** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

**(Mark One)**
| ý | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
|--------|-----------------------------------------------------------------------------------------------------|

**For the quarterly period ended March31, 2002**

**OR**
| o | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
|---|------------------------------------------------------------------------------------------------------|

**For the transition period from         to       **

**Commission File No. 000-20698**

**BROOKTROUT, INC.******(Exact name ofregistrant as specified in its charter) 
| **Massachusetts**                                                |   | **04-2814792**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction  of incorporation or organization) |   | (I.R.S. employer  identification number) |
|                                                             |   |                                     |
| **250  First Avenue**                                            |   | **02494-2814**                           |
| **Needham,  Massachusetts**                                      |
| (Address of  principal executive offices)                        |   | (Zip code)                               |

Registrant’s telephone number, including area code:**  (781) 449-4100**

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    Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý  No o

    Asof April 30, 2002, 12,208,733 shares of common stock, $.01 par value per share,were outstanding.

 

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**BROOKTROUT, INC.FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2002**

**TABLE OF CONTENTS**
| PART I             | FINANCIAL INFORMATION                                                                                                              |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                               |
|  Item 1. | Condensed Consolidated  Financial Statements                                                                                       |
|               |                                                                                                                               |
|               | Unaudited  Condensed Consolidated Balance Sheets as of March 31, 2002 and  December 31, 2001                                  |
|               |                                                                                                                               |
|               | Unaudited  Condensed Consolidated Statements of Operations for the Three Months Ended  March 31, 2002 and March 31, 2001           |
|               |                                                                                                                               |
|               | Unaudited  Condensed Consolidated Statements of Comprehensive Income for the Three  Months Ended March 31, 2002 and March 31, 2001 |
|               |                                                                                                                               |
|               | Unaudited  Condensed Consolidated Statements of Cash Flows for the Three Months Ended  March 31, 2002 and March 31, 2001           |
|               |                                                                                                                               |
|               | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                    |
|               |                                                                                                                               |
|  Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                        |
|               |                                                                                                                               |
|               | Introduction                                                                                                                       |
|               |                                                                                                                               |
|               | Critical Accounting  Policies                                                                                                      |
|               |                                                                                                                               |
|               | Three Months  Ended March 31, 2002 and March 31, 2001                                                                              |
|               |                                                                                                                               |
|               | Liquidity and Capital  Resources                                                                                                   |
|               |                                                                                                                               |
|               | Risk Factors                                                                                                                       |
|               |                                                                                                                               |
|  Item 3. | Quantitative  and Qualitative Disclosures about Market Risk                                                                        |
|               |                                                                                                                               |
| PART II       | OTHER  INFORMATION                                                                                                                 |
|               |                                                                                                                               |
|  Item 6. | Exhibits and  Reports on Form 8-K                                                                                        |
|               |                                                                                                                               |
|               | Signatures                                                                                                                         |

 

 

2

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**Brooktrout, Inc.Unaudited Condensed ConsolidatedBalance Sheets*(in thousands, except share and per sharedata)***
|                                                                                                                                    |   | **March 31, 2002** |   | **December 31, 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-----------------------|--------|
| ASSETS                                                                                                                                  |   |               |   |                  |   |
| Current assets:                                                                                                                         |   |               |   |                  |   |
| Cash and cash equivalents                                                                                                               |   | $                  | 29,276 |                  | $      | 26,218 |   |
| Marketable securities                                                                                                                   |   | 12,203             |   | 11,907                |   |
| Accounts receivable (less allowances of $2,283 in  2002 and $2,074 in 2001)                                                             |   | 9,820              |   | 8,870                 |   |
| Inventory                                                                                                                               |   | 9,420              |   | 11,954                |   |
| Income tax receivable                                                                                                                   |   | 3,923              |   | 4,635                 |   |
| Deferred tax assets                                                                                                                     |   | 8,571              |   | 9,168                 |   |
| Prepaid expenses                                                                                                                        |   | 1,158              |   | 1,022                 |   |
| Total current assets                                                                                                                    |   | 74,371             |   | 73,774                |   |
|                                                                                                                                    |   |               |   |                  |   |
| Equipment and furniture, less accumulated  depreciation and amortization                                                                |   | 4,557              |   | 5,136                 |   |
| Deferred tax assets                                                                                                                     |   | 6,745              |   | 6,981                 |   |
| Intangible assets, less accumulated amortization                                                                                        |   | 8,561              |   | 8,944                 |   |
| Investments                                                                                                                             |   | —             |   | 1,451                 |   |
| Other assets                                                                                                                            |   | 2,125              |   | 2,601                 |   |
| Total assets                                                                                                                            |   | $                  | 96,359 |                  | $      | 98,887 |   |
|                                                                                                                                    |   |               |   |                  |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                              |   |               |   |                  |   |
|                                                                                                                                    |   |               |   |                  |   |
| Current liabilities:                                                                                                                    |   |               |   |                  |   |
| Accounts payable                                                                                                                        |   | $                  | 6,579  |                  | $      | 6,436 |   |
| Accrued expenses                                                                                                                        |   | 7,176              |   | 7,303                 |   |
| Accrued compensation and commissions                                                                                                    |   | 2,802              |   | 2,858                 |   |
| Customer deposits                                                                                                                       |   | 606                |   | 697                   |   |
| Accrued warranty costs                                                                                                                  |   | 800                |   | 789                   |   |
| Net liabilities related to discontinued operations                                                                                      |   | 412                |   | 990                   |   |
| Total current liabilities                                                                                                               |   | 18,375             |   | 19,073                |   |
|                                                                                                                                    |   |               |   |                  |   |
| Deferred rent                                                                                                                           |   | 229                |   | 242                   |   |
| Total liabilities                                                                                                                       |   |               | 18,604 |                  |   | 19,315 |   |
|                                                                                                                                    |   |               |   |                  |   |
| Stockholders’ equity:                                                                                                              |   |               |   |                  |   |
| Preferred stock, $1.00 par value; authorized,  100,000 shares; issued and outstanding, none                                             |   | —             |   | —                |   |
| Common stock, $0.01 par value; authorized,  40,000,000 shares; issued and outstanding 12,463,476 shares in 2002 and  12,462,242 in 2001 |   | 125                |   | 125                   |   |
| Additional paid-in capital                                                                                                              |   | 63,848             |   | 63,841                |   |
| Notes receivable — officers                                                                                                        |   | (11,760            | )      | (11,760               | )      |
| Accumulated other comprehensive (loss)                                                                                                  |   | (68                | )      | (52                   | )      |
| Retained earnings                                                                                                                       |   | 29,370             |   | 31,178                |   |
| Treasury stock, 255,384 shares in 2002 and 2001, at  cost                                                                               |   | (3,760             | )      | (3,760                | )      |
| Total stockholders’ equity                                                                                                         |   | 77,755             |   | 79,572                |   |
| Total liabilities and stockholders’ equity                                                                                         |   | $                  | 96,359 |                  | $      | 98,887 |   |

See notes to unaudited condensed consolidatedfinancial statements.

 

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**Brooktrout, Inc.Unaudited Condensed ConsolidatedStatements of Operations*****(in thousands, exceptper share data)***
|                                                       |   | **Three Months Ended March 31,** |   |
|------------------------------------------------------------|--------|----------------------------------|--------|
|                                                       |   | **2002**                         |   | **2001** |   |
|                                                       |   |                             |   |   |   |
| Revenue                                                    |   | $                                | 18,422 |   | $ | 27,063 |   |
|                                                       |   |                             |   |   |   |
| Costs and expenses:                                        |   |                             |   |   |   |
| Cost of product sold                                       |   | 8,798                            |   | 11,195 |   |
| Research and development                                   |   | 5,619                            |   | 5,478 |   |
| Selling, general and administrative                        |   | 7,481                            |   | 9,708 |   |
| Total costs and expenses                                   |   | 21,898                           |   | 26,381 |   |
|                                                       |   |                             |   |   |   |
| Operating income (loss)                                    |   | (3,476                           | )      | 682 |   |
|                                                       |   |                             |   |   |   |
| Other income (expense):                                    |   |                             |   |   |   |
| Equity in loss of affiliates                               |   | —                           |   | (1,055 | ) |
| Interest income, net and other                             |   | 221                              |   | 310 |   |
| Total other income (expense)                               |   | 221                              |   | (745 | ) |
| Loss before income taxes                                   |   | (3,255                           | )      | (63 | ) |
| Income tax provision (benefit)                             |   | (1,367                           | )      | 367 |   |
| Loss from continuing operations                            |   | (1,888                           | )      | (430 | ) |
|                                                       |   |                             |   |   |   |
| Discontinued operations:                                   |   |                             |   |   |   |
| Gain on disposal of discontinued operations, net of  taxes |   | 80                               |   | 1,650 |   |
| Net income (loss)                                          |   | $                                | (1,808 | ) | $ | 1,220 |   |
|                                                       |   |                             |   |   |   |
| Income (loss) per common share:                            |   |                             |   |   |   |
| Continuing operations, basic                               |   | $                                | (0.15  | ) | $ | (0.04 | ) |
| Continuing operations, diluted                             |   | $                                | (0.15  | ) | $ | (0.04 | ) |
| Net income (loss), basic                                   |   | $                                | (0.15  | ) | $ | 0.10 |   |
| Net income (loss), diluted                                 |   | $                                | (0.15  | ) | $ | 0.10 |   |
|                                                       |   |                             |   |   |   |
| Shares for basic                                           |   | 12,207                           |   | 12,126 |   |
| Shares for diluted                                         |   | 12,207                           |   | 12,126 |   |
|                                                       |   |                             |   |   |   |

See notes to unaudited condensed consolidatedfinancial statements.

 

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**Brooktrout, Inc.Unaudited Condensed Consolidated Statements ofComprehensive Income*****(in thousands)***

 
|                                                                            |   | **Three Months Ended March 31,** |   |
|---------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                            |   | **2002**                         |   | **2001** |   |
| Net income (loss)                                                               |   | $                                | (1,808 | ) | $ | 1,220 |   |
| Unrealized gains (losses) on marketable securities                              |   | (24                              | )      | 6 |   |
| Foreign currency translation adjustment                                         |   | —                           |   | 3 |   |
| Comprehensive income (loss) before income tax  provision (benefit)              |   | (1,832                           | )      | 1,229 |   |
| Income tax provision (benefit) related to items of  comprehensive income (loss) |   | (8                               | )      | 2 |   |
| Comprehensive income (loss)                                                     |   | $                                | (1,824 | ) | $ | 1,227 |   |

 

See notes to unaudited condensed consolidatedfinancial statements.

 

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**Brooktrout, Inc.Unaudited Condensed Consolidated Statements of CashFlows*****(in thousands)***
|                                                                                  |   | **Three Months Ended March 31,** |   |
|---------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                  |   | **2002**                         |   | **2001** |   |
| **Cash  flows from operating activities:**                                            |   |                             |   |   |   |
| Net income (loss)                                                                     |   | $                                | (1,808 | ) | $ | 1,220 |   |
| Adjustments to reconcile net income (loss) to cash  provided by operating activities: |   |                             |   |   |   |
| (Gain) loss on disposal of discontinued operations                                    |   | 705                              |   | (2,683 | ) |
| Depreciation and amortization                                                         |   | 1,114                            |   | 1,367 |   |
| Equity in loss of affiliates                                                          |   | —                           |   | 1,055 |   |
| Deferred income taxes                                                                 |   | 326                              |   | 1,364 |   |
| Increase (decrease) in cash from changes in:                                          |   |                             |   |   |   |
| Accounts receivable                                                                   |   | (950                             | )      | 5,002 |   |
| Inventory                                                                             |   | 2,534                            |   | 631 |   |
| Prepaid expenses and other assets                                                     |   | 1,465                            |   | 454 |   |
| Liabilities                                                                           |   | 137                              |   | (5,015 | ) |
| Cash provided by operating activities                                                 |   | 3,523                            |   | 3,395 |   |
|                                                                                  |   |                             |   |   |   |
| **Cash  flows from investing activities:**                                            |   |                             |   |   |   |
| Expenditures for equipment and furniture                                              |   | (152                             | )      | (525 | ) |
| Acquired software and other investing                                                 |   | —                           |   | (145 | ) |
| Sales and maturities of marketable securities                                         |   | 2,522                            |   | — |   |
| Purchases of marketable securities                                                    |   | (2,842                           | )      | — |   |
| Cash used in investing activities                                                     |   | (472                             | )      | (670 | ) |
|                                                                                  |   |                             |   |   |   |
| **Cash  flows from financing activities:**                                            |   |                             |   |   |   |
| Proceeds from the sale of common stock                                                |   | 7                                |   | 34 |   |
| Cash provided by financing activities                                                 |   | 7                                |   | 34 |   |
| Increase in cash and cash equivalents                                                 |   | 3,058                            |   | 2,759 |   |
| Cash and cash equivalents, beginning of period                                        |   | 26,218                           |   | 23,294 |   |
| Cash and cash equivalents, end of period                                              |   | $                                | 29,276 |   | $ | 26,053 |   |

See notes to unaudited condensed consolidatedfinancial statements.

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**Brooktrout, Inc.Notes to Unaudited CondensedConsolidated Financial Statements*****(in thousands, except share and per sharedata)***

**1. Description of Business and Summary of SignificantAccounting Policies and Practices**

***(a) Description of Business***

                Brooktrout, Inc. (the“Company” or “Brooktrout”) develops, manufactures and sells communicationshardware and software products that enable the development of communicationsapplications and systems in five targeted markets, including enhanced servicesplatforms, wireless infrastructure, voice over packet gateways and switches,unified communications, and contact centers. The Company sells its products tosystem vendors, service providers, enterprise customers, original equipmentmanufacturers (“OEMs”), and value-added resellers (“VARs”), both domesticallyand internationally, through a direct sales force and a two-tiered distributionsystem. Prior to February 8, 2001, the Company was organized and reportedthe results of its operations in the following three business segments:Brooktrout Technology, Inc. (“Brooktrout Technology”), BrooktroutSoftware, Inc. (“Brooktrout Software”), and Interspeed, Inc.(“Interspeed”). These segments were differentiated based upon the productsprovided to the marketplace, the customers served, and the distributionchannels utilized. Two of these segments have been discontinued and areclassified as discontinued operations for the periods presented in thesecondensed consolidated financial statements. (See note 2). Following thediscontinuance of the Brooktrout Software and Interspeed segments, theCompany’s operations consist of one reportable segment, Brooktrout Technology.

***(b) Use of Estimates***

                Accounting policies, methods andestimates are an integral part of the condensed consolidated financialstatements and are based upon management’s current judgments. These policies,methods, and estimates affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenue and expenses duringthe reporting periods. The judgments made by management are based on knowledgeand experience with regard to past and current events and assumptions aboutfuture events that are believed to be reasonable under the circumstances. On anon-going basis, the Company’s management evaluates its estimates andassumptions and adjusts them if expectations concerning events, includingfuture events, affecting them differ markedly from management’s currentjudgments.

***(c) Principles of Consolidation***

                The accompanying unauditedcondensed consolidated financial statements have been prepared by the Companypursuant to the rules and regulations of the Securities and ExchangeCommission regarding interim financial reporting. These unaudited condensedconsolidated financial statements should be read in conjunction with the auditedconsolidated financial statements included in the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2001.

                The accompanying unauditedcondensed consolidated financial statements have been prepared on the samebasis as the audited consolidated financial statements and include alladjustments, consisting only of normal recurring adjustments, necessary for afair presentation of the interim periods presented. The condensedconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All significant intercompany balances andtransactions have been eliminated in consolidation. The operating resultsfor the interim periods presented are not necessarily indicative of the resultsthat could be expected for the full year.

***(d) Revenue Recognition***

                Revenue from product sales isrecognized upon shipment provided that persuasive evidence of an arrangementexists, the fee is fixed or determinable, delivery has occurred, and collectionis considered probable. The Company records a provision for estimated salesreturns and allowances on product sales in the same period as the relatedrevenue is recorded. These estimates are based on historical sales returns,analysis of credit memo data and other known factors. The Company provides forestimated costs of warranty repairs at the time of sale of the related product.Revenue from sales to distributors is recognized on a “sell-through” basis,that is, when the distributor reports to the Company that resale of the producthas occurred.

*** (e)Concentration of Credit Risk***

                The Company sells its productsto various customers in the high technology industry. The Company generallyrequires no collateral; however, to reduce credit risk, the Company performsongoing credit evaluations of its customers. The Company maintains allowancesfor doubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments. At March 31, 2002 and December 31,2001, 15% and 13%, respectively, of the Company’s accounts receivable were fromone customer.

 

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***(f) Inventory***

                Inventory is carried at thelower of cost or market. Cost is determined using the first-in, first-outmethod for all inventories. The Company reduces the value of its inventory forestimated obsolescence or unmarketable inventory equal to the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions.

***(g) Intangible Assets***

                Intangible assets includeacquired technology, customer base, and trademarks associated with purchasedbusiness combinations.  Acquiredtechnology is being amortized on a straight-line basis over five to10 years, while all other intangibles are being amortized over periods ofthree to five years.  Accumulatedamortization at March 31, 2002 and December 31, 2001 was $6,265 and$5,882, respectively.   Intangibleassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying value may not be recoverable.

***(h) Income Taxes***

                Deferred tax assets andliabilities are recognized for the estimated future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss carry forwards. These assets and liabilities are measured using theenacted rates and laws that are expected to be in effect when the differencesreverse.

***(i) Earnings Per Share***

                Basic earnings per common shareis computed using the weighted average number of common shares outstandingduring each period. Diluted earnings per common share is calculated by dividingnet income by the sum of the weighted average number of common sharesoutstanding, plus all additional common shares that would have been outstandingif potentially dilutive securities had been issued using the treasury method.

                Forthe three months ended March 31, 2002 and 2001, the Company is utilizingloss from continuing operations as the “control number” for purposes of determiningwhether potential common shares are dilutive for all per share calculations inaccordance with Financial Accounting Standards Board Statement of FinancialAccounting Standards ("SFAS")  128. As a result, potentialcommon shares are anti-dilutive in both periods and are excluded from thecalculation.  Stock options to purchase3,050,125 and 2,834,875 shares were not included in the computation of dilutedearnings per share in 2002 and 2001, respectively. These options are excludedfrom the calculation as to include them would have been antidilutive.

*** (j)Reclassifications***

                Certain amounts in the 2001consolidated financial statements have been reclassified to conform to the 2002presentation.

***(k) Recent Accounting Pronouncements***

                The Company adopted SFAS No.141, "Business Combinations," and SFAS No. 142, "Goodwill andOther Intangible Assets." These pronouncements provide guidance on how toaccount for the acquisition of businesses and intangible assets, includinggoodwill, which arise from such activities. SFAS No. 141 affirms that only onemethod of accounting may be applied to a business combination, the purchasemethod. SFAS No. 141 also provides guidance on the allocation of purchase priceto the assets acquired. SFAS No. 142 provides that goodwill resulting frombusiness combinations no longer be amortized to expense, but rather requires anannual assessment of impairment and, if necessary, adjustments to the carryingvalue of goodwill. The Company believes that the adoption of SFAS Nos. 141 and 142has no material effect on its consolidated financial statements.

                The Company has adopted SFAS No.144 "Accounting for the Impairment of Disposal of Long-Lived Assets."SFAS No. 144 establishes a single accounting model for impairment or disposalof long-lived assets, including discontinued operations. Management believesthat the adoption of SFAS No. 144 has no significant effect on the Company'sconsolidated financial statements.

 

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**2.  Discontinued Operations**

                On February 8, 2001, theCompany’s Board of Directors adopted formal plans to discontinue its BrooktroutSoftware and Interspeed segments.

                *Brooktrout Software, Inc.—*OnMarch 12, 2002, the Company and Sonexis, Inc. (“Sonexis”) reached anagreement resolving various post-closing adjustments and indemnification claimsof both parties that had been asserted in connection with the sale ofBrooktrout Software. As part of this agreement, the Company agreed to exchangethe Sonexis shares, received by the Company as partial consideration for thesale of Brooktrout Software, for an immediate and final resolution and releaseof substantially all claims related to the sale of Brooktrout Software.  The Sonexis shares had been classified inthe Company’s financial statements as a cost basis investment at December 31,2001.  The effect of this settlement wasa pre-tax non-cash charge to discontinued operations in the first quarter of2002 of $943.  This pre-tax non-cashcharge was substantially offset by an income tax benefit of $915.  The income tax benefit related primarily tonet deferred tax liabilities, which are no longer required due to the finalsettlement of the transaction.  As aresult, the Company recognized a net loss from discontinued operations for thethree months ended March 31, 2002 of $28. As of March 31, 2002, “Net liabilities related to discontinuedoperations” consists of $187 for accruals of expenses related to BrooktroutSoftware.

 

                *Interspeed, Inc.—* In January 2001,the Board of Directors of Interspeed announced that it was curtailing operationsand liquidating the remaining assets for the benefit of creditors.  The Company is a creditor ofInterspeed.  In the three months endedMarch 31, 2002, the Company received net proceeds from the Interspeedcreditors’ trust of $238.  These proceeds,net of income tax expense of $130, resulted in a net gain from discontinuedoperations for the three months ended March 31, 2002, of $108.  As of March 31, 2002, “Net liabilitiesrelated to discontinued operations” consists of $225 of expenses associatedwith the Interspeed business.

                Details of the gain on disposal,and basic and diluted per share amounts for discontinued operations are asfollows: 
|                                                                                                       |   | **Three Months Ended March 31,****** |   |
|------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                                       |   | **2002******                         |   | **2001****** |   |
| Gain (loss) on disposal of discontinued operations:                                                        |   |                                 |   |   |   |
| Brooktrout  Software, net of income tax benefit of $915 in 2002, and income tax expense  of $1,033 in 2001 |   | $                                    | (28    | ) | $ | 1,650 |   |
| Interspeed, net  of income tax expense of $130 in 2002                                                     |   | 108                                  |   | — |   |
| Total gain on  disposal of discontinued operations                                                         |   | $                                    | 80     |   | $ | 1,650 |   |
|                                                                                                       |   |                                 |   |   |   |
| Gain on disposal  per common share:                                                                        |   |                                 |   |   |   |
| Basic                                                                                                      |   | $                                    | 0.01   |   | $ | 0.14 |   |
| Diluted                                                                                                    |   | $                                    | 0.01   |   | $ | 0.14 |   |

**3.** ** Inventory**

                Inventory is carried at thelower of cost or market, on a first-in first-out basis, and consisted of thefollowing: 

|            |   | **March 31,2002** |   | **December 31, 2001** |   |
|-----------------|--------|-------------------|--------|----------------------------|--------|
| Raw materials   |   | $                 | 1,554  |                       | $      | 3,763 |   |
| Work in process |   | 1,782             |   | 621                        |   |
| Finished goods  |   | 6,084             |   | 7,570                      |   |
| Total           |   | $                 | 9,420  |                       | $      | 11,954 |   |

 

**4.  Equipment andFurniture**

                Equipment and furniture issummarized as follows: 

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|                                                                           |   | **March 31,********2002** |   | **December 31,********2001** |   |
|--------------------------------------------------------------------------------|--------|---------------------------|--------|------------------------------|--------|
| Computer  equipment                                                            |   | $                         | 8,012  |                         | $      | 7,987 |   |
| Furniture and  office equipment                                                |   | 8,932                     |   | 8,805                        |   |
| Total equipment  and furniture                                                 |   | 16,944                    |   | 16,792                       |   |
| Less accumulated  depreciation and amortization                                |   | (12,387                   | )      | (11,656                      | )      |
| Total equipment  and furniture, less accumulated depreciation and amortization |   | $                         | 4,557  |                         | $      | 5,136 |   |
|                                                                           |   |                      |   |                         |   |

**5.  Income Taxes**

                The Company’s tax provision in2002 is based on the estimated effective tax rate for the full year. TheCompany’s effective tax benefit rate on continuing operations was 42% for thethree months ended March 31, 2002.  TheCompany received a tax refund of $3,659 during the three months ended March 31,2002.

**6.  Investments**

                The Company has an investment inPelago Networks, Inc. (“Pelago”), which it has previously been accounted forunder the equity method of accounting. The Company’s investment in Pelago had been written down to zero as ofDecember 31, 2001 as the Company recognized its share of Pelago’s losses.In the three months ended March 31, 2002, Pelago closed on an additional roundof equity financing of its Series B preferred shares. As a result of thisfinancing, the Company’s ownership percentage is now 15%. In the three monthsended March 31, 2002, the reduction in the value of investments was due to thepreferred equity securities that constituted the Company’s investment inSonexis being exchanged with Sonexis as part of the settlement discussed innote 2.

**7.  Segment Reporting**

                Prior to its February 8,2001 decision to discontinue its Brooktrout Software and Interspeed segments,the Company was organized and reported the results of its operations in thefollowing three business segments: Brooktrout Technology, Brooktrout Softwareand Interspeed. As a result of its decision to discontinue Brooktrout Softwareand Interspeed, the Company’s continuing operations represent one reportablesegment. The remaining segment, Brooktrout Technology, provides enablingtechnologies that allow customers to deliver voice, fax and data solutions forthe electronic communications market. (See note 2).

                *ProductSales*—Brooktrout Technology’s products are sold for applications inthe New NetworkTM and for applications in Today’s Network. Today’s Networkinvolves core technologies and platforms that are primarily used in businesspremise products such as fax, LAN fax, and voice mail. The New Networkapplications expand the capabilities of communications networks to allow data,voice and fax information to be distributed using packet-based data networks,such as the Internet, for portions of the transmission and also allowinformation to be distributed using the traditional circuit-switched telephonenetwork. For the three months ended March 31, 2002, sales of products foruse in the New Network accounted for approximately 33% of total revenue ascompared to 52% of total revenue for the three months ended March 31, 2001.

                *MajorCustomers—*One customer accounted for approximately 14% and 7% ofrevenue for the three months ended March 31, 2002 and 2001, respectively.A different customer accounted for 20% of revenue for the three months endedMarch 31, 2001; this customer represented less than 1% of revenue for thethree months ended March 31, 2002.

                *InternationalSales—*International sales, principally exports from the UnitedStates, accounted for approximately 21% and 18% of revenue for the three monthsended March 31, 2002 and 2001, respectively.

 

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**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

**Results of Operations**

**Safe Harbor Statement Under the Private Securities LitigationReform Act of 1995**

                This quarterly report onForm 10-Q contains certain statements that are “forward-lookingstatements” as that term is defined under the Private Securities LitigationReform Act of 1995 and releases issued by the Securities and ExchangeCommission. The words “believes,” “expects,” “anticipates,” “intends,”“estimates,” “assumes,” “will,” “should” and other expressions that arepredictions of or indications of future events and trends and that do notrelate to historical matters, identify forward-looking statements. You shouldnot rely on forward-looking statements because they involve known and unknownrisks, uncertainties and other factors, some of which are beyond the control ofBrooktrout, Inc. (the “Company” or “Brooktrout”), which may cause theactual results, performance or achievements of the Company to differ materiallyfrom anticipated future results, performance or achievements expressed orimplied by such forward-looking statements. These forward-looking statementswere based on information, plans, and estimates at the date of this documentand the Company undertakes no obligation to update any forward-lookingstatement, whether as a result of new information, future events or otherwise.

                The future operating results andperformance trends of the Company may be affected by a number of factors,including, without limitation, risks related to the following: (i) theeconomic slowdown in the telecommunications sector; (ii) market growth,market acceptance of the Company’s products and product demand;(iii) rapid changes in technology and the evolution of thetelecommunications hardware and software market; and (iv) the impact ofcompetition. In addition to the foregoing, the Company’s actual future resultscould differ materially from those projected in the forward-looking statementsas a result of the risk factors set forth herein and in the Company’s variousfilings with the Securities and Exchange Commission and of changes in generaleconomic conditions and changes in the assumptions used in making suchforward-looking statements.

**Introduction**

                Brooktrout develops,manufactures and sells communications hardware and software products thatenable the development of communications applications and systems in fivetargeted markets, including enhanced services platforms, wirelessinfrastructure, voice over packet gateways and switches, unifiedcommunications, and contact centers. The Company’s strategy is to collaboratewith its partners on new ideas and to invest in the success of their businessesin order to help them expand into new markets, accelerate the delivery of theirapplications and services, and deliver quality products and services. TheCompany sells its products to system vendors, service providers, enterprisecustomers, original equipment manufacturers (“OEMs”), and value-added resellers(“VARs”), both domestically and internationally, through a direct sales forceand a two-tiered distribution system.

                The evolution of the world’stelecommunications systems has created important market opportunities for theCompany. One opportunity involves core technologies and platforms that areprimarily used in business premise products such as fax, LAN fax, and voicemail—Today’s Network. Another opportunity—the New NetworkTM—is the result of theglobal investments that are being made to expand the capabilities of today’scommunications networks. These new capabilities allow data, voice and faxinformation to be distributed using packet-based data networks, such as theInternet, for portions of the transmission and also allow such information tobe distributed using the traditional circuit-switched telephone network.

                Priorto February 8, 2001, the Company was organized and reported the results ofits operations in three operating segments, Brooktrout Technology, Inc.(“Brooktrout Technology”), Brooktrout Software, Inc. (“BrooktroutSoftware”), and Interspeed, Inc. (“Interspeed”). On February 8, 2001,the Company’s Board of Directors adopted formal plans to discontinue itsBrooktrout Software and Interspeed segments. Accordingly, the Company hasaccounted for these businesses as discontinued operations. (See note 2).  The following discussion focuses on theCompany’s results from continuing operations.

 

**Critical Accounting Policies**

 

                Accountingpolicies, methods and estimates are an integral part of the consolidatedfinancial statements and are based upon management’s current judgments. Thesejudgments are based on knowledge and experience with regard to past and currentevents and assumptions about future events that are believed to be reasonableunder the circumstances. On an on-going basis, the Company’s managementevaluates its estimates and assumptions and adjusts them if expectations concerningevents, including future events, affecting them differ markedly frommanagement’s current judgments. Management believes that the following arecertain critical accounting policies that particularly affect its moresignificant judgments and estimates used in the preparation of its condensedconsolidated financial statements.

                The Company’s revenuerecognition policy requires that revenue be recognized at the time of shipmentif there is persuasive evidence that an arrangement exists, the price is fixedor determinable, delivery has occurred, and collection is considered probable.The Company recognizes revenue from sales to two-tiered distributors of theCompany’s products when the distributor has sold the

 

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productsto their customers. The Company records a provision for estimated sales returnsand allowances on product sales in the same period as the related revenue isrecorded. (See Note 2). These estimates are based on historical sales returns,analysis of credit memo data and other known factors. Actual results coulddiffer from these estimates.

                The Company’s concentration ofcredit risk policy requires management to make estimates concerning therealizable value of accounts receivable assets. The current and future economicenvironment affects these estimates. The Company maintains allowances fordoubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments. If the financial condition of Brooktrout’scustomers were to deteriorate, additional allowances may be required.

                The Company’s inventoryvaluation policy requires management to make estimates concerning therealizable value of inventory. The current and future economic environmentaffects these estimates. The Company reduces the value of its inventory forestimated obsolescence or unmarketable inventory equal to the differencebetween the cost of inventory and the estimated market value based uponassumptions about future demand and market conditions. If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required.

                The Company reviews itsintangible assets for impairment whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Any evaluation ofintangible assets would include assumptions regarding estimated future cashflows and other factors to determine the fair value of the respective assets.If these estimates or their related assumptions change in the future, theCompany could be required to record impairment charges for these assets.

                The carrying value of theCompany’s deferred tax assets assumes that the Company will be able to generatesufficient future taxable income in certain tax jurisdictions, based onestimates and assumptions. If these estimates and related assumptions change inthe future, the Company may be required to record valuation allowances againstits deferred tax assets, resulting in additional income tax expense in theCompany’s consolidated statement of operations. Management evaluates therealizability of the deferred tax assets quarterly and assesses the need forvaluation allowances quarterly.

                The Company recorded estimatesfor expenses associated with Brooktrout Software, along with the expenses relatedto Interspeed, as liabilities associated with discontinued operations. (Seenote 2). These estimates are based on certain judgments by management about thelikelihood and amount expected to be paid. If actual results differ from theseestimates, an adjustment to the amounts recorded as liabilities could berequired in future periods.

**ThreeMonths Ended March 31, 2002 and 2001*******(in thousands)*

                Revenue for the three monthsended March 31, 2002 decreased by approximately 32% to $18,422, down from$27,063 for the three months ended March 31, 2001. The decline in revenueresulted primarily from the overall economic slowdown in the United States andinternational economies and, in particular, the softening in thetelecommunications market. The slowdown the Company is experiencing extendsacross all product lines and markets, though sales of products for applicationsin the New Network, specifically those sold to OEMs for use by largeservice providers, have declined most significantly. For the three months endedMarch 31, 2002, sales of products for applications in the New Networkaccounted for approximately 33% of total revenue, as compared to 52% of totalrevenue for the three months ended March 31, 2001.

                Revenue from one customeraccounted for approximately 14% of total revenue for the three months endedMarch 31, 2002, compared to 7% from this same customer for the three monthsended March 31, 2001. The Company expects that revenue from this customer willcontinue to be greater than 10% of total revenue for the foreseeable future. Adifferent customer represented 20% of sales for the three months endedMarch 31, 2001; however, revenue from this customer represented less than1% of total revenue for the three months ended March 31, 2002. For the foreseeablefuture, the Company expects that revenue from this customer will continue to besignificantly less than that of prior years.

                Cost of product sold was $8,798,or 48% of revenue, for the three months ended March 31, 2002, compared to$11,195, or 41% of revenue, for the three months ended March 31, 2001.Gross margin percent for the three months ended March 31, 2002 was 52%compared with 59% for the three months ended March 31, 2001. The lowergross margin percent in 2002 was primarily due to the reduction in highermargin products sold and unabsorbed manufacturing expenses.  The Company’s manufacturing expenses, whichare primarily fixed, represented a larger percentage of cost of product sold in2002 in comparison to 2001.  The Companyexpects that the gross margin will be approximately 51% to 53% for the nextseveral quarters.

                Research and development expensewas $5,619, or 31% of revenue, for the three months ended March 31, 2002,compared with $5,478, or 20% of revenue, for the three months endedMarch 31, 2001.  The Company’scontinuing development efforts are focused on hardware and software that makeup its network interface products, media processing products, messagingproducts and IP telephony products. The Company intends to continue to commitsignificant resources to product development and would expect that research anddevelopment expense in 2002 will continue to be slightly higher than in 2001.

 

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                Selling, general andadministrative expense was $7,481, or 41% of revenue, for the three months endedMarch 31, 2002, compared with $9,708, or 36% of revenue, for the threemonths ended March 31, 2001. The decline in this expense is primarily theresult of reduced spending for variable incentive compensation, consulting andcontract labor, employee recruiting expenses, travel and entertainmentexpenses, advertising and promotion expenses, and expendable materials andsupplies. The Company expects that selling, general and administrative expensein 2002 may increase marginally compared to 2001.

                The Company did not recognizeequity in loss of affiliates for the three months ended March 31, 2002, ascompared to $1,055 of equity in loss of affiliates from both Pelago Networks,Inc. (“Pelago”) and Telchemy, Inc (“Telchemy”) for the three months ended March31, 2001. The Company’s investment in Pelago had been written down to zero asof December 31, 2001 and since the Company has no further funding commitment,it has ceased recording its equity in Pelago’s losses. The Company will notrecognize additional losses related to Telchemy, as the Company disposed of itsequity interest in Telchemy on December 31, 2001.

                Interest income, net and otherwas $221 for the three months ended March 31, 2002, as compared with $310for the three months ended March 31, 2001. The decrease in interest income, netand other was the result of a decline in short-term interest rates, whichoffset the favorable impact that increased marketable securities balances hadon interest income.

                Theeffective tax benefit rate on continuing operations was 42% for the threemonths ended March 31, 2002. For the three months ended March 31, 2001, theeffective tax expense rate on continuing operations was 583%. This tax rate forthe first quarter of 2001 was the result of treating equity in loss ofaffiliates expense as a non-deductible item in the income tax provisioncalculation. Excluding the impact of equity in loss of affiliates, theeffective tax expense rate would have been 37% for the three months ended March31, 2001.

 

**Liquidity and Capital Resources*******(in thousands)*

 

                Forthe three months ended March 31, 2002, the Company funded its operationsprincipally through cash provided by operating activities. Cash provided byoperating activities for the three months ended March 31, 2002 was $3,523and was generated primarily from a tax refund received in the quarter of$3,659.  Cash used in investingactivities for the three months ended March 31, 2002 was $472.  Working capital increased slightly to$55,996 at March 31, 2002 from $54,701 at December 31, 2001.

                The Company has a line of creditunder which it may borrow up to $5,000 on a secured basis, subject tocompliance with certain covenants. Any amounts borrowed under the line ofcredit bear interest at the lender’s prime rate. As of March 31, 2002, lettersof credit issued against the Company’s existing line totaled $1,000,representing the collateral required for certain lease obligations. There havebeen no borrowings under the line during the past three years.  The line of credit expiresat the end of June 2002 and at that time any outstanding balances are payablein full.  The Company anticipates thatthe line of credit will be renewed on substantially the same terms as theexisting line of credit.

                The Company believes that thecurrent economic conditions will continue during this year and as a result,expects to have a loss from continuing operations for the year endedDecember 31, 2002. During the twelve months ended December 31, 2001, theCompany had an operating loss of $9,460, but during the same period was able toincrease its cash and marketable securities balances by $12,138, of which$4,927 was from the sale of Brooktrout Software. The Company believes availablecash resources will support its operations and capital needs for at least thenext twelve months, and if the current economic climate worsens beyond the nexttwelve months, the Company may need to utilize funds available under the lineof credit.

                For the three months ended March31, 2002, the Company purchased approximately $152 in equipment. The Companycurrently has no material commitments for additional capital expenditures.

                The pricing of the Company’sproducts and costs of its goods are generally determined by current marketconditions, as well as value to the customer. Market conditions can be impactedby inflation; however, the Company believes that inflation has not had asignificant effect on its operations to date.

                The Company has operating leasecommitments for its office and manufacturing facilities expiring through 2006.Certain lease agreements require the Company to pay all of the building’staxes, insurance and maintenance costs.

 

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**RiskFactors**

***The Company is exposed to general economicconditions, and the slowdown in some sectors of the telecommunications industryin particular.***

                As a result of recentunfavorable economic conditions affecting most technology sectors and thetelecommunications sector in particular, many of our customers are aggressivelyincreasing efficiency in their supply chains and reducing inventory levels.Additionally, we expect the growth of data traffic and the use of the Internetwill continue to have a significant impact on traditional voice networks, whichis driving the convergence of data and telephony and giving rise to the demandfor New Network applications. We cannot be sure what the rate of suchconvergence will be due to the slowdown in the communications industry and theresulting decrease in spending by our customers. The current economicconditions have adversely impacted the Company’s business and operatingresults, including a reduction in revenue of $8,641,000 for the three monthsended March 31, 2002, or 32% compared to the three months ended March 31, 2001.If current economic conditions continue for an extended period of time orworsen, or if a wider economic slowdown occurs, the Company may experienceadditional adverse effects on its business, operating results, and financialcondition. Specifically, as the rate at which the Company’s customers order itsproducts decreases, the more likely it is that current inventories will beexposed to technological obsolescence, thus requiring the Company to reduce thevalue of that inventory on the balance sheet.

***The Company’s operating results are likelyto fluctuate significantly and cause the Company’s stock price to be volatile,which could cause the value of your investment to decline.***

                The Company’s operating resultsare likely to fluctuate in the future due to a variety of factors, many ofwhich are outside of its control. If the Company’s operating results do notmeet the expectations of securities analysts, the trading price of theCompany’s common stock could significantly decline. This may cause the value ofyour investment in the Company to decline. In addition, the value of yourinvestment could be impacted by investor perception of the Company’s industryor its prospects generally, independent of the operating performance of theCompany. Some of the factors that could affect the Company’s operating resultsor impact the market price of the common stock include:

•                  the Company’s ability to cope withdifficult conditions in the economy in general, and the telecommunicationsmarket in particular;

•                  the Company’s ability to formulate andimplement effective strategies to respond to changing market requirements andconditions;

•                  cancellation or rescheduling of ordersfor the Company’s products;

•                  the Company’s ability to collect accountsreceivable from customers that have been adversely impacted by the difficulteconomic conditions;

•                  the Company’s ability to develop,manufacture, market and support its products and product enhancements;

•                  the timing and number of orders for theCompany’s products, which have historically been weighted more heavily towardthe last month of each quarter;

•                  the Company’s ability to hire, train andretain key management, sales and marketing and engineering personnel;

•                  announcements or technologicalinnovations by the Company’s competitors or in competing technologies;

•                  the Company’s ability to obtainsufficient supplies of sole or limited source components for the Company’sproducts;

•                  a decrease in the average selling pricesof the Company’s products;

•                  changes in costs of components that theCompany includes in its products;

•                  the mix of products that the Companysells and the mix of distribution channels through which they are sold; and

•                  a decrease in the demand for theCompany’s common stock.

                Due to these and other factors,revenue, expenses and results of operations could vary significantly in thefuture, and period-to-period comparisons should not be relied upon asindications of future performance.

***The Company has historically derived asignificant portion of its revenue from a small number of customers.***

                The Company’s failure to generateas much revenue as expected from what has historically been a relatively smallnumber of customers or the failure of these customers to purchase the Company’sproducts could seriously harm the Company’s business. For the three monthsended March 31, 2002, one customer accounted for approximately 14% of theCompany’s revenue. A different customer accounted for 20% of revenue for thethree months ended March 31, 2001; however, this customer represented lessthan 1% of revenue for the three months ended March 31, 2002 and isexpected to remain less than 10% of total revenue for the foreseeable future.The loss of any one of the Company’s major customers or the delay ofsignificant orders from such customers, even if only temporary, has or couldreduce or delay the Company’s revenue, could harm the Company’s reputation inthe industry and could 

 

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reducethe Company’s ability to accurately predict cash flow, and, as a consequence,could seriously harm the Company’s business, financial condition and results ofoperations.

                Present and future customers mayalso terminate their purchasing arrangements with the Company, significantlyreduce or delay their orders or seek to renegotiate their agreements on termsless favorable to the Company. Furthermore, in any future negotiations, theCompany may be subject to the perceived or actual leverage the customers mayhave, given their relative size and importance to the Company. Any termination,change, reduction or delay in orders could seriously harm the Company’s business,financial condition and results of operations. Accordingly, unless and untilthe Company can diversify and expand its customer base, the Company’s futuresuccess will significantly depend upon the timing and size of future purchasesby the Company’s largest customers and the financial and operational success ofthese customers.

***The telecommunications markets are highlycompetitive, and the Company may not be able to compete successfully againstnew entrants and established companies with greater resources.***

                The market fortelecommunications equipment is highly competitive. If the Company is unable todifferentiate its products from existing and future offerings of itscompetitors, and thereby effectively compete in the market fortelecommunications equipment, the Company’s results of operations could bematerially adversely affected. Many of the Company’s current and potentialcompetitors have significantly greater selling and marketing, technical,manufacturing, financial, and other resources. Moreover, the Company’scompetitors may have greater access to components necessary to manufacturetheir products. The strength and capabilities of the Company’s competitors maybe increased as a result of the trend toward consolidation in thetelecommunications market. Capitalizing on and maintaining the Company’stechnological advantage will require a continued high level of investment inresearch and development, marketing and customer service and support. Due tothe rapidly evolving markets in which the Company competes, additionalcompetitors with significant market presence and financial resources may enterthose markets, thereby further intensifying competition. The Company may notallocate sufficient resources to achieve the technological advances necessaryto compete successfully with existing competitors or new entrants.

***Internal development efforts by theCompany’s customers may adversely affect demand for its products.***

                Many of the Company’s customers,including the large OEMs on which the Company focuses a significantportion of its sales and marketing efforts, have the technical and financialability to design and produce components replicating or improving on thefunctionality of most of the Company’s products. These customers often considerin-house development of technologies and products as an alternative to doingbusiness with the Company. The Company cannot assure you that its existingcustomers or potential customers will do business with the Company, rather thanattempting to develop similar technology and products internally or obtainingthem through acquisition. The Company cannot be certain that it will be able tofind customers to replace the revenue lost as a result of customers developingtechnologies or products in-house. Any such occurrence could have a materialadverse effect on the Company’s business, financial condition or results ofoperations.

***Unless the Company is able to keep pacewith the evolution of the telecommunications hardware and software market, theCompany’s business may be adversely impacted.***

                The telecommunications hardwareand software market is characterized by:

**•**                  rapid technological advances;

**•**                  evolving industry standards;

**•**                  changes in customer requirements;

**•**                  frequent new product introductions;

**•**                  intense competition; and

**•**                  evolving offerings by telecommunications serviceproviders.

                The Company believes that itsfuture success will depend, in part, on its ability to offer products thataddress the sophisticated and varied needs of its current and prospectivecustomers and to respond to technological advances and evolving industrystandards on a timely and cost-effective basis. The Company intends to continueto invest significantly in product and technology development. The developmentof new or enhanced products is a complex and uncertain process. The Company mayexperience design, manufacturing, marketing and other difficulties that coulddelay or prevent its development, introduction or marketing of new products andenhancements. The Company may also not be able to incorporate new technologieson a cost-effective or timely basis. This may result in unexpected expenses.The introduction of new or enhanced products also requires that the Companymanage the transition from older products so as to minimize the disruption tocustomers and ensure that adequate supplies of new products can be delivered tomeet anticipated customer demand. The Company’s inability to develop on atimely basis new products or enhancements to existing products, or the failureof such new products or enhancements to achieve market acceptance, could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

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***The Company’s dependence on sole and singlesource suppliers and independent manufacturers exposes it to supplyinterruptions that could result in product delivery delays.***

                Although the Company generallyuses standard parts and components for its products, some key components arepurchased from sole or single source vendors for which alternative sources arenot currently available or are difficult to obtain. The Company’s inability toobtain sufficient quantities of these components may result in future delays orreductions in product shipments that could materially adversely affect itsbusiness, financial condition and results of operations. The Company currentlypurchases proprietary components from a number of suppliers for which there areno direct substitutes. These components could be replaced with alternativesfrom other suppliers, but that could involve redesign of the Company’sproducts. If such redesign was required, the Company would incur considerabledelay and expenses. The Company currently enters into purchase orders with itssuppliers for materials based on forecasts of need, but has no guaranteedsupply arrangements with these suppliers.

                In addition, the Companycurrently uses a number of independent manufacturers to manufacture printedcircuit boards, chassis and subassemblies in accordance with the Company’sdesign and specification. The Company’s reliance on independent manufacturersinvolves a number of risks, including the potential for inadequate capacity of,unavailability of, or interruptions in access to, process technologies, andreduced control over delivery schedules, manufacturing yields and costs. If theCompany’s manufacturers are unable or unwilling to continue manufacturing itscomponents in required quantities or to the Company’s quality expectations, theCompany will have to transfer manufacturing to acceptable alternativemanufacturers that it has identified, which could result in significant delaysin shipment of products to customers. Moreover, the manufacture of thesecomponents is extremely complex, and the Company’s reliance on the suppliers ofthese components exposes it to potential production difficulties and qualityvariations, which could negatively impact the cost and timely delivery of itsproducts. The Company currently enters into purchase orders with independentmanufacturers of materials based on forecasts of need, but has no guaranteedarrangements with these manufacturers. Any significant interruption in thesupply, or degradation in the quality, of any component would have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

***Defects in theCompany’s products or problems arising from the use of its products mayseriously harm its business and reputation.***

                Productsas complex as the Company’s may contain known and undetected errors, bugs orperformance problems. Defects are frequently found during the periodimmediately following introduction and initial implementation of new productsor enhancements to existing products. Although the Company attempts to resolveall bugs that it believes would be considered serious by its customers beforeimplementation, the Company’s products may not be bug-free. The Company alsoprovides warranties against defects in materials and workmanship on itshardware products for five years. However, errors, bugs or performance problemscould result in lost revenue or customer relationships and could be detrimentalto the Company’s business and reputation generally. In addition, the Company’scustomers generally use its products together with their own products andproducts from other vendors. As a result, when problems occur, it may bedifficult to identify the source of the problem. These problems may cause theCompany to incur significant warranty and repair costs, divert the attention ofits engineering personnel from the Company’s product development efforts andcause significant customer relations problems. To date, defects in theCompany’s products or those of other vendors’ products with which its productsare used by its customers have not had a material adverse effect on itsbusiness. However, the Company cannot be certain that product defects will notmaterially adversely affect the Company’s business in the future.

***Changes to regulations affecting thetelecommunications or Internet industries could reduce demand for the Company’sproducts or increase its costs.***

                Laws and regulations governingtelecommunications, electronic commerce and the Internet are beginning toemerge, but remain largely unsettled, even in the areas where there has beensome legislative action. Regulation may focus on, among other things, assessingaccess or settlement charges, or imposing tariffs or regulations based on thecharacteristics and quality of products, either of which could restrict theCompany’s business or increase its cost of doing business. Any changes toexisting laws or the adoption of new regulations by federal or state regulatoryauthorities or any legal challenges to existing laws or regulations relating tothe telecommunications industry could materially adversely affect the marketfor the Company’s products. Moreover, the Company’s VARs or other customers mayrequire, or the Company may otherwise deem it necessary or advisable, that theCompany alter its products to address actual or anticipated changes in theregulatory environment. The Company’s inability to alter its products oraddress any regulatory changes could have a material adverse effect on itsbusiness, financial condition or results of operations.

***Provisions in the Company’s corporatecharter may discourage takeover attempts and, thus, depress the market price ofthe common stock.***

                Provisions in the Company’sCharter may have the effect of delaying or preventing a change of control orchanges in the Company’s management or Board of Directors. These provisionsinclude:

**•**   the right of the Board of Directors, withoutstockholder approval, to issue shares of preferred stock and to establish thevoting rights, preferences, and other terms thereof;

 

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**•**   theright of the Board of Directors to elect a director to fill a vacancy createdby the expansion of the Board of Directors;

**•**   theability of the Board of Directors to alter the Company’s by-laws without priorstockholder approval;

**•**   theelection of three classes of directors to each serve three-year staggeredterms;

**•**   theelimination of stockholder voting by consent;

**•**   theremoval of directors only for cause;

**•**   thevesting of exclusive authority in the Board of Directors (except as otherwiserequired by law) to call special meetings of stockholders; and

**•**   certainadvance notice requirements for stockholder proposals and nominations forelection to the Board of Directors.

                These provisions discouragepotential takeover attempts and the ability of stockholders to changemanagement and the Board of Directors. These anti-takeover measures couldadversely affect the market price of the Company’s common stock. In addition,even if you desired to participate in a tender offer, change of control ortakeover attempt of the Company that the Company’s management and Board of Directorsopposed, these provisions may prevent you from doing so.

***Limitations on the Company’s ability toadequately protect its proprietary rights may prevent it from retaining itscompetitive advantage and negatively impact its future operating results.***

                The Company’s success and itsability to compete are dependent, in part, upon its proprietary technology.Taken as a whole, the Company believes its intellectual property rights aresignificant and any failure to adequately protect the unauthorized use of itsproprietary rights could result in the Company’s competitors offering similarproducts, potentially resulting in loss of a competitive advantage anddecreased revenue. The Company relies upon a combination of patents, trademarklaw, trade secret protections, copyright law and confidentiality agreementswith consultants and third parties to protect its proprietary rights.Notwithstanding its efforts, third parties may infringe or misappropriate theCompany’s proprietary rights. In addition, each employee of the Company hasexecuted a proprietary information agreement designed to protect the tradesecrets of the Company, inventions created in the course of employment with theCompany and other proprietary information of the Company. Moreover, effective patent,trademark, copyright or trade secret protections may not be available in everycountry in which the Company operates or intends to operate to the same extentas the laws of the United States. Also, it may be possible for unauthorizedthird parties to copy or reverse engineer aspects of the Company’s products,develop similar technology independently or otherwise obtain and useinformation that the Company regards as proprietary. Furthermore, detectingunauthorized use of the Company’s proprietary rights is difficult. Litigationmay be necessary in the future to enforce the Company’s proprietary rights.Such litigation could result in the expenditure of significant financial andmanagerial resources and could have a material adverse effect on the Company’sfuture operating results.

***Intellectual property claims against theCompany can be costly and negatively impact the Company’s business.***

                In the telecommunicationsbusiness, there is frequent litigation based on allegations of patentinfringement. As the number of entrants in the Company’s market increases andthe functionality of its products is enhanced and overlaps with the products ofother companies, the Company may become subject to claims of infringement ormisappropriation of the intellectual property rights of others. As a result,from time to time, third parties may claim exclusive patent or otherintellectual property rights to technologies that the Company uses. Althoughthe Company believes that it does not face material liability related to infringementof the intellectual property of others, any claims asserting that the Company’sproducts infringe or may infringe proprietary rights of third parties, ifdetermined adversely to the Company, could have a material adverse effect onits business, financial condition or results of operations. Any claims, with orwithout merit, could be time-consuming, result in costly litigation, divert theefforts of the Company’s engineering and management personnel, cause delays inproduct shipments or require the Company to enter into royalty or licensingagreements, any of which could have a material adverse effect upon theCompany’s operating results. If any legal action claiming patent infringementis commenced against it, the Company cannot assure you that it would prevail insuch litigation given the complex technical issues and inherent uncertaintiesin patent litigation. In addition, the Company may be required to obtain alicense or royalty agreement under the intellectual property rights of thoseparties claiming the infringement. In the event a claim against the Company wassuccessful, and it could not obtain a license on acceptable terms or license asubstitute technology or redesign to avoid infringement, the Company may beunable to market its affected products. This could have a material adverseeffect on the Company’s business, financial condition and results ofoperations.

***Certain of the Company’s products dependupon the continued availability of licensed technology from third parties.***

                The Company currently licensesand will continue to license certain technology integral to certain of itsproducts from third parties. For example, the Company has obtained licensesfrom third parties for software for certain of its voice and fax products.While the Company believes that much of this technology is available frommultiple sources, any difficulties in acquiring third-party technologylicenses, or integrating the related third-party technology into its products,could result in delays in product development or upgrade until equivalenttechnology can be identified, licensed and integrated.

                The Company may require newlicenses in the future as its business grows and technology evolves. TheCompany cannot assure you that these licenses will continue to be available toit on commercially reasonable terms, if at all, which could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

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***If the Company is unable to attract orretain key personnel, it may be unable to successfully operate its business.***

                The Company’s success depends inlarge part upon the continued contributions of its key management, sales andmarketing, and engineering personnel, many of who perform important functionsand would be difficult to replace. The Company does not have employmentcontracts with its key personnel. There has been intense competition in theCompany’s industry for qualified personnel, and, at times, the Company hasexperienced difficulty in recruiting qualified personnel. The Company may notbe able to attract and retain the necessary personnel to accomplish itsbusiness objectives, and it may experience constraints that will adverselyaffect its ability to satisfy customer demand in a timely fashion or to supportits customers and operations. The Company’s inability to hire qualifiedpersonnel on a timely basis, or to retain its key personnel, could materiallyadversely affect the Company’s business, financial condition and results ofoperations.

***The Company’s products typically have longsales cycles, causing the Company to expend significant resources beforerecognizing revenue.***

                The length of the Company’ssales cycle typically ranges from six to eighteen months and variessubstantially from customer to customer. Prospective customers generally mustcommit significant resources to test and evaluate the Company’s products andintegrate them into larger systems. This evaluation period is often prolongeddue to delays associated with approval processes that typically accompany thedesign and testing of new communications equipment by the Company’s customers.

                In addition, the rapidlyemerging and evolving nature of the markets in which the Company and itscustomers compete may cause prospective customers to delay their purchasedecisions as they evaluate new technologies and develop and implement newsystems. During the period in which the Company’s customers are evaluatingwhether to place an order with the Company, it often incurs substantial salesand marketing expenses, without any assurance of future orders or their timing.Even after a customer places an order with the Company and its product isexpected to be utilized in a product or service offering being developed by ourcustomer, the timing of the development, introduction and implementation ofthose products is controlled by, and can vary significantly with the needs of,the Company’s customers. In some circumstances, the customer will not requirethe product for several months. This complicates the Company’s planningprocesses and reduces the predictability of the Company’s earnings.

***The Company derives a significant portionof its revenue from international sales; international business operationsentail additional risks.***

                Risks arising from the Company’sinternational business include currency fluctuation, political instability inother countries, the imposition of trade and tariff regulations by foreigngovernments, and the difficulties in managing operations across disparategeographic areas. In addition, most countries require technical approvals fromtheir telecommunications regulatory agencies for products that operate inconjunction with the telephone system. Obtaining these approvals is generally aprerequisite for sales in a given jurisdiction. Obtaining requisite approvalsmay require from two months to a year or more depending on the product and thejurisdiction. These or other factors may limit the Company’s ability to sellits products in other countries, which could have a material adverse effect onthe Company’s business, financial condition and results of operations.

**Item3.  Quantitative and Qualitative Disclosures about Market Risk**

                Readers are referred to theCompany’s Annual Report on Form 10-K for the year ended December 31, 2001 foradditional information.  No significantchanges have occurred to the Company’s assessment of market risk.

**PART II.  OTHERINFORMATION**

 **Item 6.  Exhibits and Reports onForm 8-K**

                (a)Exhibits

 
|   |                                                                                                                                                                                                                                                                                                                     |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1    | Amended and Restated  By-laws of the Company are hereby incorporated by reference from Exhibit 3.4  to the Company’s Annual Report on Form 10-K for the fiscal year ended  December 31, 2001 filed with the SEC on March 25, 2002 (File No. 000-20698).                                                             |
|   |                                                                                                                                                                                                                                                                                                                     |
| 4.1    | Amendment No. 1 to  Shareholder Rights Agreement, dated as of March 1, 2002, between Brooktrout,  Inc., State Street Bank and Trust Company, as Rights Agent, and EquiServe  Trust Company, N.A. as successor Rights Agent, is hereby incorporated by  reference from Exhibit 4.2 to the Company’s Annual Report on |

 

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|   | Form 10-K for the fiscal  year ended December 31, 2001 filed with the SEC on March 25, 2002 (File No.  000-20698).                                                                                                                                                                |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                              |
| 10.1   | Brooktrout, Inc. Amended  and Restated 1992 Stock Incentive Plan is hereby incorporated by reference  from Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the fiscal  year ended December 31, 2001 filed with the SEC on March 25, 2002 (File No.  000-20698). |

 

(b)Reports on Form 8-K

None.

 

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 **SIGNATURES**

                Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
| BROOKTROUT, INC.     |
|---------------------------|
|                      |   |   |
|  Date: May 15,  2002 | By: | /s/ ERIC R.  GILER |
|                      |   | Eric R. Giler *President (Principal Executive Officer)* |
|                      |   |   |
|  Date: May 15,  2002 | By: | /s/ ROBERT  C. LEAHY |
|                      |   | Robert C. Leahy

*Vice  President of Finance and*

*Operations,  and Treasurer*

*(Principal  Financial and Accounting Officer)* |

 

 

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