President and Chief Financial Officer, as well as two former Vice Presidents, violated Section 10(b) of the Securities Exchange Act of 1934, or the 1934 Act, in connection with the historical recognition of revenues. In addition, each complaint alleges that the individual defendants are controlling persons of the Company under Section 20(a) of the 1934 Act, and as such caused the Company to engage in conduct which purportedly violated Section 10(b) of the 1934 Act. The plaintiffs seek damages in an undisclosed amount. The Company is currently reviewing the allegations in these lawsuits. The defense of these lawsuits could involve significant litigation-related expenses. In the event that any of the claims set forth in the class action complaints are determined or settled in a manner adverse to the Company, then such determinations or settlements could adversely affect financial position, results of operations or the ability of the Company to continue as a going concern. The outcome of these lawsuits cannot presently be determined. Accordingly, no provision for any loss that might result therefrom has been made in the accompanying financial statements. 14. QUARTERLY INFORMATION (UNAUDITED) The following table shows selected results of operations for each of the quarters during the years ended September 30, 2000 and 1999. During the fourth quarter, the Company recorded a provision of $2 million for excess and obsolete inventory and a provision of $1 million for expected losses related to a noncancelable purchase commitment for additional inventory (see Notes 2, 4 and 5).

Schedule II INTERSPEED, INC. Valuation and Qualifying Accounts For each of the three years in the period ended September 30, 2000 (in thousands)

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information called for by Item 10 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 2001 Annual Meeting. ITEM 11. EXECUTIVE COMPENSATION The information called for by Item 11 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 2001 Annual Meeting. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information called for by Item 12 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 2001 Annual Meeting. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for by Item 13 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 2001 Annual Meeting. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (1) Financial Statements The financial statements filed as part of the report are listed on the Index to Financial Statements on page 28. (2) Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts. (b) Reports on Form 8-K during the quarter ended September 30, 2000. The registrant filed the following Current Reports on Form 8-K during the quarter ended Sept 30, 2000: 1. On July 28, 2000, the Company filed a Current Report on Form 8-K, disclosing its results of operations for the quarter ended June 30, 2000. (c) Exhibits: (3) Articles of Incorporation and By-Laws: 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 ("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 1999 10-K. (10) Material Contracts 10.1 1997 Stock Option Plan incorporated herein by reference to Exhibit 10.1 to Amendment No. 3 to the Company's Registration Statement on Form S-1, Registration No. 333-81071, filed with the Securities and Exchange Commission on August 23, 1999 ("Amendment No. 3 to the Form S-1") to the Form S-1. 10.2 First Amendment to Interspeed, Inc. 1997 Stock Option Plan incorporated herein by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-8, Registration No. 333-91809, filed with the Securities and Exchange Commission on November 30, 1999. 10.3 1999 Stock Option and Grant Plan incorporated herein by reference to Exhibit 10.2 to Amendment No. 3 to the Form S-1. 10.4 Employee Stock Purchase Plan incorporated herein by reference to Exhibit 10.3 to Amendment No. 3 to the Form S-1. 10.5 2000 Stock Option and Grant Plan for Non-Officer Employees incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8, Registration No. 333-44408, filed with the Securities and Exchange Commission on August 24, 2000. 10.6 Transition Services Agreement, dated as of September 23, 1999, by and between Interspeed and Brooktrout, Inc. incorporated herein by reference to Exhibit 10.4 to Amendment No. 3 to the Form S-1. 10.7 Authorized Reseller Agreement, dated as of May 21, 1999, by and between Interspeed and Cabletron Systems, Inc. incorporated herein by reference to Exhibit 10.5 to Amendment No.3 to the Form S-1. 10.8 Stockholder Rights Agreement, dated as of August 9, 1999, by and between Interspeed and Brooktrout, Inc. incorporated herein by reference to Exhibit 10.6 to Amendment No. 3 to the Form S-1. 10.9 Capitalization Agreement, dated as of June 17, 1999, by and between Interspeed and Brooktrout, Inc. incorporated herein by reference to Exhibit 10.7 to Amendment No. 3 to the Form S-1. 10.10 Capitalization Agreement, dated July 23, 1999, by and between Interspeed and Brooktrout, Inc. incorporated herein by reference to Exhibit 10.8 to Amendment No. 3 to the Form S-1. 10.11 Product Reseller Agreement, dated January 26, 2000, by and between Interspeed and Cabletron Systems, Inc. is incorporated herein by reference to Exhibit 3.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000, Commission File No. 0-27401, filed with the Securities and Exchange Commission on May 15, 2000. (23) Consent of Deloitte & Touche LLP is filed herewith as Exhibit 23. (27) Financial Data Schedule is filed herewith as Exhibit 27. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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/ RAJEEV AGARWAL ------------------------------------- Rajeev Agarwal President & Chief Executive Officer Date: JANUARY 10, 2001 ----------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

INTERSPEED INC 10-K