By Debora Tidwell (TMF Debit)
UNION CITY, CA (May 9, 1997)/FOOLWIRE/ --- US Robotics released their second quarter 1997 earnings on April 23rd. This was their 23rd earnings announcement as a public company and probably also their last earnings announcement as an independent public company. They were pleased to report their 23rd consecutive quarter of record revenues and, excluding non-recurring items, their 23rd consecutive quarter of record earnings. They are all extremely proud of this performance. Once again this quarter they made great strides in all aspects of their business -- strong financial results, continued worldwide growth, and expansion of their technology portfolio.
REVENUES. Sales and net earnings levels reached new highs again this quarter. Net sales for the March quarter were $690.2 million, an increase of $44.8 million or 6.9% from the December quarter total of $645.4 million. Compared to the March quarter of last year, this is an increase of $235.7 million or 51.9%. Revenue growth for the March quarter was driven primarily by higher overall market demand for information access devices and the introduction of x2 products. They experienced increased end user demand for all of their major product categories.
X2 PRODUCTS DROVE REVENUE GROWTH. Increased revenues from the sales of their network system products and the higher average selling prices of Sportster desktop modems, following the introduction of x2 native products in the last month of the March quarter were the primary reasons for the increase in total revenues from the December quarter. Network system product revenues for the quarter were $177 million, approximately double the total from the March quarter of last year. They continue to see major investments in network expansion by their large ISP customers as well as growth in purchases of both their Total Control and Net Server products by smaller ISPs and enterprise customers. They expect the percentage of total revenues attributable to sales of network systems products to continue to increase over time, with quarter-to-quarter variability in the growth rate based on the ordering pattern of their major systems customers. PC-related product revenues totalled $513 million in the March quarter, up modestly from the December quarter.
REVENUES BY GEOGRAPHY. Domestic network system sales were $124 million in the March quarter. International network system sales, primarily in Europe, were $53 million in the March quarter, more than double the total in the March quarter last year. The international results are primarily a result of the continued investment they have made in recent quarters in building their European network systems sales force. They are particularly proud of the results of their international operations this quarter. International sales made up 33% of their total revenues for the March quarter and were $230 million, an increase of 81% over the levels of a year ago. As they previously stated, they expect their international operations to contribute up to half of their total sales within the next several years. International sales of their systems products were particularly strong at $53 million, driven by their successes in Europe. The investment they have been making in building their European sales force is paying off. These results are remarkable considering they only began making significant investments in their continental European sales force last Summer. This shows that when they have the appropriate sales force in place, their systems products are highly competitive in the marketplace. The markets for their network systems products throughout all of Europe and Eastern Asia are very strong. They are seeing in these markets a tremendous race for the creation of new ISPs and major POP additions by existing ISPs. Sell-through of their desktop modem products continues to increase in Europe. In their view, the overall European market for desktop modems is strong, driven by increasing availability of online service providers. As the best known modem brand in the world, they are benefitting from this growth.
UNIT SHIPMENTS. Total worldwide unit shipments of PC-related products into the distribution channel during the March quarter were down 2.4% from the December quarter. Total North American unit shipments of PC-related products into the distribution channel during the March quarter were down 8.1%. Average selling prices of PC-related products worldwide increased 7% during the March quarter. This increase was primarily related to the initial shipments of the x2 Sportster desktop modem in North America during March. Total unit sales-out of desktop and PC card products from the North American distribution channel in the March quarter were up from the December quarter. The information from distribution partners outside North America is not as complete, however they believe the trend in the rest of the world was consistent with the increased end user demand they experienced in North America.
X2 MODEM SALES. Since they became available at retail the last week of February, sales out of x2 native Sportster desktop modems, as a percentage of their total North American desktop modem sales out of the retail distribution channel have steadily increased. Currently, approximately 20% of total Sportster weekly sales out are x2 native units. They expect the sales out mix to continue to shift to x2 native products over time, with continued strong sales of x2 upgradeable units through the remainder of 1997 and into 1998. They expect the crossover point for x2 native units to become the majority of sales out to occur faster than it took for v.34 unit sales to overtake v.32bis unit sales in the same period. Total North American channel inventories of Sportster desktop modems, excluding the newly introduced x2 native products were down 18% from the end of the December quarter.
GROSS MARGINS. Gross margins for the March quarter were 49.1%, up from the 42.8% reported for the December quarter. The increase was primarily due to higher margin on the initial shipments of native x2 desktop modem products as well as a greater percentage of the total revenues for the quarter being derived from the sale of network systems products than was the case in the December quarter. They are currently benefitting from being first to market with their x2 products. They believe margins will return to the levels of recent quarters over time as competitors develop and introduce viable product offerings in this category. They expect to remain agressive in the pricing of all of their products as they seek to expand market share. They will continue to reduce the cost of their products through design and engineering improvements and increases in manufacturing efficiency.
OPERATING EXPENSES. Total operating expenses for the March quarter were $220 million, or 31.9% of net sales. This compares to total operating expenses of $165 million or 25.6% of net sales for the December quarter. The largest component of operating expenses was selling and marketing expenses. These expenses were $134 million or 19.4% of net sales for the March quarter compared to $100.8 million or 15.6% of net sales for the December quarter. The increase in these expenses in absolute dollars as a percentage of net sales in part reflects the cost associated with two major initiatives -- the introduction of x2 products and continuing investments to build the company's sales force and expand market share.
SALES & MARKETING EXPENSES. The costs associated with the advertising programs for the x2 launch and other sales, marketing, and promotional programs tied to x2 products are included in the March quarter totals. USR increased the worldwide sales force by more than 6% again this quarter on top of the 25% increase during the previous two quarters in order to take advantage of the opportunities that exist for their products, particularly in the international markets. The majority of this quarter's sales and marketing personnel additions occurred in Europe and Asia. They have realized significant revenue benefits from the expanded international sales force during the March quarter as evidenced by the increase in sales attributable to customers outside the US, both in absolute dollars and as a percentage of total sales. They expect to realize even greater returns on their sales force investment in future quarters.
GENERAL & ADMINISTRATIVE EXPENSES. General and administrative expenses were $41.6 million or 6% of sales compared to $30 million or 4.7% of net sales for the December quarter. Contributing to the increase were additions to the reserve for bad debts (of $2-3 million) to maintain reserve levels, higher personnel and facility related costs, and increased costs associated with outside services necessary to support the company's expanded level of business activity.
RESEARCH & DEVELOPMENT EXPENSES. R&D costs were $44.4 million or 6.5% of net sales compared to $34.2 million or 5.3% of net sales for the December quarter. The increase resulted mainly from additions to the company's engineering staff and related facility and support costs, and from other technology related costs. These costs are necessary to support USR's continuing commitment to new product and technology development. They intend to position themselves to take advantage of the huge opportunities they see in the markets they serve by accelerating their investments in new technologies such as x2, wireless, and broadband access including DSL and cable. They believe it is absolutely essential to the ongoing health of the company that they maintain a significant level of investment in research and development during fiscal year 1997 in order to agressively capitalize on the long-term growth opportunities in broadband and other technologies.
OTHER EXPENSES. Other expenses net for the quarter were $2 million compared to $1.3 million for the December quarter. The change was due primarily to the increased interest expense as a result of higher average short-term borrowing.
TAXES. The effective tax rate for the quarter was 21.8%, reflecting a non-recurring tax benefit of $17.9 million related to the acquisition of Scorpio Communications. Their September quarter results reflected a $54 million write off of in-process R&D with no corresponding tax benefit due to the uncertainty at that time regarding the benefit's realizability. The uncertainty was resolved by new income tax regulations which became effective this quarter and which permitted the company to make an election resulting in US tax deductions for the writeoff of in-process R&D and other intangible assets acquired in the Scorpio transaction. Excluding the impact of the non-recurring benefit, the effective income tax rate for the March quarter was 37.1%, unchanged from the December quarter.
EARNINGS. Net earnings excluding the impact of the non-recurring tax benefit were $73.5 million or $0.77 per share. This is a 7% increase over the $69 million or $0.72 per share reported for the December quarter and a 42% increase over the $51.6 million or $0.55 per share reported for the March quarter last year. Including the impact of the non-recurring tax benefit, net earnings for the March quarter were a record $91.5 million or $0.95 per share.
CASH. Cash and cash equivalents were $49.9 million at the end of the quarter, an increase of $31.2 million over the $18.7 million balance at the end of the December quarter. The company generated over $85 million in cash flow from operating activities during the quarter, excluding investments and working capital items.
ACCOUNTS RECEIVABLE. Accounts receivable net of allowances were $718.4 million at the end of the quarter compared to $631.2 million at the end of the December quarter. The increase in A/R was attributable to several factors including the overall growth in net sales sequentially, a higher percentage of international sales which tend to have longer collection periods, and a greater skewing of shipments to late in the quarter than was the case in the December quarter because of the x2 introduction. They indicated in last quarter's call that the shipping patterm for the March quarter would be heavily dependent on market acceptance and the deployment of their x2 products and that, as a result it might be back-end weighted. This proved to be the case. In fact, with shipments of x2 native client products and deployments by their network systems customers occurring primarily during the month of March. DSO increased during the qaurter to 95 from 89 days due to the factors just discussed. The average credit period extended to customers during the March quarter was shorter than in the December quarter. Accounts receivable balances are generally being collected in accordance with their terms. As a result they do not anticipate there will be any significant issues or problems related to collectability. Since the end of the quarter, the net receivable balance has declined over $75 million. As they noted in the previous conference calls, the back-end weighting of shipments during the last two quarters was expected stemming from the timing of the availability of x2 upgradeable products and x2 native products for shipment during those quarters. They expect to return to a more normal shipping pattern through the remainder of the year. Inventories were $155.8 million at the end of the March quarter compared to $152.2 million at the end of the December quarter. Inventory turns for the quarter were 9.1 times, up slightly from the prior quarter level of 8.7 times.
PROPERTY, PLANT & EQUIPMENT/CAPITAL EXPENSES. Net PP&E of $346.6 million at the end of the quarter reflected an increase of $34.9 million from the December quarter balance of $311.7 million. New capital expenditures during the quarter were $47 million, primarily for the purchase and continued development and outfitting of their Mt. Prospect Illinois manufacturing and engineering facility. They expect capital expenditures for the remainder of the year to decline significantly from the levels reqauired during the first half of fiscal 1997 to expand their manufacturing capacity and other facilities around the world.
LIABILITIES. Accounts payable and accrued liabilities totaled $372.2 million at the end of the quarter, up from $292.5 million at the end of the previous quarter. A portion of the increase relates to higher accruals for the marketing promotions and programs while the remainder reflects the company's expanded level of activity and timing differences related to normal trade allowances payable and routine accruals. Short term borrowings totalled $60.7 million at the end of the quarter compared to $50 million at the end of December. These additional borrowings were used to finance the investments in working capital and capital expenditures made during the quarter. Long-term obligations including current maturities were $67.4 million at the end of the quarter, essentially unchanged from the prior quarter.
3COM MERGER. They continue to be very excited about their pending merger with 3Com, which was announced on February 26th. They believe the combined company will be among the very strongest in the networking industry with leading positions in each of its core markets and an installed base of more customer connections to the Internet and corporate intranets than any other company. The combined company will be able to provide customers worldwide with comprehensive end-to-end LAN/WAN networking solutions, with superior product offerings at virtually all points of network connection and access. From the enterprise, LAN workgroup switching and routing system, to intelligent network interface devices on the desktop and on mobile and wireless platforms. Also, the combined company will be competitively positioned to provide the industry's best solutions from the edge of the network to the data center and from the edge of the network to telephone central offices -- both in current markets and in new and emerging markets. The strategic rationale for this transaction remains compelling. They believe today as they did in February that the technologies, product lines, and fundamental business and operational strategies of US Robotics and 3Com are complementary and consistent and that US Robotics and 3Com together can provide a great range of products and superior market coverage compared to any alternative combination and that a combination of the two companies provides a greater potential for enhanced shareholder value over time than any other course.
MERGER PLANNING UNDERWAY. Planning the operations of the merged companies is well underway and they expect to move ahead quickly with the integration of the business as soon as the merger is complete. On April 18th, they announced that the waiting period under the Hart-Scott-Rodino Anti-Trust Improvements Act expired on April 17th. The companies are therefore eligible under the act to complete the transaction pending receipt of stockholder approval and the completion of other customary conditions including SEC review of the proxy materials and certain foreign antitrust reviews. They expect the transaction to be completed in June. For further information regarding the merger with 3Com they refer people to the preliminary joint prospectus and proxy statement available on the US Robotics and 3Com websites as well as the SEC's EDGAR website.
X2 PRODUCTS LAUNCHED. Without question, the company's x2 technology continues to be their biggest product news of the 1997 fiscal year. x2 is a key breakthrough in modem technology that provides Internet and online connections for downloading information at speeds nearly twice as fast as those currently available over regular telephone lines. x2 increases the top speed of a standard modem for downloading data from 28,800 bits per second or 33,600 bits per second to over 50,000 bits per second, which is comparable to many ISDN connections without the need for expensive new central office equipment required by other high speed technologies.
X2 DEPLOYMENT SO FAR. US Robotics is uniquely positioned to deliver and capitalize on breakthroughs like x2. They are able to do this because, in contrast to many of their competitors, they control the underlying core technology in their products. Because of their flexible software based modem architecture, they have the capability to deliver, via software upgrade, the x2 technology to every digital Total Control chassis ever shipped. They have well over one million Total Control ports in their installed base and added approximately 300,000 ports this quarter. x2 is being rapidly rolled out by their systems customers who are making this new high-speed analog service quickly available to their customers areound the world. Over 500 ISPs have announced they are deploying x2 technology in their networks. Over 200 ISPs including some of the nation's largest have already deployed x2 service. There are over 1300 POPs using x2 technology today with local dial-up service available in nearly 700 cities in North America. Netcom announced this week availability of x2 service in 37 US cities, expanding to 55 within the next two weeks. IBM Global Networks is scheduled to introduce x2 service throughout their entire network of more than 550 POPs in May.
FAST X2 ROLLOUT EXPECTED TO CONTINUE. They expect rollouts of x2 service to continue throughout the coming months. They also expect initial rollout of x2 service in Europe and Asia to occur during May. ISPs around the world with over 18 million subscribers have announced they will deploy x2 technology in their networks. US Robotics believes that the widespread adoption of 56K modem technology, both by service providers and end users, will occur faster than any previous analog modem speed change.
X2 SOLVES SPEED PROBLEMS. They base their view on the fact that the number one problem facing Internet users today is the length of time required to download information. Moreover, user satisfaction is a central issue for service providers to keep and grow their subscriber base. US Robotics is already seeing this. x2 is helping their service provider customers grow their businesses. Mindspring, WebAmerica, and JavaNet, to name a few, are all aggressively promoting x2 and winning new subscribers.
WILL EXPLOIT X2 TIME-TO-MARKET ADVANTAGE. While every US Robotics Sportster modem they have shipped since mid-August is x2 upgradeable, they have only been shipping native x2 units since the end of February. Even with the limited period of time x2-native Sportsters have been available at retail, they have quickly grown to roughly 20% of US Robotics' total North American retail sellout. x2-native Sportster sales have clearly been additive. Their unit sellout at retail has continued to increase for the upgradeable units despite the introduction of the x2-native product. They clearly have a significant time-to-market advantage. They will continue to aggressively exploit this advantage with engineering, sales, and marketing efforts. Their best engineering resources are dedicated to this project.
X2 SOFTWARE. They continue to refine the software that is at the heart of both their client and central site products because both are upgradeable. As software code is refined, they can easily make improvements available to their customer. The result is that they are able to continually improve the speeds at which actual connections are being made. Based on information from their major ISP customers, the majority of x2 downloads are being made at speeds in excess of 40K. For example, Mindspring reported, based on a survey of their x2 calls between March 24th and April 2nd that 82% of the downloads occurred at speeds above 40K and 54% of downloads occurred at speeds above 45K. They fully expect their ISP and online service provider customers to continue the rollout of x2 services quickly as they are able to fully test x2 within their networks. However, their deployment schedules are outside of US Robotics' control. They mentioned this because their future results will be impacted by the speed of x2 adoption on the client and central site sides. However, all the early indications point to a rapid rollout of x2 service by ISPs and a rapid adoption of x2 technology by consumers. x2 is helping them win new customers. In the ISP marketplace, the providers who are first to market with 56K service will win the war for subscribers. x2 has been an important factor in winning millions of dollars of new network systems products business since it has been introduced. This is a business where they have displaced the incumbent vendor and won the business in open competition. Examples include ISPs like Mindspring, Earthlink, The Grid, ExecPC and many more.
X2 STANDARDS. There have also been some developments since the last conference call on the 56K standards front. The members of the International Telecommunication Union, Telecommunications Standardization Section, commonly referred to as the ITUT, working on this issue have accelerated their projected schedule for establishing a worldwide standard for 56K technology. ITU develops communications standards worldwide. Study Group 16 of the ITUT is developing the worldwide standard for PCM host code modulation modems, more commonly known as 56K modems. PCM codes used in the digital portion of the phone network are used by all of the proposed 56K modem technologies. Based on the ITUT's more aggressive meeting schedule, a draft PCM modem recommendation currently dubbed v.PCM is expected this September. A final recommendation could be approved as early as January 1998. The decision to accelerate the process was finalized at a recent ITU meeting in response to the need for a single standard for 56K modems that could be implemented worldwide. The ITU and TIA previously had been developing independent standards for PCM modems and have now joined their efforts towards the development of a single ITUT recommendation. The appropriate members of these two organizations plan to meet at the same time and location going forward. US Robotics believes the establishment of a standard will help the market for these products grow more rapidly and that US Robotics will be a prime beneficiary of such growth.
X2 MARKETING AND PROMOTIONS. They have been generating awareness and interest in x2 technology via the press and advertising since October. Their TV and print ad campaign is successfully positioning the US Robotics brand as the world leader in modem technology. The advertising elevates the importance of the category and highlights the benefits of x2. This is a very visible strategic maneuver designed to exploit their time to market advantage and solidifies their position as the most preferred, most trusted modem brand in the world. They are first, they are the world leader in access products, and they intend to drive demand for their products with this advertising including aggressive online advertising and promotion campaigns. Additionally, they have put together innovative joint marketing programs with their ISP customers to leverage their installed base and are capitalizing on their unique retail channel strengths. They recently trained over 11,000 in-store sales reps in the US and Canada on the benefits of x2 products. Through much of the March quarter, x2 technology has been up and running in some of the world's larges Internet access networks. During this period of time, their competitors are still talking about standards and continuing to revise the schedules for availability of their products, both client and central site.
MARKETSHARE. They remain committed to increasing their marketshare positions. As recently reported by IDC, the US Robotics worldwide marketshare of desktop and PC card modems has grown from 25% in 1995 to 40% in 1996. With technology breakthroughs like x2, they continue to make progress in building share in the modem market. A VisionQuest study of the North American retail desktop modem market shows that the US Robotics share increased to 46% in March of 1997, up 6% fromt he share they had in their last conference call.
PALMPILOT ORGANIZER. Their PalmPilot connected organizer was introduced in Europe during the December quarter and it appears it will be as successful in European markets as it has become in North America. In addition to the English version they have introduced French and German language versions of the product in Europe. Customizing the product for local markets is key to broadening consumer demand for products like the PalmPilot. They expect even stronger results in Europe as they go forward. While they have made great strides, they need to do more to capitalize on the huge opportunities that exist for their products in other parts of the world, most notably in Asia and Latin America -- areas in which 3Com has great strength.
PALMPILOT SALES CONTINUE TO GROW. Sales of their PalmPilot products continue to grow. Without question, this has been the most successful product ever introduced in this category. PC Data reports that PalmPilot has a 70% marketshare of current North American retail sales for handheld PCs and PDAs. The next closest competitor has approximately a 10% share. Near the end of the March quarter they began shipping the next generation of PalmPilot products. They have significantly enhanced the product by adding backlighting, email connectivity, and TCP/IP capability. They have introduced an add-on battery powered modem, the Co-pilot, that enables remote hot synch synchronization with the users desktop PC. They view the PalmPilot as being the handheld entry device to the network. The addition to these capabilities begins to make real the true future potential of this device. All the market evidence confirms their belief that the PalmPilot is an excellent implementation of a great product concept and that this category will become a major part of their business as it continues to grow. They believe it's unprecedented positive acceptance and publicity will benefit the brand imagery of their other US Robotics brands.
ISPs NEED SPEED, LOAD MANAGEMENT. In the ISP business they see several trends evolving that are impacting the way ISPs run their businesses. First, speed is critically important in differentiating the service they offer their customers. US Robotics is addressing that need with their x2 technology. Load management or the user-to-modem ratio is becoming an important issue primarily driven by the flat-rate pricing model. Eighteen months ago it was not unusual for dial-up network providers to operate with a user-to-modem-port ratio in excess of 20 to 1. They expect the prevalent ratio to be well below 10 to 1 by the end of the year. The result of this move is the growing demand for more ports by US Robotics customers, obviously great news for their systems business.
ISPs NEED TO CONTROL COSTS. At the same time ISPs are adding ports, they are coping with the need to reduce their cost of doing business. Historically US Robotics has addressed this issue by making sure that the future was built into their Total Control product. Software upgradeability is a prime example of the investment protection available to their customers. Their customers are moving to 56K technology with a simple software download -- no costly hardware needs to be replaced or added to offer this breakthrough service. Another way they are addressing the needs of their customers in this area is through their soon-to-be-released high-performance DSP technology and high-density remote access system. High performance DSP technology does two things. First it delivers, by far, the highest density solution in the industry and second it paves the way for integration of multimedia technologies into Total Control. To deliver this density breakthrough, they are for the first time simultaneously processing two analog calls with a single DSP. This allows them to support 336 analog calls in a single chassis, occupying only 9 inches of vertical rack space. To handle 28 T1 lines, an ISP needs only two high-density Total Control chassis and 18 inches of rack space. By way of comparison, to handle 28 T1 lines, an Ascend TNT requires 42 inches of rack space, 133% more. US Robotics expects these enhanced modem cards will be available early this Summer and can be used with existing Total Control chassis, thus continuing to preserve customers investment in their US Robotics equipment.
DSL AND CABLE MODEMS. They expect broadband access products will be a prime area of growth in 1998 and beyond. They gave an overview of current progress in their digital subscriber line or DSL unit and their cable access unit. There are switch congestion problems in the central offices that currently face the LECs and PTTs. The growth of data traffic and Internet usage have placed demands on the public telephone system it was never designed to handle. A potential solution for the problem is to divert Internet traffic around the central office switch. The technology to make this possible and to offer broadband access over the existing telephone distribution system is XDSL. The LECs and PTTs are initiating trials to examine how to cost-effectively deploy quality broadband remote access service offerings that generate new and profitable revenue growth. US Robotics demonstrated their first two products for DSL remote access solutions at the CeBIT fair in Hannover last month. The products, designed for telephone service providers, small business offices, and consumers provide high-speed affordable remote access to corporate LANs and the net over normal copper telephone lines. Their solution comprises equipment for both ends of the DSL connection. Telcos can now initiate trials with their release one product offerings for 30 users for as little as $30,000. This is 3-5 times prices advantage over their competition.
DSL GROWTH IN EUROPE. At the CeBIT trade show in Germany, they announced an alliance with the French systems integration giant CS Telcom as well as support for their approach by the Spanish PTT Telefonica. The CS Telcom alliance is particularly noteworthy in that it couples US Robotics' strength in DSL client products and remote access concentrators with CS Telcom's ATM and frame relay technology. The initial target market for their combined efforts will be Europe. They believe the market for DSL solutions will develop faster in Europe and the rest of the world than in North America. They are currently participating in four trials in the US and 5 in Europe. Request for delivery of available product for trial use is growing. Europeans appear particularly eager to adopt this technology. In contrast to the US which is dominated by the few regional telephone companies, Europe although fragmented has a number of primary and secondary service providers in each country and European PTTs have different business models and regulatory environments that seem to be conducive to new access business development programs.
DSL STRATEGY. Their initial product offerings are designed to support telecom service providers users trials while the market develops. They will use their manufacturing scale and engineering expertise to move aggressively to drive down costs and enhance the scalability of these products as the market grows. Their strategy in this market is quite simple, to help the telecom service provider realize new profitable revenue growth with a complete, affordable DSL solution.
DSL END-TO-END SOLUTION. They are designing their products to solve a business problem, not just deliver technology. The USR DSL system architecture is unique in this respect. What they offer is a complete end-to-end solution that is flexible, scalable, and most importantly, cost effective. The initial client product is an affordable RADSL to Ethernet router that supports multiple users on an Ethernet LAN. The product is housed in a familiar US Robotics compact desktop modem package and is powered by CAP modulation chipsets. By far, CAP is the predominant modulation scheme deployed today. It is affordable and important in the central office primarily because it uses significantly less power than DMT. Recently, Aware announced their licensing of DMT intellectual property to US Robotics. USR's target market customers demand support for both CAP and DMT and they will support both modulation schemes in their products. They plan to offer DMT support in the product beginning in 1998.
CPE PRODUCT SPECIFICS. The current CPE product works with a splitter, which they will also supply, to allow users to transfer data while using the same line for voice conversations simultaneously. Software for this product is upgradeable and is stored on a Flash ROM. Transfer speeds are 7 megabits downstream and 1 megabit upstream at 12,000 feet. The Central Office Solution includes two port-rate adaptable Excel card set for the Total Control chassis. When outfitted with the Excel card sets, the Total Control chassis becomes an RADSL access concentrator for the central office environment. The Ethernet lines are concentrated with their Total Switch product and interoperate with their Net Server products which provide a v.35 interface to the frame relay networks or with a third party router. USR also provides the network management capability that allows a system manager to configure and manage not only the central office equipment but also the end user's modem attached across the DSL. In coming months, USR plans to expand and enhance their product lines and further develop their channels through more key alliances. While there would not be meaningful revenues generated in this area until at least 1998, this is a natural market for them to pursue by leveraging their existing strengths, one they believe that has great potential.
CABLE MODEMS. Another market with significant potential that they intend to exploit is cable. To-date, one of the major roadblocks to the deployment of broadband Internet access across the exisitng cable TV infrastructure has been the capital investment required by the cable systems operator. What USR has done is provide the cable operator with a new business model for delivering data over cable quickly and cost effectively. Their new end-to-end cable access system is designed for rapid deployment as well as long-term flexibility for cable operators. The system initially utilizes a telco return architecture that is compatible with the cable operator's current network infrastructures. It also provides an easy, inexpensive pathway to two-way cable as operators upgrade their networks in the future. USR's solution is a true end-to-end delivery system designed to work on today's predominantly one-way cable plants and to manage all aspects of the network from the head end to the client modem.
STANDARDS FOR CABLE MODEMS. A recent event that has made this approach financially attractive for cable operators is the move by the cable industry to develop standards for cable modem. MC&S, an organization formed by the leading North American cable operators, is in the proces of developing industry-wide specifications for cable modems. USR has been asked by the MC&S to work closely with them in the design of an interoperable specification for both telco return and two-way cable modem systems. USR expects these de facto standards to be finalized shortly.
LOWER COST FOR CABLE OPERATORS. Client cable modems can often represent more than one half of the total capital cost for the operators of cable internet service. The operator would typically have to buy the modems, lease them to customers and then maintain them. By establishing a standard, one client cable modem will work on virtually all cable systems, much the same way analog desktop modems interoperate today. With this level of standardization and interoperability, the cable operator can get out of the financing business. The capital outlay for the cable modem can be transferred to the customer from the cable operator.
CONSUMER PRODUCT STRATEGY FOR CABLE MODEMS. By capitalizing on a consumer product and marketing expertise and powerful retail distribution network, USR is uniquely qualified to transform cable modems from costly lease products into inexpensive interoperable products that consumers will be able to purchase directly from their local electronics retailer. USR is bringing to market cable modems that are affordably priced and easy for the customer to install and configure. In doing so, they will make it possible for cable operators to deliver high-speed Internet service with minimal capital investment and risk and to generate positive cash flows almost immediately.
SOFTMODEM TECHNOLOGY. The technology to do softmodem has been around for some time and it is being enhanced as stronger and stronger DSPs are available and microprocessor technology improves. USR doesn't see a dramatic, significant shift to softmodems coming quickly. There are a number of natural inhibitors to this even though it is technically possible. For one, it doesn't eliminate the need for hardware, you still have to have a network interface. Two, there remain in the international marketplace, significant homologation issues that require hardware changes from product to product, even with a softmodem implementation. Three, to really do a softmodem, you're talking about putting the circuitry between the processor and the DAA into the motherboard and that complicates the technology in the motherboard at a time when people are generally trying to simplify it. So, they think any move towards softmodems will be gradual. However, USR continues to believe that, as the best company in the world in developing firmware to implement communications solutions, they are ideally positioned to take advantage of any trend as it develops by providing the intellectual property that people use to implement softmodems.
SUMMARY. USR is very bullish about the future of their business. They have leading share positions in each of their core businesses. They are exploring new technologies such as x2, new product segments with Palm Pilot, and soon new markets with DSL and cable. They continue to believe that communication and networking markets offer excellent growth opportunities to companies who apply technology to deliver products and systems which provide increased value and performance to customers. US Robotics is such a company. So is 3Com. Combined into the new 3Com, they believe they are uniquely positioned to continue this performance and take advantage of growth opportunities. They anticipate the pending merger with 3Com will close prior to the completion of the June quarter. Accordingly, in all likelihood, US Robotics will not be reporting its results of operations on a standalone basis in the future. For this reason as well as some uncertainty regarding the impact of the merger on their existing operations they do not believe it would be appropriate to provide specific guidance at this time with respect to the company's future business model.
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