**UNITEDSTATES********SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Markone)**

 

| ** **                                                                                                                                                                                                                                                          | **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                |
| **For the quarterly period ended June 30,  2004**                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                |
| **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 of Registrant as Specified in Its Charter)

 

| **MASSACHUSETTS**                                                                | ** ** | **04-2814792**                       |
|----------------------------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation or  Organization)                  |       | (I.R.S. Employer Identification No.) |
|                                                                             |       |                                 |
| **250 FIRST AVENUE, NEEDHAM, MASSACHUSETTS 02494**                               |
| (Address of Principal Executive Offices) (Zip Code)                              |
|                                                                             |       |                                 |
| Registrant’s Telephone Number, Including Area Code: **(781) 449-4100** |

 

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 of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes ý       No o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes ý       No o

 

Asof July 30, 2004,13,001,985 shares of common stock, $.01 par value per share, wereoutstanding.

 

 

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**BROOKTROUT, INC.FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2004**

 

**TABLE OF CONTENTS**

 
| **PART I  FINANCIAL INFORMATION** | ­Pag­­­e                                                                                                                              |
|----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.                                | Condensed Consolidated Financial Statements                                                                                                               | 1 |
|                                   | Unaudited Condensed Consolidated Balance Sheets as of June 30,  2004 and December 31, 2003                                                      | 1 |
|                                   | Unaudited Condensed Consolidated Statements  of Operations for the Three and Six Months Ended June 30, 2004 and  June 30, 2003                  | 2 |
|                                   | Unaudited Condensed Consolidated Statements  of Comprehensive Income (Loss) for the Three and Six Months Ended  June 30, 2004 and June 30, 2003 | 3 |
|                                   | Unaudited Condensed Consolidated Statements of Cash Flows for the Six  Months Ended June 30, 2004 and June 30, 2003                             | 4 |
|                                   | Notes to Unaudited Condensed Consolidated  Financial Statements                                                                                           | 5 |
| Item 2.                                | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                               | 11 |
|                                   | Overview                                                                                                                                                  | 11 |
|                                   | Application of Critical Accounting Policies                                                                                                               | 11 |
|                                   | Results of Operations                                                                                                                                     | 12 |
|                                   | Liquidity and Capital Resources                                                                                                                           | 17 |
|                                   | Factors That May Affect Future Results                                                                                                                    | 19 |
| Item 3.                                | Quantitative and Qualitative Disclosures  About Market Risk                                                                                               | 27 |
| Item 4.                                | Controls and Procedures                                                                                                                                   | 27 |
|                                   |                                                                                                                                                      |   |
| **PART II OTHER INFORMATION**          |                                                                                                                                                      |
| Item 2.                                | Changes in Securities, Use of Proceeds and  Issuer Purchases of Equity Securities                                                                         | 28 |
| Item 4.                                | Submission  of Matters to a Vote of Security Holders                                                                                                      | 28 |
| Item 6.                                | Exhibits and Reports on Form 8-K                                                                                                                          | 29 |
|                                   | Signatures                                                                                                                                                | 31 |
|                                   | Exhibit  Index                                                                                                                                            | 32 |

 

“BROOKTROUT”and the “NEW NETWORK” are trademarks or registered trademarks of Brooktrout,Inc.

 

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**PART IFINANCIAL INFORMATION**

 

**Item 1.****Condensed Consolidated Financial Statements**

 

**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATED BALANCESHEETS***(in thousands, exceptshare and per share data)*

 
| ** **                                                                                                                                                                                                             | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                                             |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                        |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                              |       | $                       | 21,382     |                        | $          | 28,081 |   |
| Marketable debt securities                                                                                                                                                                                             |       | 28,926                  |       | 27,869                      |       |
| Accounts receivable (less allowances for doubtful  accounts and sales returns of $847 at June 30, 2004 and $843 at  December 31, 2003)                                                                       |       | 9,196                   |       | 10,232                      |       |
| Inventory                                                                                                                                                                                                              |       | 4,423                   |       | 4,465                       |       |
| Income tax receivable                                                                                                                                                                                                  |       | 74                      |       | 433                         |       |
| Deferred tax assets                                                                                                                                                                                                    |       | 4,312                   |       | 3,830                       |       |
| Prepaid expenses and other current assets                                                                                                                                                                              |       | 2,337                   |       | 2,354                       |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Total current assets                                                                                                                                                                                                   |       | 70,650                  |       | 77,264                      |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Equipment and furniture, less accumulated  depreciation                                                                                                                                                                |       | 2,424                   |       | 2,245                       |       |
| Deferred tax assets                                                                                                                                                                                                    |       | 14,402                  |       | 9,413                       |       |
| Intangible assets, less accumulated amortization                                                                                                                                                                       |       | 6,200                   |       | 5,909                       |       |
| Other assets, less accumulated amortization                                                                                                                                                                            |       | 1,999                   |       | 1,748                       |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Total assets                                                                                                                                                                                                           |       | $                       | 95,675     |                        | $          | 96,579 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                          |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                                   |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                       |       | $                       | 5,061      |                        | $          | 5,350 |   |
| Accrued expenses and other                                                                                                                                                                                             |       | 5,318                   |       | 5,128                       |       |
| Accrued compensation and commissions                                                                                                                                                                                   |       | 2,328                   |       | 2,405                       |       |
| Accrued warranty costs                                                                                                                                                                                                 |       | 1,197                   |       | 1,138                       |       |
| Customer deposits                                                                                                                                                                                                      |       | 726                     |       | 758                         |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Total current liabilities                                                                                                                                                                                              |       | 14,630                  |       | 14,779                      |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Deferred rent and other long-term liabilities                                                                                                                                                                          |       | 132                     |       | 146                         |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Total liabilities                                                                                                                                                                                                      |       | 14,762                  |       | 14,925                      |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Commitments and contingencies (Note 8)                                                                                                                                                                                 |       |                    |       |                        |       |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                             |       |                    |       |                        |       |
| Preferred stock, $1.00 par value; authorized  100,000 shares; issued and outstanding, none                                                                                                                             |       | —                  |       | —                      |       |
| Common stock, $0.01 par value; authorized  80,000,000 shares at June 30, 2004 and 40,000,000 shares at December 31,  2003; issued 13,344,329 at June 30, 2004 and 12,937,019 at  December 31, 2003 |       | 133                     |       | 129                         |       |
| Additional paid-in capital                                                                                                                                                                                             |       | 71,285                  |       | 68,270                      |       |
| Accumulated other comprehensive loss                                                                                                                                                                                   |       | (169                    | )          | (45                         | )          |
| Notes receivable — officers                                                                                                                                                                                       |       | (9,845                  | )          | (9,845                      | )          |
| Retained earnings                                                                                                                                                                                                      |       | 24,197                  |       | 26,942                      |       |
| Treasury stock, 348,237 shares at June 30,  2004 and 260,386 shares at December 31, 2003, at cost                                                                                                            |       | (4,688                  | )          | (3,797                      | )          |
|                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Total stockholders’ equity                                                                                                                                                                                        |       | 80,913                  |       | 81,654                      |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                        |       | $                       | 95,675     |                        | $          | 96,579 |   |

 

See notes to unaudited condensed consolidatedfinancial statements.

 

1

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**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS***(in thousands, except pershare data)*

 
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                           | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                              |       | $                                     | 19,193     |                                | $          | 17,390 |   | $ | 37,886 |   | $ | 32,924 |   |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Costs and expenses:                  |       |                                  |       |                                |       |   |   |   |   |
| Cost of product sold                 |       | 6,306                                 |       | 6,270                               |       | 12,274 |   | 12,600 |   |
| Research and development             |       | 4,847                                 |       | 4,827                               |       | 9,332 |   | 9,413 |   |
| In-process research and development  |       | 2,490                                 |       | —                              |       | 2,490 |   | — |   |
| Selling, general and administrative  |       | 8,711                                 |       | 7,565                               |       | 16,829 |   | 14,834 |   |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Total costs and expenses             |       | 22,354                                |       | 18,662                              |       | 40,925 |   | 36,847 |   |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Operating loss                       |       | (3,161                                | )          | (1,272                              | )          | (3,039 | ) | (3,923 | ) |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Other income, net                    |       | 117                                   |       | 245                                 |       | 299 |   | 445 |   |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Loss before income taxes             |       | (3,044                                | )          | (1,027                              | )          | (2,740 | ) | (3,478 | ) |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Income tax (benefit) provision       |       | (117                                  | )          | (325                                | )          | 5 |   | (1,113 | ) |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Net loss                             |       | $                                     | (2,927     | )                                   | $          | (702 | ) | $ | (2,745 | ) | $ | (2,365 | ) |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Net loss per common share:           |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted                    |       | $                                     | (0.22      | )                                   | $          | (0.06 | ) | $ | (0.21 | ) | $ | (0.19 | ) |
|                                 |       |                                  |       |                                |       |   |   |   |   |
| Weighted average shares outstanding: |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted                    |       | 13,020                                |       | 12,286                              |       | 12,937 |   | 12,284 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

2

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**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OFCOMPREHENSIVE INCOME (LOSS)***(in thousands)*

 
| ** **                                                                        | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss                                                                          |       | $                                     | (2,927     | )                                   | $          | (702 | ) | $ | (2,745 | ) | $ | (2,365 | ) |
| Unrealized (losses) gains on marketable debt  securities, net of applicable taxes |       | (109                                  | )          | 2                                   |       | (112 | ) | 49 |   |
| Foreign currency translation adjustments                                          |       | (15                                   | )          | —                              |       | (12 | ) | — |   |
| Total other comprehensive (loss) income                                           |       | (124                                  | )          | 2                                   |       | (124 | ) | 49 |   |
| Comprehensive loss                                                                |       | $                                     | (3,051     | )                                   | $          | (700 | ) | $ | (2,869 | ) | $ | (2,316 | ) |

 

See notes to unaudited condensed consolidated financial statements.

 

3

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**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTSOF CASH FLOWS***(in thousands)*

 
| ** **                                                            | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                            | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| **Cash flows from operating activities:**                             |       |                               |       |   |   |
| Net loss                                                              |       | $                                  | (2,745     | ) | $ | (2,365 | ) |
| Adjustments to reconcile net loss to cash from  operating activities: |       |                               |       |   |   |
| In-process research and development                                   |       | 2,490                              |       | — |   |
| Depreciation and amortization                                         |       | 1,260                              |       | 1,732 |   |
| Amortization of purchased and licensed technology                     |       | 349                                |       | 333 |   |
| Inventory obsolescence expense                                        |       | 275                                |       | 527 |   |
| Provision for doubtful accounts and sales returns                     |       | 33                                 |       | (167 | ) |
| Deferred income taxes                                                 |       | (50                                | )          | — |   |
| Increase (decrease) in cash from changes in:                          |       |                               |       |   |   |
| Accounts receivable                                                   |       | 1,188                              |       | 1,373 |   |
| Inventory                                                             |       | (142                               | )          | 689 |   |
| Prepaid expenses and other assets                                     |       | 365                                |       | 4,659 |   |
| Current and other liabilities                                         |       | (1,083                             | )          | (2,718 | ) |
|                                                                  |       |                               |       |   |   |
| Cash flows from operating activities                                  |       | 1,940                              |       | 4,063 |   |
|                                                                  |       |                               |       |   |   |
| **Cash flows from investing  activities:**                            |       |                               |       |   |   |
| Sales and maturities of marketable debt securities                    |       | 14,463                             |       | 7,263 |   |
| Purchases of marketable debt securities                               |       | (15,698                            | )          | (18,083 | ) |
| Acquisition of subsidiary, net of cash acquired                       |       | (8,255                             | )          | — |   |
| Expenditures for equipment and furniture                              |       | (678                               | )          | (259 | ) |
| Purchased and licensed technology                                     |       | (599                               | )          | — |   |
|                                                                  |       |                               |       |   |   |
| Cash flows from investing activities                                  |       | (10,767                            | )          | (11,079 | ) |
|                                                                  |       |                               |       |   |   |
| **Cash flows from financing  activities:**                            |       |                               |       |   |   |
| Exercises of stock options                                            |       | 2,982                              |       | 142 |   |
| Purchase of treasury stock                                            |       | (854                               | )          | — |   |
|                                                                  |       |                               |       |   |   |
| Cash flows from financing activities                                  |       | 2,128                              |       | 142 |   |
|                                                                  |       |                               |       |   |   |
| Decrease in cash and cash equivalents                                 |       | (6,699                             | )          | (6,874 | ) |
| Cash and cash equivalents, beginning of period                        |       | 28,081                             |       | 23,685 |   |
|                                                                  |       |                               |       |   |   |
| Cash and cash equivalents, end of period                              |       | $                                  | 21,382     |   | $ | 16,811 |   |
|                                                                  |       |                               |       |   |   |
| Supplemental schedule of cash flow  information:                 |       |                               |       |   |   |
| Tax refunds received                                                  |       | $                                  | 323        |   | $ | 6,040 |   |
| Tax payments                                                          |       | $                                  | 43         |   | $ | 34 |   |
| Non-cash activities:                                                  |       |                               |       |   |   |
| Common stock received for exercise of stock  options                  |       | $                                  | 37         |   | $ | 36 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

4

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1.Description of Business and Summary of Significant Accounting Policies andPractices**

 

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

 

Brooktrout, Inc. (the “Company” or “Brooktrout”) develops,manufactures and sells software and hardware products that enable thedevelopment of communications systems and services. The Company sells its productsto system vendors, service providers, enterprise customers, original equipmentmanufacturers, and value-added resellers, both domestically andinternationally, through a direct sales force and a two-tiered distributionsystem. The Company’s operations consist of one reportable segment.

 

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

 

Accounting policies, methods and estimates are an integral part of thecondensed consolidated financial statements and are based upon management’scurrent judgments. These policies, methods, and estimates affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the reporting periods. The judgments made by managementare based on their knowledge and experience with regard to past and currentevents and assumptions about future events that are believed to be reasonableunder the circumstances. Management evaluates these estimates and assumptionsand adjusts them if expectations concerning events, including future events,affecting them differ markedly from their original expectations.

 

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

 

The accompanying unaudited condensed consolidated financial statementshave been prepared by the Company pursuant to the rules and regulations of theSecurities and Exchange Commission regarding interim financial reporting. Theseunaudited condensed consolidated financial statements should be read inconjunction with the audited consolidated financial statements included in theCompany’s Annual Report on Form 10-K for the fiscal year endedDecember 31, 2003.

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared on the same basis as the audited consolidated financial statements andinclude all adjustments, consisting only of normal recurring adjustments,necessary for a fair presentation of the interim periods presented. Theconsolidated 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 is recognized upon shipment to the customer(which constitutes delivery), provided that persuasive evidence of anarrangement exists, the fee is fixed or determinable, and collection isreasonably assured. To the extent that one or more of these conditions are notmet, which has occurred from time to time, revenue is deferred until such timeas all four criteria are met. Revenue from sales to certain distributors isrecognized on a “sell-through” basis, that is, when the distributors report tothe Company that resale of the product to the ultimate customer of thedistributor has occurred. If the Company receives a payment from a customerprior to meeting all of the revenue recognition criteria, the payment is recordedas a customer deposit or deferred revenue. The Company records a provision forestimated sales returns and allowances on product sales in the same period asthe related revenue is recorded. These estimates are based on historical salesreturns, analysis of credit memo data and other known factors.

 

5

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

***(e) Stock-Based Compensation***

 

The Company uses the intrinsic value method to measure compensationexpense associated with the grants of stock options or awards to employees. TheCompany accounts for stock options and awards to non-employees using the fairvalue method.

 

Under the intrinsic value method, compensation associated with stockawards to employees is determined as the excess, if any, of the current fairvalue of the underlying common stock on the date compensation is measured overthe price an employee must pay to exercise the award. The measurement date foremployee awards is generally the date of grant. Under the fair value method,compensation associated with stock awards to non-employees is determined basedon the estimated fair value of the award itself, measured using either currentmarket data or an established option pricing model. The measurement date fornon-employee awards is generally the date that performance of services iscomplete.

 

Had the Company used the fair value method to measure compensationrelated to stock awards to employees, reported net loss and net loss per sharewould have been as follows:

 
| **(in  thousands, except per share data)**         | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                         | **2004**   | ** **                            | **2003**   | ** **                          | **2004**   | ** ** | **2003** | ** ** |
|                                               |       |                                  |       |                                |       |   |   |   |   |
| Net loss, as reported                              |       | $                                     | (2,927     | )                                   | $          | (702 | ) | $ | (2,745 | ) | $ | (2,365 | ) |
| Stock-based compensation recorded                  |       | —                                |       | —                              |       | — |   | — |   |
| Pro forma stock-based compensation, net of tax     |       | (1,094                                | )          | (952                                | )          | (2,481 | ) | (1,888 | ) |
|                                               |       |                                  |       |                                |       |   |   |   |   |
| Net loss, pro forma                                |       | $                                     | (4,021     | )                                   | $          | (1,654 | ) | $ | (5,226 | ) | $ | (4,253 | ) |
|                                               |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted loss per common share, pro forma |       | $                                     | (.31       | )                                   | $          | (.13 | ) | $ | (.40 | ) | $ | (.35 | ) |

 

Basicweighted average shares outstanding were used in calculating the pro forma netloss per common share since the use of diluted weighted average shares wouldhave had an anti-dilutive effect.

 

Forpurposes of determining the disclosures provided above, the fair value ofoptions on their grant date and grants made under the Company’s Employee StockPurchase Plan (the “Purchase Plan”) are measured using the Black-Scholesoption-pricing model. Key assumptions used to apply this pricing model were asfollows:

 
| ** **                              | ** ** | **2004**        | ** ** | **2003**          | ** ** |
|-----------------------------------------|------------|-----------------|------------|-------------------|------------|
| ** **                              | ** ** | **Option Plan** | ** ** | **Purchase Plan** | ** ** | **Option Plan** | ** ** | **Purchase Plan** | ** ** |
| Risk-free interest rate                 |       | 4.1             | %          | 1.6               | %          | 2.5 | % | 1.0 | % |
| Expected life (years)                   |       | 5.6             |       | .5                |       | 5.5 |   | .5 |   |
| Expected volatility of underlying stock |       | 87              | %          | 84                | %          | 88 | % | 49 | % |

 

Theestimated weighted average fair value of options granted during the threemonths ended June 30, 2004 and 2003 was $8.03 and $4.10,respectively.  The estimated weighted average fair value of optionsgranted during the six months ended June 30, 2004 and 2003 was $8.54 and$3.84, respectively.  The estimatedweighted average fair value per share of grants made under the Purchase Planduring the six months ended June 30, 2004 and 2003 was $2.42 and $0.70,respectively.

 

***(f) Earnings Per Share***

 

Basicearnings per common share is computed using the weighted average number of common sharesoutstanding during each period. Diluted earnings per common share is calculatedby dividing the net income by the sum of the weighted average number of commonshares outstanding and all additional common shares that would have beenoutstanding if potentially dilutive securities had been issued, using thetreasury method.

 

6

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

                Stock options to purchase 3,625,955 shareswere excluded from the computation of diluted earnings per share in the threeand six months ended June 30, 2004, because of their anti-dilutiveeffect.  Stock options to purchase3,500,534 shares were excluded from the computation of diluted earnings pershare in the three and six months ended June 30, 2003, because of theiranti-dilutive effect.

 

***(g) Reclassifications***

 

Certainamounts in the 2003 unaudited condensed consolidated financial statements havebeen reclassified to conform to the 2004 presentation.

 

**2.Acquisition**

 

On April 5, 2004, the Company acquired the outstanding capitalstock of SnowShore Networks, Inc. (“SnowShore”) pursuant to the terms of anAgreement and Plan of Merger entered into on March 25, 2004. SnowShore,now a wholly owned subsidiary, is a leading-edge provider of software andhardware for voice over IP communications systems.  SnowShore was acquired to expand the Company’svoice over IP product offerings specifically for the media server and mediafirewall markets.   The purchase pricefor the outstanding capital stock of SnowShore was $9.0 million, paid in cash,plus $0.2 million of transaction costs.

 

The acquisition has been accounted for as a purchase, and accordingly,the results of operations of SnowShore have been included in the Company’scondensed consolidated financial statements from the date of acquisition. Thepurchase price has been allocated to the assets acquired based on their fairvalues using an independent appraisal. The purchase price is subject to finalization and could change.  The fair value of the assets acquired andliabilities assumed exceeded the purchase price due primarily to deferred taxassets acquired.  These assets were notrealizable by SnowShore and therefore had zero value to SnowShore.  The resulting negative goodwill related tothis transaction resulted in a pro rata reduction in the identified long-livedassets purchased. This reduction has been reflected in the asset valuescontained in the table below. The following is a summary of the purchase priceallocation:

 
| ** **                                                      | ** ** | **(in thousands)** | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|
|                                                            |       |               |       |
| Cash paid                                                       |       | $                  | 9,000      |   |
| Acquisition-related costs                                       |       | 220                |       |
| Total purchase price                                            |       | $                  | 9,220      |   |
|                                                            |       |               |       |
| Cash and cash equivalents                                       |       | $                  | 965        |   |
| Accounts receivable                                             |       | 185                |       |
| Inventory                                                       |       | 91                 |       |
| Prepaid and other assets                                        |       | 36                 |       |
| Equipment and furniture                                         |       | 122                |       |
| Intangible assets                                               |       | 930                |       |
| Deferred tax assets, net of valuation allowances  of $ 755 |       | 5,346              |       |
| In-process research and development                             |       | 2,490              |       |
| Accounts payable, accrued expenses and other  liabilities       |       | (714               | )          |
| Accrued compensation and commissions                            |       | (231               | )          |
| Total                                                           |       | $                  | 9,220      |   |

 

Of the $0.9 million of acquired intangible assets, $0.7 million wasassigned to patents (10-year weighted average useful life) and the remaining$0.2 million was assigned to completed technology, trademarks and customerlists (4-year weighted average useful life).

 

7

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

 

The Company recorded a charge of $2.5 million in the second quarter of2004 for purchased in-process technology related to development projects thathave not reached technological feasibility, have no alternative future use, andfor which successful development was uncertain. The value of thepurchased in-process research and development was computed by determining thepresent value of the project’s future economic benefits from future revenuesnet of anticipated costs and expenses.  Adiscount rate of 25% was used in this calculation and was derived based on theestimated weighted average cost of capital as adjusted to reflect theadditional risk inherent in product development.  At the time of the acquisition, the projectwas approximately 40% complete. The Company estimates the projects will requirean additional spending of $0.6 million to complete, with estimated completiondate of December 31, 2004.

 

The following pro forma financial summary is presented as if theacquisition of SnowShore was completed at the beginning of each periodpresented.  The pro forma revenue, netloss, and basic and diluted net loss per common share for the three monthsended June 30, 2004, would not have been materially different from theamounts reported in the unaudited condensed consolidated statements ofoperations if this acquisition had taken place on April 1, 2004 becausethe acquisition occurred on April 5, 2004.

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue                                     |       | $                                     | 19,200     |                                | $          | 17,911 |   | $ | 38,300 |   | $ | 33,578 |   |
| Net loss                                    |       | $                                     | (2,900     | )                                   | $          | (1,753 | ) | $ | (3,300 | ) | $ | (4,444 | ) |
| Basic and diluted net loss per common share |       | $                                     | (0.22      | )                                   | $          | (0.14 | ) | $ | (0.26 | ) | $ | (0.36 | ) |

 

**3.Marketable Debt Securities**

 

Marketabledebt securities consisted of the following:

 
| ** **                                              | ** ** | **Amortized  Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Market  Value** | ** ** |
|---------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                              | ** ** | **(in thousands)**  | ** ** |
| June 30, 2004:                                     |       |                |       |                  |       |                   |       |              |       |
| U.S. government notes and bonds                         |       | $                   | 15,123     |                  | $          | —                 |       | $                 | (49        | ) | $ | 15,074 |   |
| Corporate debt securities and  foreign investments |       | 13,943              |       | —                |       | (91                    | )          | 13,852            |       |
|                                                    |       | $                   | 29,066     |                  | $          | —                 |       | $                 | (140       | ) | $ | 28,926 |   |
|                                                    |       |                |       |                  |       |                   |       |              |       |
| December 31, 2003:                                 |       |                |       |                  |       |                   |       |              |       |
| U.S. government notes and bonds                         |       | $                   | 13,789     |                  | $          | 22                     |       | $                 | (2         | ) | $ | 13,809 |   |
| Corporate debt securities and  foreign investments |       | 14,042              |       | 27                    |       | (9                     | )          | 14,060            |       |
|                                                    |       |                |       |                  |       |                   |       |              |       |
|                                                    |       | $                   | 27,831     |                  | $          | 49                     |       | $                 | (11        | ) | $ | 27,869 |   |

 

Realizedgains and losses from the sale of available-for-sale securities are determinedon a specific identification basis. Realized gains from the sale of marketable debt securities for the sixmonths ended June 30, 2004 were immaterial.  As of June 30, 2004 andDecember 31, 2003, the remaining maturities of debt securities ranged fromone month to approximately two years.

 

8

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

 

**4.Inventory**

 

Thecomponents of inventory, net of reserves, consisted of the following:

 
| ** **      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **      | ** ** | **(in thousands)**      | ** ** |
| Raw materials   |       | $                       | 816        |                        | $          | 569 |   |
| Work in process |       | 406                     |       | 373                         |       |
| Finished goods  |       | 3,201                   |       | 3,523                       |       |
|            |       |                    |       |                        |       |
| Total           |       | $                       | 4,423      |                        | $          | 4,465 |   |

 

Thefollowing is a rollforward of reserves provided for inventory obsolescence:

 
| ** **                       | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(in thousands)**                 | ** ** |
| Balance, beginning of the period |       | $                                  | 4,379      |   | $ | 3,909 |   |
| Provisions                       |       | 275                                |       | 527 |   |
| Write offs                       |       | (1,059                             | )          | (297 | ) |
| Other                            |       | 29                                 |       | — |   |
|                             |       |                               |       |   |   |
| Balance, end of period           |       | $                                  | 3,624      |   | $ | 4,139 |   |

 

Other changes in the reserves provided for inventory obsolescencerelate to amounts recorded in connection with the acquisition of SnowShore (seeNote 2).

 

**5.Valuation and Qualifying Accounts**

 

***Allowances for doubtful accounts and sales returns:***

 

Thefollowing is a rollforward of allowances provided for doubtful accounts andsales returns:

 
| ** **                       | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(in thousands)**                 | ** ** |
| Balance, beginning of the period |       | $                                  | 843        |   | $ | 1,679 |   |
| Provisions                       |       | 33                                 |       | (167 | ) |
| Write offs                       |       | (27                                | )          | (113 | ) |
| Recoveries                       |       | 42                                 |       | — |   |
| Rebate payments to customers     |       | (118                               | )          | (161 | ) |
| Other                            |       | 74                                 |       | — |   |
|                             |       |                               |       |   |   |
| Balance, end of period           |       | $                                  | 847        |   | $ | 1,238 |   |

 

Other changes in allowances provided for doubtful accounts andsales returns relate to amounts recorded in connection with the acquisition ofSnowShore (see Note 2).

 

9

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**BROOKTROUT, INC.**

**NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

 

***Accrued warranty costs:***

 

The following is a rollforward of accrued warranty costs:

 
| ** **                       | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------|------------|------------------------------------|------------|
| ** **                       | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(in thousands)**                 | ** ** |
| Balance, beginning of the period |       | $                                  | 1,138      |   | $ | 1,060 |   |
| Provisions for claims            |       | 164                                |       | 74 |   |
| Claims incurred                  |       | (117                               | )          | (59 | ) |
| Other                            |       | 12                                 |       | — |   |
|                             |       |                               |       |   |   |
| Balance, end of period           |       | $                                  | 1,197      |   | $ | 1,075 |   |

 

Other changes in accrued warranty costs relate to amountsrecorded in connection with the acquisition of SnowShore (see Note 2).

 

**6.Stockholders’ Equity**

 

On October 16, 2003, the Company’s Board of Directors authorizedthe repurchase of up to 1,000,000 shares of the Company’s common stock fromtime to time on the open market or in privately negotiated transactions. Underthe program, shares may be repurchased prior to October 15, 2004 and insuch amounts as market conditions warrant, and subject to regulatory and otherconsiderations. The Company plans to use the repurchased shares for generalcorporate purposes including the Company’s stock option plans, employee stockpurchase plan and other stock benefit plans. In the three months endedJune 30, 2004, the Company repurchased 86,000 shares of common stock onthe open market for approximately $0.9 million.

 

**7. SegmentReporting**

 

The Company’s operations consist of onereportable segment.

 

*Major Customers*—The Company has one customerthat generates more than 10% of total revenue. This customer accounted forapproximately 15% and 17% of revenue for the three months ended June 30,2004 and 2003, respectively. In both of the six month periods endedJune 30, 2004 and 2003, the customer accounted for approximately 16% ofrevenue.

 

*International Sales*—International sales,principally exports from the United States, accounted for approximately 19% and20% of revenue for the three months ended June 30, 2004 and 2003,respectively. For the six months ended June 30, 2004 and 2003,international sales accounted for approximately 21% and 24% of revenue,respectively.

 

**8.Commitments and Contingencies**

 

From time to time, the Company is a party to legal and other actions,which may include allegations of patent infringement made against us and/or ourcustomers that arise in the normal course of business. The Company, taking intoaccount advice of counsel, does not currently believe the eventual outcome ofany such pending or potential matters, including matters in which we may havean obligation on behalf of our customers, will have a material effect on theCompany’s consolidated financial position or results of operations.

 

10

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**Item 2.****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**Overview**

 

We develop software and hardware platforms that original equipmentmanufacturers, or OEMs, developers and corporate information technologymanagers build into their communications systems. Customers incorporate ourproducts into applications, systems and services that allow voice, fax and datato be distributed over both Internet protocol, or IP,packet-based networks, which we refer to as the New Network, and thetraditional circuit-switched telephone network. We supply products for mediaprocessing, network interface, call control and signal processing, includingprotocols that allow Internet and traditional telephony systems to communicate.

 

We measure our operating success using both financial and marketmetrics. The financial metrics include revenue, gross profit, operatingexpenses, and income from continuing operations, as well as working capital andcash flows from operating activities. Key market metrics include the totalnumber of customers, customers whose purchases exceed $100,000, and the portionof our revenue that is generated by sales of products to enterprise and serviceprovider customers. Our long-term business model stresses our commitment toestablishing and maintaining close customer relationships, increasingpenetration of the telecommunications markets that we serve and continuing todevelop innovative products.

 

The most significant trend that has impacted our business has been theunfavorable economic conditions affecting the communications sector. Thisresulted in a decrease in our revenue from 2000 to 2002.  Furthermore, we experienced revenue decreasesfor the first two quarters of 2003 when compared to the corresponding quartersof 2002.  Sales of products, particularlyfor applications in the New Network, to OEMs for use by large serviceproviders declined most significantly over these periods. In response to therevenue decreases, we have implemented expense control programs to reduceoperating expenses, while we have continued to invest in developing productsthat we believe our customers will need when the economy further improves. Webelieve that the economic conditions in our industry generally have begun, atleast temporarily, to improve and that this improvement was reflected in ourrevenue for the first two quarters of 2004, which exceeded the revenue in thecorresponding quarters of 2003. We currently expect the revenue for the thirdquarter of 2004 to be similar to the revenue for the corresponding quarter of2003.

 

On April 5, 2004, we completed our acquisition of the outstandingcapital stock of SnowShore Networks, Inc., or SnowShore, for approximately $9.2million in cash.  SnowShore, now ourwholly owned subsidiary, is a provider of leading-edge voice over IPcommunications infrastructure products for the media server and media firewallmarkets.

 

Despite the general economic conditions, our $9.2 million acquisitionof SnowShore in April 2004, and our repurchase of $0.9 million in stock inMay 2004, our cash and cash equivalents and marketable debt securities balances increased $8.5 million from $41.8 million atDecember 31, 2002 to $50.3 million at June 30, 2004. This wasaccomplished primarily through cash flow from operations, bolstered by incometax refunds, operating expense reductions, and inventory reductions.  Ifeconomic conditions do not continue to improve or if they weaken again, we mayexperience adverse effects on our business, operating results, and cash andcash equivalents and marketable debt securities balances.

 

**Applicationof Critical Accounting Policies**

 

Management’s discussion and analysis of financial condition and resultsof operations is based upon our condensed consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America applicable to interim financialinformation. We make estimates and assumptions in the preparation of thecondensed consolidated financial statements that affect the reported amounts ofassets and liabilities, revenue and expenses, and the related disclosures ofcontingent assets and liabilities. These estimates form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. We base our estimates and judgments onhistorical experience and on various other assumptions that we believe arereasonable under the circumstances. However, actual results may differ fromthese estimates under different assumptions or conditions.

 

11

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We consider the following to be the critical accounting policies andareas where significant judgment is applied, which we believe an investorshould understand when assessing our financial reporting and performance:

 

•                  Revenuerecognition;

 

•                  Allowances fordoubtful accounts and for inventory obsolescence;

 

•                  Intangibleassets;

 

•                  Deferred incometaxes; and

 

•                  Accrued warrantycosts.

 

This is not intended to be a comprehensive list of all of oursignificant accounting policies.  Formore information on our critical accounting policies and on our significantaccounting policies in general, see the discussion on those policies in ourAnnual Report on Form 10-K for the year ended December 31, 2003 and Note 1to the condensed consolidated financial statements in Part 1, Item 1 of thisreport.

 

**Results of Operations**

 

The table below sets forth certain condensed consolidated statements ofoperations data as a percentage of total revenue for the periods presented:

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Domestic revenue                          |       | 81                                    | %          | 80                                  | %          | 79 | % | 76 | % |
| International revenue, principally export |       | 19                                    |       | 20                                  |       | 21 |   | 24 |   |
| Total revenue                             |       | 100                                   |       | 100                                 |       | 100 |   | 100 |   |
| Cost of product sold                      |       | 33                                    |       | 36                                  |       | 32 |   | 38 |   |
| Gross profit                              |       | 67                                    |       | 64                                  |       | 68 |   | 62 |   |
| Operating expenses:                       |       |                                  |       |                                |       |   |   |   |   |
| Research and development                  |       | 25                                    |       | 28                                  |       | 25 |   | 29 |   |
| In-process research and development       |       | 13                                    |       | —                              |       | 7 |   | — |   |
| Selling, general and administrative       |       | 45                                    |       | 43                                  |       | 44 |   | 45 |   |
| Total operating expenses                  |       | 83                                    |       | 71                                  |       | 76 |   | 74 |   |
| Operating loss                            |       | (16                                   | )          | (7                                  | )          | (8 | ) | (12 | ) |
| Other income, net                         |       | —                                |       | 1                                   |       | 1 |   | 1 |   |
| Loss before income taxes                  |       | (16                                   | )          | (6                                  | )          | (7 | ) | (11 | ) |
| Income tax (benefit) provision            |       | (1                                    | )          | (2                                  | )          | — |   | (4 | ) |
| Net loss                                  |       | (15                                   | )%         | (4                                  | )%         | (7 | )% | (7 | )% |

 

***Revenue***

 

*ThreeMonths Ended June 30, 2004 and 2003*

 

The following table presents our domestic and international revenue:

 

 
| ** **                                | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|
| ** **                                | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **(dollars in thousands)**           | ** ** |
| Domestic revenue                          |       | $                                    | 15,606     |   | 81 | % | $ | 13,861 |   | 80 | % |
| International revenue, principally export |       | 3,587                                |       | 19 |   | 3,529 |   | 20 |   |
|                                      |       |                                 |       |   |   |   |   |   |   |
| Total revenue                             |       | $                                    | 19,193     |   | 100 | % | $ | 17,390 |   | 100 | % |

 

12

----

 

Revenue in the three months ended June 30, 2004 was$19.2 million compared to $17.4 million in the corresponding periodof 2003, an increase of approximately 10%. This increase was primarily the result of increased sales to domesticchannel customers and value-added resellers and enterprise customers.  Many of our customers resumed spending oncommunications equipment, which had slowed in 2001, 2002, and early 2003. In addition, sales of SnowShore products resulted in an increase in revenue of$0.3 million during the quarter.  Incomparison to the three months ended June 30, 2003, international revenuefor the corresponding period of 2004 increased by $0.06 million.  This was the result of increased sales toPacific Rim customers of $0.5 million due primarily to our establishment of adirect sales operation in Japan, offset by a $0.4 million decrease in sales toour European customers.  The $0.4 milliondecrease in sales to European customers is net of a $0.1 million increase inrevenue due to favorable foreign currency exchange rates for Europeansales.  During the three months endedJune 30, 2004, revenue from enterprise customers accounted forapproximately 82% of total revenue, as compared to 79% of total revenue for thethree months ended June 30, 2003. The remaining revenue was attributable to sales to service providercustomers.

 

In the three months ended June 30, 2004, approximately 31 of ourcustomers each purchased over $100,000 of products, in aggregate representing75% of total revenue for the quarter.  Inthe three months ended June 30, 2003, approximately 30 of our customerseach purchased over $100,000 of products, in aggregate representingapproximately 73% of total revenue for the quarter.  Total customers in the second quarter of 2004decreased to approximately 316 from approximately 349 in the second quarter of2003, primarily due to a decline in the number of customers that purchased$5,000 or less in the quarter.  Revenuefrom one customer accounted for 15% of total revenue in the three months endedJune 30, 2004, compared to 17% in the corresponding period of 2003. Weexpect that revenue from this customer will be greater than 10% of totalrevenue for 2004.

 

*Six MonthsEnded June 30, 2004 and 2003*

 

The following table presents our domestic and international revenue:

 
| ** **                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|
| ** **                                | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                                | ** ** | **(dollars in thousands)**         | ** ** |
| Domestic revenue                          |       | $                                  | 29,941     |   | 79 | % | $ | 25,143 |   | 76 | % |
| International revenue, principally export |       | 7,945                              |       | 21 |   | 7,781 |   | 24 |   |
|                                      |       |                               |       |   |   |   |   |   |   |
| Total revenue                             |       | $                                  | 37,886     |   | 100 | % | $ | 32,924 |   | 100 | % |

 

Revenue in the six months ended June 30, 2004 was$37.9 million compared to $32.9 million in the corresponding period of2003, an increase of approximately 15%. This increase was primarily the result of increased sales to domesticOEMs, value-added resellers, and enterprise customers.  Many of our customers resumed spending oncommunications equipment, which had slowed in 2001, 2002, and early 2003. In comparison to the six months ended June 30, 2003, international revenuefor the corresponding period of 2004 increased by $0.2 million.  This was the result of increased sales toPacific Rim customers of $0.9 million due primarily to our establishment of adirect sales operation in Japan, offset by a $0.7 million decrease in sales toour European customers.  The $0.7 milliondecrease in sales to European customers is net of a $0.2 million increase inrevenue due to favorable foreign currency exchange rates for Europeansales.  During the six months endedJune 30, 2004, revenue from enterprise customers accounted forapproximately 84% of total revenue, as compared to 79% of total revenue for thesix months ended June 30, 2003.  Theremaining revenue was attributable to sales to service provider customers.

 

13

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In the six months ended June 30, 2004, approximately 59 of ourcustomers each purchased over $100,000 of products, in aggregate representing84% of total revenue for the six month period. In the six months ended June 30, 2003, approximately 55 of ourcustomers each purchased over $100,000 of products, in aggregate representingapproximately 81% of total revenue for the six month period.  Total customers in the six months endedJune 30, 2004 decreased to approximately 439 from approximately 540 in thesix months period ended June 30, 2003, primarily due to a decline in thenumber of customers that purchased $5,000 or less in the period.  Revenue from one customer accounted for 16%of total revenue in the six months ended June 30, 2004, compared to 16% inthe corresponding period of 2003. We expect that revenue from this customerwill be greater than 10% of total revenue for 2004.

 

***Cost of Product Sold and Gross Profit***

 

*ThreeMonths Ended June 30, 2004 and 2003*

 

The following table presents cost of product sold and gross profitinformation:

 
| ** **              | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------|------------|--------------------------------------|------------|
| ** **              | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **              | ** ** | **(dollars in thousands)**           | ** ** |
| Cost of product sold    |       | $                                    | 6,306      |   | $ | 6,270 |   |
| Gross profit            |       | $                                    | 12,887     |   | $ | 11,120 |   |
| Gross profit percentage |       | 67                                   | %          | 64 | % |

 

The cost of product sold in the three months ended June 30, 2004,compared to the corresponding period in 2003, increased by $.04 million.  Our inventory obsolescence expense in thesecond quarter of 2004 relative to the same period of 2003 was consistent.  Our manufacturing expenses in the secondquarter of 2004 relative to the same period of 2003 were also consistent.  Our change in product mix to higher marginproducts contributed to a significant improvement in the gross profitpercentage in the second quarter of 2004, compared to the second quarter of2003.

 

*Six MonthsEnded June 30, 2004 and 2003*

 

The following table presents cost of product sold and gross profitinformation:

 
| ** **              | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------|------------|------------------------------------|------------|
| ** **              | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **              | ** ** | **(dollars in thousands)**         | ** ** |
| Cost of product sold    |       | $                                  | 12,274     |   | $ | 12,600 |   |
| Gross profit            |       | $                                  | 25,612     |   | $ | 20,324 |   |
| Gross profit percentage |       | 68                                 | %          | 62 | % |

 

The decrease in cost of product sold in the six months endedJune 30, 2004, compared to the corresponding period in 2003, was theresult of changes in product mix, increased sales of our digital fax products(which have higher margins), and reduced inventory obsolescence andmanufacturing expenses.  Our inventoryobsolescence expense decreased by $0.3 million in the six months endedJune 30, 2004 relative to the same period of 2003 primarily due to reducedreserve requirements for service provider product inventory.  Our manufacturing expenses decreased by $0.2million in the six months ended June 30, 2004 relative to the same periodof 2003, primarily due to reduced purchases of manufacturing supplies.  Our change in product mix to higher marginproducts contributed to a significant improvement in the gross profitpercentage in the six months ended June 30, 2004, compared to thecorresponding period of 2003.

 

14

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***Operating Expenses***

 

*ThreeMonths Ended June 30, 2004 and 2003*

 

The following table presents our operating expenses:

 
| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|
| ** **                          | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **(in thousands)**                   | ** ** |
| Research and development            |       | $                                    | 4,847      |   | $ | 4,827 |   |
| In-process research and development |       | 2,490                                |       | — |   |
| Selling, general and administrative |       | 8,711                                |       | 7,565 |   |
|                                |       |                                 |       |   |   |
| Total operating expenses            |       | $                                    | 16,048     |   | $ | 12,392 |   |

 

Research and development expense

 

Research and development expense represented 25% of revenue in thesecond quarter of 2004, compared with 28% of revenue in the second quarter of2003. The slight increase in research and development expense in the secondquarter of 2004 relative to the corresponding period of 2003 was primarily theresult of increased expenses related to the SnowShore operation of $0.5 millionoffset by decreases in salaries and depreciation expense of $0.5 million. Ourcontinuing development efforts are focused on hardware and software for mediaprocessing products (voice, fax and data), network interface products, callcontrol products and signal processing products.  Research and development expense for thethird quarter of 2004 is expected to be approximately 25% to 27% of revenue.

 

In-process research and development

 

We recorded a one-time charge of $2.5 million for purchased in-processtechnology related to development projects which have not yet reachedtechnological feasibility, have no alternative future use, and for whichsuccessful development is uncertain. The value of the purchasedin-process research and development was computed by determining the present valueof the project’s future economic benefits including revenues net of anticipatedcosts and expenses.  At the time of theacquisition, the projects were approximately 40% complete.  We estimate the projects will require anadditional spending of $0.6 million to complete, with an estimated completiondate of December 31, 2004.

 

Selling, general and administrative expense

 

Selling, general and administrative expense represented 45% of revenuein the second quarter of 2004, compared with 44% of revenue in the secondquarter of 2003.  The $1.1 millionincrease in selling, general and administrative expense in the second quarterof 2004 relative to the corresponding period of 2003 was primarily due toexpense increases of $0.4 million related to the SnowShore operations and of$0.3 million related to our new Japan sales operation, increases inprofessional fees of $0.2 million, increases in commission expense of $0.1million and increases in marketing expenses of $0.1 million, offset by adecrease in depreciation and amortization expense of $0.1 million.  Selling, general and administrative expensefor the third quarter of 2004 is expected to be approximately 43% to 45% ofrevenue.

 

15

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*Six MonthsEnded June 30, 2004 and 2003*

 

The following table presents our operating expenses:

 
| ** **                          | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------|------------|------------------------------------|------------|
| ** **                          | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                          | ** ** | **(in thousands)**                 | ** ** |
| Research and development            |       | $                                  | 9,332      |   | $ | 9,413 |   |
| In-process research and development |       | 2,490                              |       | — |   |
| Selling, general and administrative |       | 16,829                             |       | 14,834 |   |
|                                |       |                               |       |   |   |
| Total operating expenses            |       | $                                  | 28,651     |   | $ | 24,247 |   |

 

Research and development expense

 

Research and development expense represented 25% of revenue in the sixmonths ended June 30, 2004, compared with 29% of revenue in the correspondingperiod of 2003. The $0.1 million decrease in research and development expensein the six months ended June 30, 2004 relative to the corresponding periodof 2003 was primarily the result of reduced salaries of $0.3 million andreduced depreciation expense of $0.2 million offset by increased expenses forSnowShore of $0.5 million.  Ourcontinuing development efforts are focused on hardware and software for mediaprocessing products (voice, fax and data), network interface products, callcontrol products and signal processing products.

 

In-process research and development

 

We recorded a one-time charge of $2.5 million for purchased in-processtechnology related to development projects which have not yet reachedtechnological feasibility, have no alternative future use, and for whichsuccessful development is uncertain.  Thevalue of the purchased in-process research and development was computed bydetermining the present value of the project’s future economic benefitsincluding revenues net of anticipated costs and expenses.  At the time of the acquisition, the projectswere approximately 40% complete. We estimate the projects will require anadditional spending of $0.6 million to complete, with an estimated completiondate of December 31, 2004.

 

Selling, general and administrative expense

 

Selling, general and administrative expense represented 44% of revenuein the six months ended June 30, 2004, compared with 45% of revenue in thecorresponding period of 2003.  The $2.0million increase in selling, general and administrative expense in the sixmonths ended June 30, 2004 relative to the corresponding period of 2003was primarily due to expense increases related to our new Japan sales operationof $0.6 million, increases in professional fees of $0.5 million, increasesrelated to the SnowShore acquisition of $0.4 million, increases in marketingexpenses of $0.3 million and increases in commission expense of $0.2 million.

 

***Other Income, Net***

 

*ThreeMonths Ended June 30, 2004 and 2003*

 

Other income, net, was $0.1 million for the three months endedJune 30, 2004 and $0.2 million for the three months ended June 30,2003.  The decrease was due to a foreigncurrency exchange loss of $0.04 million for the three months endedJune 30, 2004 compared to a foreign currency exchange gain of $0.06million for the three months ended June 30, 2003.

 

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*Six MonthsEnded June 30, 2004 and 2003*

 

Other income, net, was $0.3 million for the six months endedJune 30, 2004 and $0.4 million for the six months ended June 30,2003.  The decrease was due to a foreigncurrency exchange loss of $0.08 million for the six months ended June 30,2004 compared to a foreign currency exchange gain of $0.06 million for the sixmonths ended June 30, 2003.

 

***Income Tax (Benefit) Provision***

 

*ThreeMonths Ended June 30, 2004 and 2003*

 

The following table presents our income tax benefit and effective taxrate:

 
| ** **         | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------|------------|--------------------------------------|------------|
| ** **         | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **         | ** ** | **(dollars in thousands)**           | ** ** |
| Income tax benefit |       | $                                    | (117       | ) | $ | (325 | ) |
| Effective tax rate |       | (4                                   | )%         | (32 | )% |
|                    |            |                                      |            |  |  |  |  |

 

The effective tax rate for the second quarter of 2004, excluding theimpact of the SnowShore in-process research and development charge ofapproximately $2.5 million, which is not deductible for tax purposes, isapproximately (21)%. This effective tax rate differsfrom the statutory rate as a result of the disproportionate relationshipbetween permanent taxable items and our forecasted pre-tax income (loss). Thisin-process research and development charge is not deductible for the purposesof determining the income tax benefit due to the nature of the SnowShoreacquisition transaction.

 

*Six MonthsEnded June 30, 2004 and 2003*

 

The following table presents our income tax provision (benefit) andeffective tax rate:

 
| ** **                     | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**         | ** ** |
| Income tax provision (benefit) |       | $                                  | 5          |   | $ | (1,113 | ) |
| Effective tax rate             |       | 0.2                                | %          | (32 | )% |
|                                |            |                                    |            |  |  |  |  |

 

We recorded an income tax provision in the six months endedJune 30, 2004, compared with an income tax benefit in the six months endedJune 30, 2003. The effective tax rate for the six months ended June 30,2004 differs from the statutory rate as a result of the disproportionaterelationship between permanent taxable items and our forecasted pre-tax income(loss). Excluding the impact of the SnowShore in-process research anddevelopment charge, which is not deductible for tax purposes, the effective taxrate is 2%. The in-process research and development charge is not deductiblefor the purposes of determining the income tax provision due to the nature ofthe SnowShore acquisition transaction.

 

**Liquidityand Capital Resources**

 

Cash flows for the six months ended June 30, 2004 and 2003

 

Cash flows from operating activities were $1.9 million in the sixmonths ended June 30, 2004. This primarily resulted from non-cash expensesexceeding our net loss, along with a decrease in accounts receivable offset bya decrease in current liabilities.  Cashflows from operating activities were $4.0 million in the six months endedJune 30, 2003. This primarily resulted from net income tax refunds of $6.0million, which were classified as other current assets and are not expected toreoccur, and reductions in accounts receivable, offset by a decrease in currentliabilities.

 

Cash flows from investing activities was $10.8million in the six months ended June 30, 2004.  This primarily resulted from the net decreasein cash of $8.3 million as a result of the SnowShore acquisition, net purchasesof marketable debt securities of $1.2 million, expenditures for capitalequipment of $0.7 million and the purchase and license of technology for $0.6million to be used in the development of new products and the modification ofexisting products.  Cash flows frominvesting activities was $11.1 million in the sixmonths ended June 30, 2003. This primarily resulted from net purchases ofmarketable debt securities of $10.8 million.

 

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Cash flows from financing activities was $2.1 millionin the six months ended June 30, 2004. This was attributable to proceeds from the sale of common stock issuedunder our employee stock option plans of $3.0 million offset by $0.9 millionfor the repurchase of 86,000 shares of our common stock.  Cash flows from financing activities was $0.1 million in the six months ended June 30, 2003,all of which was attributable to proceeds from the sale of common stock underour employee stock purchase plan.

 

Contractual Obligations and Capital Expenditures

 

The following table presents our future contractual obligations andcommercial commitments as of June 30, 2004:

 
| ** **       | ** ** | **Total**          | ** ** | **Remainder  of 2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **Thereafter** | ** ** |
|------------------|------------|--------------------|------------|------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| ** **       | ** ** | **(in thousands)** | ** ** |
| Operating leases |       | $                  | 5,146      |                   | $          | 1,518    |       | $        | 2,098      |     | $          | 800      |       | $              | 226        |   | $ | 226 |   | $ | 278 |   |
|                  |            |                    |            |                        |            |          |            |          |            |          |            |          |            |                |            |  |  |  |  |  |  |  |

 

We have operating lease commitments for our primary office andmanufacturing facilities that expire between 2005 and 2006. We lease officespace for sales and support functions that expire beyond 2006.  Certain lease agreements require us to payall of the building’s taxes, insurance and maintenance costs.  In addition, we have a capital leaseobligation for office equipment totaling $0.02 million as a result of ouracquisition of SnowShore. This capital lease expires in 2005.

 

We purchased $0.7 million and $0.3 million of capital equipment in thesix months ended June 30, 2004 and 2003, respectively.  We currently have no material commitments foradditional capital expenditures.  In thesix months ended June 30, 2004 we acquired technology and, contingent uponsatisfactory performance by the seller and our final acceptance, we will beobligated to purchase engineering services of  $0.4 million.  We have certain inventory purchasecommitments that are part of our ordinary course of business in which theproduct delivery dates range from one month to five months into thefuture.  We do not expect these short-term commitments to have a materialimpact on our financial results.

 

Cash and Cash Liquidity Position

 

The following table presents our cash and liquidity position as ofJune 30, 2004 and December 31, 2003:

 
| ** **                       | ** ** | **June 30,  2004**    | ** ** | **December 31,  2003** | ** ** |
|----------------------------------|------------|----------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(dollars in thousands)** | ** ** |
| Cash and cash equivalents        |       | $                          | 21,382     |                        | $          | 28,081 |   |
| Marketable debt securities       |       | 28,926                     |       | 27,869                      |       |
| Total                            |       | $                          | 50,308     |                        | $          | 55,950 |   |
|                             |       |                       |       |                        |       |
| Working capital                  |       | $                          | 56,020     |                        | $          | 62,485 |   |
| Quick ratio                      |       | 4.1                        |       | 4.5                         |       |
| Maximum available line of credit |       | $                          | 5,000      |                        | $          | 5,000 |   |

 

Cash and cash equivalents and marketable debt securities decreased to$50.3 million as of June 30, 2004 from $56.0 million as ofDecember 31, 2003, primarily due to the $9.0 million purchase of SnowShorein April 2004 and stock repurchase transactions of $0.9 million, offset by$1.0 million of SnowShore cash acquired, proceeds from the sale of common stockissued under our employee stock option plans of $3.0 million and non-cashexpenses exceeding our net loss.  Workingcapital decreased by $6.5 million from December 31, 2003 toJune 30, 2004. This decrease in working capital was primarily caused bythe same factors described above that resulted in the decrease in cash and cashequivalents and marketable debt securities.

 

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Our quick ratio decreased from 4.5 at December 31, 2003 to 4.1 atJune 30, 2004, due primarily to the SnowShore acquisition and stockrepurchase activity mentioned above. Quick ratio consists of the total of cashand cash equivalents, marketable debt securities, and accounts receivabledivided by current liabilities, and is an indicator of a company’s ability tomeet short-term financial obligations.

 

We have a $5.0 million working capital line of credit availablefrom a commercial bank. Any borrowings would bear interest at the lender’sprime rate. The line of credit is secured by a pledge of substantially all ofour assets. Availability of funds under this line of credit is subject tocompliance with certain financial covenants relating to our quick ratio,minimum tangible net worth, and other standard reporting requirements. As ofJune 30, 2004, letters of credit issued against the existing line totaled$1.0 million, representing the collateral required for certain leaseobligations. Other than the issuance of letters of credit and the use of thecredit line to secure immaterial foreign currency forward contracts, there havebeen no borrowings under the line during the past three years. The line ofcredit expires on July 29, 2005.

 

In October 2003, our board of directors authorized the repurchaseof up to 1,000,000 shares of our common stock from time to time on the openmarket or in privately negotiated transactions. This program will be funded by our existing and future cash and cashequivalents and marketable debt securities balances.  As of August 6, 2004, we haverepurchased 86,000 shares under the program for approximately $0.9 million.

 

We believe that our cash and cash equivalents and marketable debtsecurities are likely to meet our needs for the foreseeable future. Though we do not expect to make any major capital expenditures in the remainderof 2004, we are always looking for opportunities to expand our business, whichcould include acquisitions or organic expansion into new markets.  InApril 2004, we used approximately $9.0 million to purchase the outstandingstock of SnowShore.  If we find that ourcash and cash equivalents, marketable debt securities and funds available fromour bank line of credit are not sufficient, we may choose to utilize or to seekother sources of financing. If we were to seek future equity financings, theterms may be dilutive to our stockholders and may contain restrictivecovenants, which could limit our ability to pursue certain courses of action.It is possible that, should the need arise, we will not be able to obtainadditional financing, or that the financing made available to us will not be onacceptable terms.

 

The pricing of our products and the costs of our goods can besignificantly affected by current market conditions. Market conditions can beimpacted by inflation; however, we believe that inflation has not had asignificant effect on our operations to date.

 

**FactorsThat May Affect Future Results**

 

Therisks and uncertainties described below are those that we currently believe maymaterially affect us. The trading price of our common stock could decline dueto any of these factors. You should also refer to the other information in thisreport, including the condensed consolidated financial statements and relatednotes.

 

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**Risks Related to Our Business**

 

***Downturns in the economy generally, and insectors of the telecommunications industry in particular, make it difficult toanticipate or expand sales.***

 

As a result of the uncertain economic conditions that have affectedmost technology sectors and the telecommunications sector in particular, overthe past few years many of our customers have aggressively sought to increaseefficiency in their supply chains and reduce their inventory levels.Additionally, the slowdown in the telecommunications industry and the resultingdecrease in spending by companies in our target markets have reduced the rateof growth of data traffic and the use of the Internet, which are driving theconvergence of data and telephony that we expect will give rise to demand forNew Network applications. The economic downturn adversely affected our businessand operating results for the first two quarters of 2003, and even more so forthe years ended December 31, 2002 and 2001. While we believe the economiccondition may be improving somewhat, if current economic conditions do notcontinue to improve or if they worsen, we may experience additional adverseeffects on our revenue, net income and cash flow. For example, if the rate atwhich our customers order product decreases, it becomes more likely that ourcurrent inventories would be exposed to technological obsolescence, which wouldrequire us to reduce the value of those inventories on our balance sheet.

 

***If we fail to compete successfully in thehighly competitive telecommunications market, our revenue and profitabilitywill suffer.***

 

The market for telecommunications equipment is highly competitive. Ifwe are unable to differentiate our products from existing and future offeringsof our competitors, and thereby effectively compete in the market fortelecommunications equipment, our operating results could be materiallyadversely affected. Many of our current and potential competitors havesignificantly greater selling and marketing, technical, manufacturing,financial and other resources than we have. We expect our current competitorsto continue to improve the design and performance of their existing productsand to introduce new products and enhancements with improved price andperformance characteristics. Our product sales may be threatened by newtechnologies, products or market trends, and we may have to reduce the pricesof our products to stay competitive. In addition, new competitors may emerge inthe markets we serve. An acquisition of, or by, one of our competitors mayresult in a substantially strengthened competitor with greater financial,engineering, manufacturing, marketing and customer service and supportresources than we have. If our current or future competitors enter intostrategic relationships with leading manufacturers covering products similar tothose sold or being developed by us, our ability to sell products to thosemanufacturers may be adversely affected.

 

Capitalizing on our technology will require a continued high level ofinvestment in research and development, marketing and customer service andsupport. We may be unable, or otherwise fail, to allocate sufficient resourcesto achieve the technological advances necessary to compete successfully withexisting competitors or new entrants.

 

***Internal development efforts by our customersmay adversely affect demand for our products.***

 

Many of our customers, including the large OEMs on which we focusa significant portion of our sales and marketing efforts, have the technicaland financial ability to design and produce components replicating or improvingon the functionality of most of our products. These customers often considerin-house development of technologies and products as an alternative to doingbusiness with us. We cannot guarantee that our existing or potential customerswill do business with us, rather than attempting to develop similar technologyand products internally or obtaining technology or products throughacquisitions. We cannot be certain that we will be able to find customers toreplace the revenue lost as a result of customers developing technologies orproducts in-house. Any such occurrence could have a material adverse effect onour business, financial condition or operating results.

 

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***If we fail to develop and sell new orenhanced products for the telecommunications hardware and software market, wewill not be able to compete effectively.***

 

The telecommunications hardware and software market is characterizedby:

 

*•**                                         *rapid technological advances;

 

*•**                                         *evolvingindustry standards;

 

*•**                                         *changes in customer requirements and product life cycles;

 

*•**                                         *frequent new product introductions or innovations;

 

*•**                                         *decliningprices;

 

*•**                                         *intense competition; and

 

*•**                                         *evolvingofferings by telecommunications service providers.

 

Our future success depends in large part on our ability to offerproducts that address the sophisticated and varied needs of our current andprospective customers and to respond to technological advances and evolvingindustry standards on a timely and cost-effective basis.

 

The timely development of new or enhanced products is a complex anduncertain process. We intend to continue to invest significantly in product andtechnology development. We may experience design, manufacturing, marketing andother difficulties that could delay or prevent our development, introduction orcommercialization of any new and enhanced products. We also may not be able toincorporate new technologies on a cost-effective or timely basis, which mayresult in unexpected expenses. We may not anticipate technological or markettrends accurately or manage long development cycles successfully. We may berequired to collaborate with third parties to develop products and may not beable to do so on a timely and cost-effective basis, ifat all.

 

The introduction of new or enhanced products also requires that wemanage 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. If we are unable to develop new products orenhancements on a timely and cost-effective basis, or if the new products orenhancements that we introduce fail to achieve market acceptance, our abilityto grow our business would be harmed and competitors could achieve greatermarket share.

 

***Our revenue could decline significantly if welose a major customer or if a major customer cancels, reduces or delays anorder.***

 

One customer accounted for 19% of our revenue in the year endedDecember 31, 2003, and we expect this customer will account for more than10% of our total revenue in 2004. The loss of this or any other major customeror the cancellation, reduction or delay of significant orders from suchcustomers, even if only temporary, could significantly reduce our revenue andcash flow and could harm our reputation in the industry.

 

***Our products typically have long salescycles, causing us to expend significant resources before recognizing revenue.***

 

The length of our sales cycle typically ranges from six to eighteenmonths and varies substantially from customer to customer. Prospectivecustomers generally must commit significant resources to test and evaluate ourproducts and integrate them into larger systems. This evaluation period isoften prolonged due to delays associated with approval processes that typicallyaccompany the design and testing of new communications equipment by ourcustomers.

 

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In addition, the rapidly emerging and evolving nature of the markets inwhich we and our customers compete may cause prospective customers to delaytheir purchase decisions as they evaluate new technologies and develop andimplement new systems. During the period in which our customers are evaluatingwhether to place an order with us, we often incur substantial sales andmarketing expenses, without any assurance of future orders or their timing.Even after a customer places an order, the timing of the development,introduction and implementation of our product is controlled by, and can varysignificantly with the needs of, the customer. In some circumstances, thecustomer will not require the product for several months. This continuinguncertainty can complicate our planning processes and reduce the predictabilityof our earnings and cash flows.

 

***Our business and operating results could beadversely affected by downturns in economic conditions in countries outside theUnited States and other risks associated with international operations.***

 

Sales of our products to customers outside the United States accountedfor 21% of our revenue in the six months ended June 30, 2004. Weanticipate that international sales will continue to account for a significantportion of our revenue. We are subject to a number of risks as a result of ourinternational sales, including:

 

*•*                                          volatility in currency exchange rates;

 

*•*                                          political and economic instability in other countries;

 

*•*                                          the imposition of trade restrictions, trade barriers, andtariff regulations by foreign governments;

 

*•*                                          difficulties in accounts receivable collections;

 

*•*                                          extendedpayment terms beyond those customarily offered in the United States;

 

*•**                                         *potentially adverse tax consequences; and

 

*•**                                         *difficulties in managing and/or expanding operations acrossdisparate geographic areas.

 

In addition, most countries require technical approvals from theirtelecommunications regulatory agencies for products that operate in conjunctionwith the local telephone system. Obtaining these approvals is generally aprerequisite for sales in a given jurisdiction. Obtaining requisite approvalstakes from two months to a year or more depending on the product and thejurisdiction. These or other factors may limit our ability to sell our productsin other countries, which could have a material adverse effect on our business,financial condition and operating results.

 

***We may seek to expand through acquisitions ofcomplementary businesses, and we may not be able to successfully integrateacquired companies.***

 

In April 2004, we completed our acquisition of SnowShore, aprovider of voice over IP communications infrastructure products for themedia server and media firewall markets. We may seek to acquire additional strategic complementary companies inthe future. In addition to the difficulties we may face in identifying andconsummating acquisitions, we will also be required to integrate andconsolidate any acquired businesses or assets with our existing operations.Managing an acquired business entails numerous operational and financial risks,including difficulties in integrating disparate administrative, accounting andfinance and information systems, difficulties in assimilating acquiredoperations and new personnel, diversion of management’s attention from otherbusiness concerns, and potential loss of key employees or customers of anyacquired operations. Accordingly, we may be unable to successfully identify,consummate and integrate future acquisitions or operate acquired businessesprofitably. If we are unable to integrate an acquired company successfully, ourfuture growth may suffer, and our results of operations could be harmed.

 

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***Our dependence on sole and single sourcesuppliers and independent manufacturers could result in increased costs ordelays in the manufacture and delivery of our products.***

 

Although we generally use standard parts and components for ourproducts, some key components are purchased from sole or single source vendorsfor which alternative sources are not currently available or are difficult toobtain. Our inability to obtain sufficient quantities of these components mayresult in future delays or reductions in product shipments that could cause usto lose sales, incur additional costs and suffer harm to our reputation. Wecurrently purchase proprietary components from a number of suppliers for whichthere are no direct substitutes.

 

These components could be replaced with alternatives from othersuppliers, but that might require redesign of our products. If such a redesignwere required, we would incur considerable delay and expenses. We currentlyenter into purchase orders with our suppliers for materials based on forecastsof need, but have no guaranteed supply arrangements with these suppliers.

 

In addition, we currently use independent manufacturers to manufactureprinted circuit boards, chassis and subassemblies in accordance with our designand specification. Our reliance on independent manufacturers involves a numberof risks, including the potential for inadequate capacity of, unavailabilityof, or interruptions in access to, process technologies and reduced controlover delivery schedules, manufacturing yields and costs. If our manufacturersare unable or unwilling to continue manufacturing our components in requiredquantities or to our quality expectations, we will have to transfermanufacturing to acceptable alternative manufacturers that we have identified,which could result in significant delays in shipment of products to customers.Moreover, the manufacture of these components is extremely complex, and ourreliance on the suppliers of these components exposes us to potentialproduction difficulties and quality variations, which could negatively affectthe cost and timely delivery of our products. We currently enter into purchaseorders with independent manufacturers of materials based on forecasts of need,but have no guaranteed capacity arrangements with these manufacturers. Anysignificant interruption in the supply, or degradationin the quality, of any component could cause us to lose sales, incur additionalcosts and suffer harm to our reputation.

 

***Defects in our products or problems arisingfrom the use of our products may seriously harm our business and reputation.***

 

Products as complex as ours may contain known and undetected errors,bugs, or other performance problems. Defects arefrequently found during the period immediately following introduction andinitial implementation of new products or enhancements to existing products.Although it is our objective to resolve all bugs that we believe would beconsidered serious by our customers before implementation, our products may notbe bug-free. We also provide warranties against defects in materials andworkmanship on our hardware products for five years. Errors, bugs orperformance problems could result in lost revenue or customer relationships andcould be detrimental to our business and reputation generally. In addition, ourcustomers generally use our 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 us toincur significant warranty and repair costs, divert the attention of ourengineering personnel from our product development efforts and causesignificant customer relations problems.

 

***Changes to regulations affecting thetelecommunications or Internet industries could reduce demand for our productsor increase our costs.***

 

Laws and regulations governing telecommunications, electronic commerceand the Internet are emerging, but remain largely unsettled, even in the areaswhere there has been some legislative action. Regulation may focus on, amongother things, assessing access or settlement charges, or imposing tariffs orregulations based on the characteristics and quality of products, either ofwhich could restrict our business or increase our cost of doing business. Anychanges to existing laws or the adoption of new regulations by federal or state regulatory authorities or any legalchallenges to existing laws or regulations relating to the telecommunicationsindustry could materially adversely affect the market for our products.Moreover, our value-added resellers or other customers may require us, or wemay otherwise deem it necessary or advisable, to alter our products to addressactual or anticipated changes in the regulatory environment. Our inability toalter our products or address any regulatory changes could have a materialadverse effect on our business, financial condition or operating results.

 

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***Limitations on our ability to adequatelyprotect our proprietary rights may prevent us from retaining our competitiveadvantage and negatively affect our future operating results.***

 

Our success and ability to compete are dependent, in part, upon ourproprietary technology. Taken as a whole, we believe our intellectual propertyrights are significant and any failure to adequately protect the unauthorizeduse of our proprietary rights could result in our competitors offering similarproducts, potentially resulting in loss of a competitive advantage anddecreased revenue. We rely upon a combination of patents, trademark law, tradesecret protections, copyright law and confidentiality agreements withconsultants and third parties to protect our proprietary rights. In addition,we generally require each of our employees to execute a proprietary informationagreement designed to protect our trade secrets, our inventions created in thecourse of employment with us and other proprietary information of our company.Notwithstanding our efforts, third parties may infringe or misappropriate ourproprietary rights. Moreover, effective patent, trademark, copyright or tradesecret protections may not be available in every country in which we operate orintend to operate to the same extent as the laws of the United States. Also, itmay be possible for unauthorized third parties to copy or reverse engineeraspects of our products, develop similar technology independently or otherwiseobtain and use information that we regard as proprietary. Furthermore,detecting unauthorized use of our proprietary rights is difficult. Litigationmay be necessary to enforce our proprietary rights. Such litigation couldresult in the expenditure of significant financial and managerial resources andcould have a material adverse effect on our future operating results.

 

***Intellectual property claims against us canbe costly and negatively affect our business.***

 

In the telecommunications business, there is frequent litigation basedon allegations of patent infringement. As the number of entrants in our marketincreases and the functionality of our products is enhanced and overlaps withthe products of other companies, we may become subject to claims ofinfringement or misappropriation of the intellectual property rights of others.As a result, from time to time, third parties may claim exclusive patent orother intellectual property rights to technologies that we use. Although webelieve that we do not face material liability related to infringement of theintellectual property of others, any claims asserting that our productsinfringe or may infringe proprietary rights of third parties, if determinedadversely to us, could have a material adverse effect on our business,financial condition or operating results. Any claims, with or without merit,could be time-consuming, result in costly litigation, divert the efforts of ourengineering and management personnel, cause delays in product shipments orrequire us to enter into royalty or licensing agreements, any of which couldhave a material adverse effect upon our operating results. In any legal actionclaiming patent infringement commenced against us, we cannot assure you that wewould prevail given the complex technical issues and inherent uncertainties inpatent litigation. In the event a claim against us was successful, and we couldnot obtain a license on acceptable terms or license a substitute technology orredesign to avoid infringement, we may be unable to market our affectedproducts. This could have a material adverse effect on our business, financialcondition and operating results.

 

***Certain of our products depend upon thecontinued availability of licensed technology from third parties.***

 

We currently license and will continue to license from third partiescertain technology integral to certain of our products. For example, we haveobtained licenses from third parties for software for certain of our voice andfax products. While we believe that much of this technology is available frommultiple sources, any difficulties in acquiring third-party technologylicenses, or integrating the related third-party technology into our products,could result in delays in product development or upgrades until equivalenttechnology can be identified, licensed and integrated.

 

We may require new licenses in the future as our business grows andtechnology evolves. We cannot assure you that these licenses will continue tobe available to us on commercially reasonable terms, if at all, which couldhave a material adverse effect on our business, financial condition andoperating results.

 

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***If we are unable to attract or retain keypersonnel, we may be unable to operate our business successfully.***

 

Our success depends in large part upon the continued contributions ofour key management, sales, marketing and engineering personnel,many of whom perform important functions and would be difficult to replace. Ifwe lose one or more members of our senior management team our business andoperating results would be harmed. We do not have employment contracts with ourkey personnel. There has been significant competition in our industry for qualifiedpersonnel, and, at times, we have experienced difficulty in recruitingqualified personnel. We may not be able to attract and retain the necessarypersonnel to accomplish our business objectives, and we may experienceconstraints that will adversely affect our ability to satisfy customer demandin a timely fashion or to support our customers and operations. Our inabilityto hire qualified personnel on a timely basis, or to retain our key personnel,could materially adversely affect our business, financial condition andoperating results.

 

***We are subject to environmental andoccupational health and safety regulations that can increase the costs ofoperations or limit our activities.***

 

We are subject to environmental and occupational health and safety regulationsrelating to matters such as reductions in the use of harmful substances,comprehensive risk management in manufacturing activities and final products,the use of lead-free soldering, and the recycling of products and packagingmaterials. On February 13, 2003 the European Parliament and the Counsel ofthe European Union published directives on waste electrical and electronicequipment and on the restriction of the use of certain hazardous substances inelectrical and electronic equipment. These directives will generally requireelectronics producers after August 2005 to bear the cost of collection,treatment, recovery and safe disposal of past and future products fromend-users and to ensure after June 2006 that new electrical and electronicequipment does not contain specified hazardous substances. While the cost ofthese directives to us cannot be determined before regulations are adopted inindividual member states of the European Union, it may be substantial and maydivert resources, which could detract from our ability to develop new products.We may not be able to comply in all cases with applicable environmental andother regulations, and if we do not, we may incur remediation costs or we maynot be able to offer our products for sale in certain countries, which couldadversely affect our results.

 

**Risks Related to Our Common Stock**

 

***Our operating results could fluctuatesignificantly and cause our stock price to be volatile, which may cause thevalue of your investment to decline.***

 

Our operating results could fluctuate in the future due to a variety offactors, many of which are outside of our control. If our operating results donot meet the expectations of securities analysts, the trading price of ourcommon stock could significantly decline. This may cause the value of yourinvestment in our company to decline. In addition, the value of your investmentcould be affected by investor perception of our industry or our prospectsgenerally, independent of our operating performance. Some of the factors thatcould affect our operating results or the market price of our common stockinclude:

 

*•**                                        *our ability to cope with difficult conditions in the economyin general, and the telecommunications market in particular;

 

*•**                                        *our ability to formulate and implement effective strategiesto respond to changing market requirements and conditions;

 

*•**                                         *cancellation or rescheduling of orders for our products;

 

*•**                                         *our ability to collect accounts receivable from customersthat have been adversely affected by the difficult economic conditions;

 

*•**                                         *our ability to develop, manufacture, market and support ourproducts and product enhancements;

 

*•**                                         *the timing and number of orders for our products, which havehistorically been weighted more heavily toward the last month of each quarterand the second and fourth quarters of each year;

 

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*•**                                         *quarterlyfluctuations in our revenue, which typically is lower in the third quarter dueto customer summer vacation schedules, particularly in Europe, and to a lesserextent in the first quarter of each year;

 

*•**                                         *our ability to hire, train and retain key management, sales,marketing and engineering personnel;

 

*•**                                         *announcements or technological innovations by ourcompetitors or in competing technologies;

 

*•**                                         *our ability to obtain sufficient supplies of sole or limitedsource components for our products;

 

*•**                                         *a decrease in the average selling prices of our products;

 

*•**                                         *changes in costs of components that we include in ourproducts;

 

*•**                                         *the mix of products that we sell;

 

*•**                                         *any interruptions in the flow of our products through ourresellers or our two-tiered distribution system; and

 

*•**                                         *a decrease in the demand for our common stock.

 

Due to these and other factors, revenue, expenses and operating resultscould vary significantly in the future, and period-to-period comparisons shouldnot be relied upon as indications of future performance.

 

***The market price of our common stock may bevolatile, which could lead to losses for individual investors.***

 

Stock markets in general, and the market for technology stocks,including our common stock, in particular, have experienced extreme price andvolume fluctuations that often have been unrelated, or disproportionate, to theoperating performance of those companies. The market for our common stock hasbeen and is likely to continue to be volatile. Many factors could cause thetrading price of our common stock to fluctuate substantially, including thefollowing:

 

*•**                                         *future announcements concerning our business, technology,acquisitions, strategic partnerships, management, customers or competitors;

 

*•**                                         *introduction of new products or changes in product pricingpolicies by us, our competitors or our customers;

 

*•**                                         *changesin earnings estimates by securities analysts or announcements of results ofoperations that are not aligned with the expectations of analysts andinvestors;

 

*•**                                         *changes in market valuations of similar companies;

 

*•**                                         *reducedspending for telecommunications hardware and software;

 

*•**                                         *the economic and competitive conditions in thetelecommunications sectors in which our customers operate; and

 

*•**                                         *general economic conditions and stock market trends.

 

In the past, following periods of volatility in the market price of aparticular company’s securities, securities class action litigation has oftenbeen brought against that company. Many technology companies have been subjectto this type of litigation. This type of litigation, if instituted against us,could result in substantial costs and a diversion of our management’s attentionand resources.

 

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***Our corporate documents may prevent a changein control or management that stockholders consider desirable.***

 

Our charter and by-laws contain provisions that might enable ourmanagement to resist a takeover of our company. In addition, our board ofdirectors has adopted a shareholder rights plan. These provisions and ourshareholder rights plan could have the effect of delaying, deferring, orpreventing a change in control of Brooktrout or a change in our management thatstockholders consider favorable or beneficial. They could discourage proxycontests and make it more difficult for you and other stockholders to electdirectors and take other corporate actions. They also could limit the pricethat investors may be willing to pay in the future for shares of our commonstock.

 

***We may need additional financing in thefuture, and any additional financing may result in restrictions on ouroperations or substantial dilution to our stockholders.***

 

We may need to raise additional funds in the future, for example, todevelop new technologies, support our expansion, respond to competitivepressures, acquire complementary businesses or respond to unanticipatedsituations. We may decide to raise additional funds through public or privatefinancings, strategic relationships or other arrangements. Our ability toobtain debt or equity funding will depend on a number of factors, includingmarket conditions, our operating performance and investor interest. Additionalfunding may not be available to us on acceptable terms or at all. If adequatefunds are not available, we may be required to revise our business plan toreduce expenditures, including curtailing our growth strategies, foregoingacquisitions or reducing our product development efforts. If we succeed inraising additional funds through the issuance of equity or convertiblesecurities, the issuance could result in substantial dilution to existingstockholders. If we raise additional funds through the issuance of debtsecurities or preferred stock, these new securities would have rights,preferences and privileges senior to those of the holders of our common stock.The terms of these securities, as well as any borrowings under our bank line ofcredit agreement, could impose restrictions on our operations.

 

**Item 3.****Quantitative andQualitative Disclosures About Market Risk**

 

Ourexposure to market risk from changes in interest rates and currency exchangerates has not changed materially from our exposure at December 31,2003.  Please refer to our Annual Reporton Form 10-K for the year ended December 31, 2003 for more information.

 

**Item 4.****Controls and Procedures**

 

(a) Evaluation of disclosure controls and procedures.

 

Our management, with the participation of our chief executive officerand chief financial officer, evaluated the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended, or the Exchange Act) as ofJune 30, 2004.  Based on thisevaluation, our chief executive officer and chief financial officer concludedthat, as of June 30, 2004, our disclosure controls and procedures were (1)designed to ensure that material information relating to our company, includingour consolidated subsidiaries, is made known to our chief executive officer andchief financial officer by others within those entities, particularly duringthe period in which this report was being prepared and (2) effective, in thatthey provide reasonable assurance that information required to be disclosed byus in the reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms.

 

(b) Changes ininternal control over financial reporting. ( currently discussing potential modificationsto b)

 

No change in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during thefiscal quarter ended June 30, 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PARTII OTHER INFORMATION**

 

**Item 2.****  Changes in Securities,Use of Proceeds and Issuer Purchases of Equity Securities**

 

**Issuer Purchases of Equity Securities**

 
| **Period**                              | ** ** | **Total  Number of  Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of Shares  Purchased as Part of  Publicly Announced  Plans or Programs (1)** | ** ** | **Maximum Number of  Shares that May Yet Be  Purchased Under the  Plans or Programs** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
|                                    |       |                                    |       |                               |       |                                                                                        |       |                                                                                  |       |
| April 1 – April 30, 2004 |       | —                                  |       | $                                  | —     |                                                                                        | —     |                                                                                  | —     |   |
| May 1 – May 31, 2004               |       | 86,000                                  |       | 9.93                               |       | 86,000                                                                                      |       | 914,000                                                                               |       |
| June 1 – June 30, 2004   |       | —                                  |       | —                             |       | —                                                                                      |       | —                                                                                |       |
| Total                                   |       | 86,000                                  |       | $                                  | 9.93       |                                                                                        | 86,000     |                                                                                  | 914,000    |   |

 

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(1)                                  In October 2003, our board of directorsauthorized the repurchase of up to 1,000,000 shares of our common stock fromtime to time on the open market or in privately negotiated transactions. The program expires in October 2004.

 

**Item 4.****Submission of Matters to a Vote of Security Holders**

 

We held our 2004 annual meeting of stockholders on May 5, 2004. At theannual meeting, our stockholders were asked to consider proposals to:

 

•                  elect two ClassIII directors to serve for three-year terms;

 

•                  approve anamendment to our charter to increase the number of shares of authorized commonstock by 40,000,000, from 40,000,000 to 80,000,000;

 

•                  approve anamendment to our 2001 stock option and incentive plan to increase the number ofshares of common stock issuable under such plan by 750,000, from 1,500,000 to2,250,000; and

 

•                  transact anyother business properly presented at the meeting.

 

With regard to the election of two Class III directors, Robert G.Barrett and Eric R. Giler were nominated to serve until the 2007 annualmeeting.  Our other directors whose terms of office continued after theannual meeting are as follows:  David L. Chapman (Class I director), DavidW. Duehren (Class I director), and W. Brooke Tunstall (Class II director).

 

At the annual meeting, by a vote of 10,901,729 votes of common stock infavor of Robert G. Barrett, a plurality of the eligible votes, and 984,635votes withheld for Mr. Barrett, Mr. Barrett was elected as a Class IIIdirector. By a vote of 10,993,520 votes of common stock in favor of Eric R.Giler, a plurality of the eligible votes, and 892,844 votes withheld for Mr.Giler, Mr. Giler was elected as a Class III director.

 

In addition, at the annual meeting, by a vote of 11,057,194 votes infavor, representing in excess of a majority of the outstanding shares of commonstock, with 789,248 votes against and 39,922 votes abstaining, the amendment toour charter to increase the number of shares of authorized common stock by40,000,000, from 40,000,000 to 80,000,000, was approved.

 

Also at the annual meeting, by a vote of 4,015,740 votes in favor,4,503,750 votes against, 393,719 votes abstaining, and 2,973,155 brokernon-votes, the amendment to our 2001 stock option and incentive plan to increasethe number of shares of common stock issuable under such plan by 750,000, from1,500,000 to 2,250,000, was not approved.

 

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**Item 6.****  Exhibits and Reports on Form 8-K**

 
| (a)    |   | Exhibits                                                                                                                                                                                                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 2.1    |   | Agreement and Plan of  Merger, dated as of March 25, 2004, among Brooktrout, Inc., Canal  Acquisition Corp. and SnowShore Networks, Inc. is hereby incorporated by  reference from Exhibit 2.1 to Current Report on Form 8-K dated April 5,  2004 filed with the SEC on April 9, 2004 (File No. 000-20698). |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.1    |   | Restated Articles of  Organization of Brooktrout, Inc. are hereby incorporated by reference from  Exhibit 3.1 to Annual Report on Form 10-K for the fiscal year ended  December 31, 1992 filed with the SEC on March 31, 1993 (File No.  000-20698).                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.2    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for  the fiscal year ended December 31, 1998 filed with the SEC on  March 30, 1999 (File No. 000-20698).                                |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.3    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for  the fiscal year ended December 31, 1999 filed with the SEC on  March 30, 2000 (File No. 000-20698).                                |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.4    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.3 to Amendment No. 2 to the  quarterly report on Form 10-Q/A for the fiscal quarter ended June 30,  2000 filed with the SEC on November 17, 2000 (File No. 000-20698).  |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.5    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc.                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.6    |   | Amended and Restated By-laws  of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.4 to  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).                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 31.1   |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14 or 15d-14, as adopted  pursuant to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 31.2   |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14, as adopted  pursuant to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 32.1   |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 32.2   |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| (b)    |   | Reports on Form 8-K                                                                                                                                                                                                                                                                                                   |

 

OnApril 5, 2004, we filed a current report on Form 8-K, dated April 5,2004, furnishing under Item 12 our press release updating guidance for thequarter ended March 31, 2004 and for the remainder of 2004.

 

OnApril 9, 2004, we filed a current report on Form 8-K, dated April 5,2004, reporting the completion of the acquisition of the outstanding capitalstock of SnowShore Networks, Inc.

 

OnApril 21, 2004, we filed a current report on Form 8-K, datedApril 21, 2004, furnishing under Item 12 our press release announcingfinancial results for the quarter ended March 31, 2004.

 

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OnJune 18, 2004, we filed Amendment No. 1 to current report on Form 8-K/A,dated April 5, 2004, amending the current report on Form 8-K filed onApril 9, 2004 to include the financial statements and pro formainformation required by Items 7(a) and 7(b) of Form 8-K.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| ** **                | ** ** | **BROOKTROUT, INC.** |
|---------------------------|------------|---------------------------|
|                      |       |                      |
| Date: August 6, 2004 |       | By:                       | /s/  ERIC R. GILER |
|                      |       |                      | Eric  R. Giler*President  (Principal Executive Officer)* |
|                      |       |                      |   |
| Date: August 6, 2004 |       | By:                       | /s/  ROBERT C. LEAHY |
|                      |       |                      | Robert  C. Leahy*Vice President of Finance and Operations  (Principal Financial and Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| 2.1    |   | Agreement and Plan of  Merger, dated as of March 25, 2004, among Brooktrout, Inc., Canal  Acquisition Corp. and SnowShore Networks, Inc. is hereby incorporated by  reference from Exhibit 2.1 to Current Report on Form 8-K dated April 5,  2004 filed with the SEC on April 9, 2004 (File No. 000-20698). |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.1    |   | Restated Articles of  Organization of Brooktrout, Inc. are hereby incorporated by reference from  Exhibit 3.1 to Annual Report on Form 10-K for the fiscal year ended  December 31, 1992 filed with the SEC on March 31, 1993 (File No.  000-20698).                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.2    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for  the fiscal year ended December 31, 1998 filed with the SEC on  March 30, 1999 (File No. 000-20698).                                |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.3    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for  the fiscal year ended December 31, 1999 filed with the SEC on  March 30, 2000 (File No. 000-20698).                                |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.4    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc. are hereby  incorporated by reference from Exhibit 3.3 to Amendment No. 2 to the  quarterly report on Form 10-Q/A for the fiscal quarter ended June 30,  2000 filed with the SEC on November 17, 2000 (File No. 000-20698).  |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.5    |   | Articles of Amendment to  the Restated Articles of Organization of Brooktrout, Inc.                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.6    |   | Amended and Restated  By-laws of Brooktrout, Inc. are hereby incorporated by reference from Exhibit  3.4 to 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).                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 31.1   |   | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14 or 15d-14, as adopted  pursuant to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 31.2   |   | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14, as adopted  pursuant to Section 302 of Sarbanes-Oxley Act of 2002.                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 32.1   |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 32.2   |   | Certification of Chief  Financial Officer pursuant 18 U.S.C. Section 1350, as adopted pursuant  to Section 906 of Sarbanes-Oxley Act of 2002.                                                                                                                                                                    |

 

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