**UNITED STATES********SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

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

 

**For the quarterly period ended March 31, 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                   .**

 

**CommissionFile 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 April 30, 2004,13,065,082 shares of common stock, $.01 par value per share, wereoutstanding.

 

 

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**BROOKTROUT, INC.FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2004**

 

**TABLE OFCONTENTS**

 
|                                   | Page                                                                                                                                                |
|----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
| **PART I  FINANCIAL INFORMATION** | 3                                                                                                                                                   |
| Item 1.                                | Condensed  Consolidated Financial Statements                                                                                                        | 3 |
|                                   | Unaudited  Condensed Consolidated Balance Sheets as of March 31, 2004 and  December 31, 2003                                              | 3 |
|                                   | Unaudited Condensed Consolidated Statements  of Operations for the Three Months Ended March 31, 2004 and  March 31, 2003                  | 4 |
|                                   | Unaudited Condensed Consolidated Statements  of Comprehensive Income (Loss) for the Three Months Ended March 31, 2004  and March 31, 2003 | 5 |
|                                   | Unaudited Condensed Consolidated Statements  of Cash Flows for the Three Months Ended March 31, 2004 and  March 31, 2003                  | 6 |
|                                   | Notes to Unaudited Condensed Consolidated  Financial Statements                                                                                     | 7 |
| Item 2.                                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                         | 12 |
|                                   | Overview                                                                                                                                            | 12 |
|                                   | Application of Critical Accounting Policies                                                                                                         | 12 |
|                                   | Results of Operations                                                                                                                               | 13 |
|                                   | Liquidity and Capital Resources                                                                                                                     | 15 |
|                                   | Factors That May Affect Future Results                                                                                                              | 17 |
| Item 3.                                | Quantitative  and Qualitative Disclosures About Market Risk                                                                                         | 23 |
| Item 4.                                | Controls  and Procedures                                                                                                                            | 23 |
|                                   |                                                                                                                                                |   |
| **PART II OTHER INFORMATION**          | 24                                                                                                                                                  |
| Item  2.                               | Changes  in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                                                                   | 24 |
| Item 6.                                | Exhibits  and Reports on Form 8-K                                                                                                                   | 24 |
|                                   | Signatures                                                                                                                                          | 25 |
|                                   | Exhibit  Index                                                                                                                                      | 26 |

 

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

 

2

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**PART I FINANCIAL INFORMATION**

 

**Item 1****. CondensedConsolidated Financial Statements**

 

**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS***(in thousands, except share and per share data)*

 
|                                                                                                                                              |   | **March 31,  2004** |   | **December 31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
| **Assets**                                                                                                                                        |   |                     |   |                        |   |
| Current assets:                                                                                                                                   |   |                     |   |                        |   |
| Cash and cash equivalents                                                                                                                         |   | $                        | 28,724 |                        | $      | 28,081 |   |
| Marketable debt securities                                                                                                                        |   | 29,723                   |   | 27,869                      |   |
| Accounts receivable (less allowances for doubtful  accounts and sales returns of $897 at March 31, 2004 and $843 at  December 31, 2003) |   | 9,874                    |   | 10,232                      |   |
| Inventory                                                                                                                                         |   | 5,041                    |   | 4,465                       |   |
| Income tax receivable                                                                                                                             |   | 184                      |   | 433                         |   |
| Deferred tax assets                                                                                                                               |   | 3,661                    |   | 3,830                       |   |
| Prepaid expenses and other current assets                                                                                                         |   | 1,979                    |   | 2,354                       |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Total current assets                                                                                                                              |   | 79,186                   |   | 77,264                      |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Equipment and furniture, less accumulated  depreciation                                                                                           |   | 2,266                    |   | 2,245                       |   |
| Deferred tax assets                                                                                                                               |   | 9,413                    |   | 9,413                       |   |
| Intangible assets, less accumulated amortization                                                                                                  |   | 5,606                    |   | 5,909                       |   |
| Other assets, less accumulated amortization                                                                                                       |   | 2,177                    |   | 1,748                       |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Total assets                                                                                                                                      |   | $                        | 98,648 |                        | $      | 96,579 |   |
| **Liabilities  and Stockholders’ Equity**                                                                                                    |   |                     |   |                        |   |
| Current liabilities:                                                                                                                              |   |                     |   |                        |   |
| Accounts payable                                                                                                                                  |   | $                        | 4,826  |                        | $      | 5,350 |   |
| Accrued expenses                                                                                                                                  |   | 4,797                    |   | 5,128                       |   |
| Accrued compensation and commissions                                                                                                              |   | 2,398                    |   | 2,405                       |   |
| Accrued warranty costs                                                                                                                            |   | 1,161                    |   | 1,138                       |   |
| Customer deposits                                                                                                                                 |   | 812                      |   | 758                         |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Total current liabilities                                                                                                                         |   | 13,994                   |   | 14,779                      |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Deferred rent                                                                                                                                     |   | 141                      |   | 146                         |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Total liabilities                                                                                                                                 |   | 14,135                   |   | 14,925                      |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Commitments and contingencies (Note 7)                                                                                                            |   |                     |   |                        |   |
|                                                                                                                                              |   |                     |   |                        |   |
| Stockholders’ equity:                                                                                                                        |   |                     |   |                        |   |
| Preferred stock, $1.00 par value; authorized  100,000 shares; issued and outstanding, none                                                        |   | —                   |   | —                      |   |
| Common stock, $0.01 par value; authorized  40,000,000 shares; issued 13,308,957 at March 31, 2004 and 12,937,019 at  December 31, 2003  |   | 133                      |   | 129                         |   |
| Additional paid-in capital                                                                                                                        |   | 70,946                   |   | 68,270                      |   |
| Accumulated other comprehensive loss                                                                                                              |   | (44                      | )      | (45                         | )      |
| Notes receivable — officers                                                                                                                  |   | (9,845                   | )      | (9,845                      | )      |
| Retained earnings                                                                                                                                 |   | 27,124                   |   | 26,942                      |   |
| Treasury stock, 260,629 shares at March 31,  2004 and 260,386 shares at December 31, 2003, at cost                                      |   | (3,801                   | )      | (3,797                      | )      |
|                                                                                                                                              |   |                     |   |                        |   |
| Total stockholders’ equity                                                                                                                   |   | 84,513                   |   | 81,654                      |   |
| Total liabilities and stockholders’ equity                                                                                                   |   | $                        | 98,648 |                        | $      | 96,579 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

3

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**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS***(in thousands, except per share data)*

 
|                                 |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------|--------|-----------------------------------------|--------|
|                                 |   | **2004**                                |   | **2003** |   |
| Revenue                              |   | $                                       | 18,693 |   | $ | 15,534 |   |
|                                 |   |                                    |   |   |   |
| Costs and expenses:                  |   |                                    |   |   |   |
| Cost of product sold                 |   | 5,968                                   |   | 6,330 |   |
| Research and development             |   | 4,485                                   |   | 4,586 |   |
| Selling, general and administrative  |   | 8,118                                   |   | 7,269 |   |
|                                 |   |                                    |   |   |   |
| Total costs and expenses             |   | 18,571                                  |   | 18,185 |   |
|                                 |   |                                    |   |   |   |
| Operating income (loss)              |   | 122                                     |   | (2,651 | ) |
|                                 |   |                                    |   |   |   |
| Other income, net                    |   | 182                                     |   | 200 |   |
|                                 |   |                                    |   |   |   |
| Income (loss) before income taxes    |   | 304                                     |   | (2,451 | ) |
|                                 |   |                                    |   |   |   |
| Income tax provision (benefit)       |   | 122                                     |   | (788 | ) |
|                                 |   |                                    |   |   |   |
| Net income (loss)                    |   | $                                       | 182    |   | $ | (1,663 | ) |
|                                 |   |                                    |   |   |   |
| Income (loss) per common share:      |   |                                    |   |   |   |
| Net income (loss), basic and diluted |   | $                                       | 0.01   |   | $ | (0.14 | ) |
| Weighted average shares outstanding: |   |                                    |   |   |   |
| Basic                                |   | 12,854                                  |   | 12,282 |   |
| Diluted                              |   | 14,305                                  |   | 12,282 |   |

 

See notes to unaudited condensed consolidated financial statements.

 

4

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**BROOKTROUT, INC.UNAUDITED CONDENSED CONSOLIDATED STATEMENTSOFCOMPREHENSIVE INCOME (LOSS)***(in thousands)*

 
|                                                                              |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                              |   | **2004**                                |   | **2003** |   |
| Net income (loss)                                                                 |   | $                                       | 182    |   | $ | (1,663 | ) |
| Unrealized (losses) gains on marketable debt  securities, net of applicable taxes |   | (3                                      | )      | 47 |   |
| Foreign currency translation adjustments                                          |   | 4                                       |   | — |   |
| Total other comprehensive income                                                  |   | 1                                       |   | 47 |   |
| Comprehensive income (loss)                                                       |   | $                                       | 183    |   | $ | (1,616 | ) |

 

See notes to unaudited condensed consolidated financial statements.

 

5

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

 
|                                                                           |   | **Three  Months Ended March 31,** |   |
|--------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                           |   | **2004**                               |   | **2003** |   |
| **Cash flows from operating activities:**                                      |   |                                   |   |   |   |
| Net income (loss)                                                              |   | $                                      | 182    |   | $ | (1,663 | ) |
| Adjustments to reconcile net income (loss) to cash  from operating activities: |   |                                   |   |   |   |
| Deferred income taxes                                                          |   | 174                                    |   | — |   |
| Provision for doubtful accounts and sales returns                              |   | 62                                     |   | 95 |   |
| Depreciation and amortization                                                  |   | 612                                    |   | 895 |   |
| Amortization of purchased and licensed technology                              |   | 162                                    |   | 165 |   |
| Inventory obsolescence expense                                                 |   | 89                                     |   | 362 |   |
| Increase (decrease) in cash from changes in:                                   |   |                                   |   |   |   |
| Accounts receivable                                                            |   | 296                                    |   | 1,479 |   |
| Inventory                                                                      |   | (665                                   | )      | 272 |   |
| Prepaid expenses and other assets                                              |   | 607                                    |   | 4,903 |   |
| Current and other liabilities                                                  |   | (781                                   | )      | (2,370 | ) |
|                                                                           |   |                                   |   |   |   |
| Cash flows from operating activities                                           |   | 738                                    |   | 4,138 |   |
|                                                                           |   |                                   |   |   |   |
| **Cash flows from investing activities:**                                      |   |                                   |   |   |   |
| Sales and maturities of marketable debt securities                             |   | 10,322                                 |   | 3,669 |   |
| Purchases of marketable debt securities                                        |   | (12,173                                | )      | (9,351 | ) |
| Expenditures for equipment and furniture                                       |   | (330                                   | )      | (83 | ) |
| Purchased and licensed technology                                              |   | (590                                   | )      | — |   |
|                                                                           |   |                                   |   |   |   |
| Cash flows from investing activities                                           |   | (2,771                                 | )      | (5,765 | ) |
|                                                                           |   |                                   |   |   |   |
| **Cash flows from financing activities:**                                      |   |                                   |   |   |   |
| Exercises of stock options                                                     |   | 2,676                                  |   | 25 |   |
|                                                                           |   |                                   |   |   |   |
| Cash flows from financing activities                                           |   | 2,676                                  |   | 25 |   |
|                                                                           |   |                                   |   |   |   |
| Increase (decrease) in cash and cash equivalents                               |   | 643                                    |   | (1,602 | ) |
| Cash and cash equivalents, beginning of period                                 |   | 28,081                                 |   | 23,685 |   |
|                                                                           |   |                                   |   |   |   |
| Cash and cash equivalents, end of period                                       |   | $                                      | 28,724 |   | $ | 22,083 |   |
|                                                                           |   |                                   |   |   |   |
| Supplemental schedule of cash flow  information:                          |   |                                   |   |   |   |
| Tax refunds received                                                           |   | $                                      | 323    |   | $ | 6,040 |   |
| Tax payments                                                                   |   | $                                      | 31     |   | $ | 13 |   |
| Non-cash activities:                                                           |   |                                   |   |   |   |
| Common stock received for exercise of stock  options                           |   | $                                      | 4      |   | $ | — |   |

 

See notes to unaudited condensed consolidated financial statements.

 

6

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**BROOKTROUT, INC.NOTES TO UNAUDITED CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**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 itsproducts to system vendors, service providers, enterprise customers, originalequipment manufacturers, 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) 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.

 

***(c) 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 bymanagement are based on their knowledge and experience with regard to past andcurrent events and assumptions about future events that are believed to bereasonable under the circumstances. Management evaluates these estimates andassumptions and adjusts them if expectations concerning events, includingfuture events, affecting them differ markedly from their original expectations.

 

***(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 isrecorded as a customer deposit or deferred revenue. The Company records aprovision for estimated sales returns and allowances on product sales in thesame period as the related revenue is recorded. These estimates are based onhistorical sales returns, analysis of credit memo data and other known factors.

 

***(e) Warranties***

 

The Company provides warranties on its products for periods of up tofive years. Provisions are made at the time revenue is recognized for the costof fulfilling these commitments. Actual costs of fulfilling these warrantyobligations have been within amounts estimated and provided.

 

7

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**BROOKTROUT, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(continued)**

 

***(f) Concentration of Credit Risk***

 

TheCompany sells its products to various customers in the high technologyindustry. The Company generally requires no collateral. To reduce credit risk,the Company performs credit evaluations of its customers. The Company maintainsallowances for doubtful accounts for estimated losses resulting from itscustomers’ inability to make required payments. At March 31, 2004 andDecember 31, 2003, 15% and 22%, respectively, of the Company’s accountsreceivable were from one customer.  Accounts receivable from a secondcustomer represented 11% of the Company’s accounts receivable at bothMarch 31, 2004 and December 31, 2003.

 

***(g) 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 for employeeawards 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 income (loss) and net lossper share would have been as follows:

 
| **(in thousands, except per share  data)**             |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                   |   | **2004**                                |   | **2003** |   |
|                                                   |   |                                    |   |   |   |
| Net income (loss), as reported                         |   | $                                       | 182    |   | $ | (1,663 | ) |
| Stock-based compensation expense recorded              |   | —                                  |   | — |   |
| Pro forma stock-based compensation expense, net of tax |   | (1,387                                  | )      | (934 | ) |
|                                                   |   |                                    |   |   |   |
| Net loss, pro forma                                    |   | $                                       | (1,205 | ) | $ | (2,597 | ) |
|                                                   |   |                                    |   |   |   |
| Basic and diluted net loss per common share, pro forma |   | $                                       | (0.09  | ) | $ | (0.21 | ) |

 

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 is measured using the Black-Scholes option-pricingmodel. Key assumptions used to apply this pricing model were as follows:

 
|                                    |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------|--------|-----------------------------------------|--------|
|                                    |   | **2004**                                |   | **2003** |   |
| Risk-free interest rate                 |   | 3.2                                     | %      | 2.5 | % |
| Expected life of option grants (years)  |   | 5.6                                     |   | 4.3 |   |
| Expected volatility of underlying stock |   | 85                                      | %      | 43 | % |

 

Theestimated weighted average fair value of option grants made during the threemonths ended March 31, 2004 and 2003 was $12.16 and $1.98, respectively,per option.

 

8

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**BROOKTROUT, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(continued)**

 

***(h) Earnings Per Share***

 

Basicearnings per common share is computed using the weighted average number ofcommon shares outstanding during each period. Diluted earnings per common shareis calculated by dividing the net income by the sum of the weighted averagenumber of common shares outstanding and all additional common shares that wouldhave been outstanding if potentially dilutive securities had been issued, usingthe treasury method.  For the threemonths ended March 31, 2004, the weighted average shares used forcomputing diluted earnings per share included 1,451,000 shares that representthe additional potentially dilutive common shares that would have beenoutstanding if exercised as of that date using the treasury method.

 

Areconciliation of weighted average shares used for the basic and dilutedcomputations is as follows:

 
|                                |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------|--------|-----------------------------------------|--------|
|                                |   | **2004**                                |   | **2003** |   |
|                                |   |                                    |   |   |   |
| Weighted average shares for basic   |   | 12,854,000                              |   | 12,282,000 |   |
| Dilutive effect of stock options    |   | 1,451,000                               |   | — |   |
| Weighted average shares for diluted |   | 14,305,000                              |   | 12,282,000 |   |

 

Stock options to purchase 739,388 shares were excluded from the computationof diluted earnings per share in the three months ended March 31,2004.  Stock options to purchase3,526,687 shares were excluded from the computation of diluted earnings pershare in the three months ended March 31, 2003, because of their anti-dilutiveeffect.

 

***(i) Reclassifications***

 

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

 

**2.Marketable Debt Securities**

 

Marketabledebt securities consisted of the following:

 
|                                             |   | **Amortized********Cost** |   | **Unrealized  Gains** |   | **Unrealized  Losses** |   | **Market********Value** |   |
|--------------------------------------------------|--------|---------------------------|--------|-----------------------|--------|------------------------|--------|-------------------------|--------|
|                                             |   | **(in thousands)**        |   |
| March 31, 2004:                             |   |                      |   |                  |   |                   |   |                    |   |
| U.S. government notes and bonds                  |   | $                         | 14,182 |                  | $      | 28                     |   | $                       | — |   | $ | 14,210 |   |
| Corporate debt securities andforeign investments |   | 15,500                    |   | 19                    |   | (6                     | )      | 15,513                  |   |
|                                             |   |                      |   |                  |   |                   |   |                    |   |
| Total                                            |   | $                         | 29,682 |                  | $      | 47                     |   | $                       | (6     | ) | $ | 29,723 |   |
|                                             |   |                      |   |                  |   |                   |   |                    |   |
| December 31, 2003:                          |   |                      |   |                  |   |                   |   |                    |   |
| U.S. government notes and bonds                  |   | $                         | 13,789 |                  | $      | 22                     |   | $                       | (2     | ) | $ | 13,809 |   |
| Corporate debt securities andforeign investments |   | 14,042                    |   | 27                    |   | (9                     | )      | 14,060                  |   |
|                                             |   |                      |   |                  |   |                   |   |                    |   |
| Total                                            |   | $                         | 27,831 |                  | $      | 49                     |   | $                       | (11    | ) | $ | 27,869 |   |

 

**3.Inventory**

 

Thecomponents of inventory, net of reserves, are as follows:

 
|            |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-----------------|--------|--------------------------|--------|-----------------------------|--------|
|            |   | **(in  thousands)**      |   |
| Raw materials   |   | $                        | 1,020  |                        | $      | 569 |   |
| Work in process |   | 422                      |   | 373                         |   |
| Finished goods  |   | 3,599                    |   | 3,523                       |   |
|            |   |                     |   |                        |   |
| Total           |   | $                        | 5,041  |                        | $      | 4,465 |   |

 

9

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**BROOKTROUT, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(continued)**

** **

Thefollowing is a rollforward of reserves provided for inventory obsolescence:

 
|                             |   | **Three  months ended March 31,** |   |
|----------------------------------|--------|----------------------------------------|--------|
|                             |   | **2004**                               |   | **2003** |   |
|                             |   | **(in  thousands)**                    |   |
| Balance, beginning of the period |   | $                                      | 4,379  |   | $ | 3,909 |   |
| Provisions                       |   | 89                                     |   | 362 |   |
| Write offs                       |   | (398                                   | )      | (213 | ) |
|                             |   |                                   |   |   |   |
| Balance, end of period           |   | $                                      | 4,070  |   | $ | 4,058 |   |

 

**4.Intangible Assets and Other Assets**

 

Intangibleassets consisted of the following:

 
|                                   |   | **March 31,  2004** |   | **December 31,  2003** |   |
|----------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                   |   | **(in  thousands)**      |   |
| Acquired technology                    |   | $                        | 12,038 |                        | $      | 12,038 |   |
| Customer base                          |   | 1,264                    |   | 1,264                       |   |
| Trademarks and other                   |   | 1,273                    |   | 1,273                       |   |
|                                   |   |                     |   |                        |   |
| Total intangible assets                |   | 14,575                   |   | 14,575                      |   |
| Less: accumulated amortization         |   | (8,969                   | )      | (8,666                      | )      |
|                                   |   |                     |   |                        |   |
| Intangible assets, net of amortization |   | $                        | 5,606  |                        | $      | 5,909 |   |

 

Intangible asset amortization expense was $0.3 million and $0.4 millionfor the three months ended March 31, 2004 and 2003, respectively. All intangibles carried on the balance sheet are being amortized.

 

Amortizationexpense associated with these intangible assets for the years ending December 31is anticipated to be as follows: 

 
|              |   | **Amortization  Expense********(in thousands)** |       |
|-------------------|--------|-------------------------------------------------|------------|
|              |   |                                            | ** ** |
| Remainder of 2004 |   | $                                               | 913        |   |
| 2005              |   | 1,216                                           |       |
| 2006              |   | 1,216                                           |       |
| 2007              |   | 1,216                                           |       |
| 2008              |   | 1,045                                           |       |
|                   |        |                                                 |            |  |

 

Otherassets consisted of the following:

 
|                                                   |   | **March 31,  2004** |   | **December 31,  2003** |   |
|--------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                   |   | **(in  thousands)**      |   |
| Purchased and licensed technology                      |   | $                        | 3,890  |                        | $      | 3,300 |   |
| Deposits                                               |   | 309                      |   | 308                         |   |
|                                                   |   |                     |   |                        |   |
| Total other assets                                     |   | 4,199                    |   | 3,608                       |   |
| Less: accumulated amortization of purchased technology |   | (2,022                   | )      | (1,860                      | )      |
|                                                   |   |                     |   |                        |   |
| Other assets, net                                      |   | $                        | 2,177  |                        | $      | 1,748 |   |

 

Other asset amortization expense was $0.2 million in both the threemonths ended March 31, 2004 and 2003.

 

Totalestimated amortization expense associated with these other assets for the yearsending December 31 is anticipated to be as follows: 

 
|              |   | **Amortization  Expense********(in thousands)** |       |
|-------------------|--------|-------------------------------------------------|------------|
|              |   |                                            | ** ** |
| Remainder of 2004 |   | $                                               | 568        |   |
| 2005              |   | 555                                             |       |
| 2006              |   | 497                                             |       |
| 2007              |   | 248                                             |       |
|                   |        |                                                 |            |  |

 

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**BROOKTROUT, INC.NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(continued)**

 

**5.Valuation and Qualifying Accounts**

 

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

 

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

 
|                                 |   | **Three  months ended March 31,** |   |
|--------------------------------------|--------|----------------------------------------|--------|
|                                 |   | **2004**                               |   | **2003** |   |
|                                 |   | **(in  thousands)**                    |   |
| Balance, beginning of the period     |   | $                                      | 843    |   | $ | 1,679 |   |
| Provisions                           |   | 62                                     |   | 95 |   |
| Write offs and payments to customers |   | (8                                     | )      | (87 | ) |
|                                 |   |                                   |   |   |   |
| Balance, end of period               |   | $                                      | 897    |   | $ | 1,687 |   |

 

***Accrued warranty costs:***

 

The following is a rollforward of accrued warranty costs:

 
|                             |   | **Three  months ended March 31,** |   |
|----------------------------------|--------|----------------------------------------|--------|
|                             |   | **2004**                               |   | **2003** |   |
|                             |   | **(in  thousands)**                    |   |
| Balance, beginning of the period |   | $                                      | 1,138  |   | $ | 1,060 |   |
| Provisions for claims            |   | 76                                     |   | 61 |   |
| Claims incurred                  |   | (53                                    | )      | (35 | ) |
|                             |   |                                   |   |   |   |
| Balance, end of period           |   | $                                      | 1,161  |   | $ | 1,086 |   |

 

**6. SegmentReporting**

 

The Company’s operations consist of one reportable segment. 

 

*Major Customers*—Onecustomer accounted for approximately 16% and 14% of revenue for the quartersended March 31, 2004 and 2003, respectively.

 

*International Sales*—Internationalsales, principally exports from the United States, accounted for approximately23% and 27% of revenue for the quarters ended March 31, 2004 and 2003,respectively.

 

**7.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, takinginto account advice of counsel, does not currently believe the eventual outcomeof any such pending or potential matters, including matters in which we mayhave an obligation on behalf of our customers, will have a material effect onthe Company’s consolidated financial condition or results of operations.

 

**8.Subsequent Events**

 

On April 5, 2004, the Company completed its acquisition of theoutstanding capital stock of SnowShore Networks, Inc. (“SnowShore”) for anaggregate purchase price of approximately $9.0 million in cash.  The Company paid the purchase price fromworking capital, and will account for the acquisition as a purchasetransaction.  SnowShore, now a whollyowned subsidiary of the Company, is a provider of leading-edge voice over IPcommunications infrastructure products for the media server and media firewallmarkets.  Immediately after the closingof the acquisition, SnowShore had 19 employees.  The Company has hired a third party to perform a valuation reviewto assist with the purchase price allocations. The Company expects to record a one-time in-process research and developmentcharge of approximately $2.3 million to $2.8 million in the second quarter of2004.

 

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**Item 2****. Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

*The following discussion should be read in conjunction withthe condensed consolidated financial statements and related notes appearingelsewhere in this quarterly report and in our Annual Report on Form 10-K forthe year ended December 31, 2003. The discussion contains forward-lookingstatements that involve known and unknown risks and uncertainties, includingthose set forth below under “Factors That May Affect Future Results.”*

 

**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 the traditional circuit-switchedtelephone network. We supply products for media processing, network interface,call control and signal processing, including protocols that allow Internet andtraditional 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 provided by operating activities. Other key 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 and to continuingdevelop innovative products.

 

The most significant trend that has impacted our business has been theunfavorable economic conditions affecting the communications sector. This hadresulted in a decrease in our revenue from 2000 to 2001 and from 2001 to2002.  Furthermore, we experiencedrevenue decreases for the first two quarters of 2003 when compared to the correspondingquarters of 2002.  Sales of products,particularly for applications in the New Network, to OEMs for use by largeservice providers declined most significantly over these periods. In responseto the revenue decreases, we have implemented expense control programs toreduce operating expenses, while we have continued to invest in developingproducts that we believe our customers will need when the economy furtherimproves. We believe that the economic conditions in our industry generallyhave begun, at least temporarily, to improve and that this improvement wasreflected in our revenue for the first quarter of 2004, which exceeded therevenue in the corresponding period of 2003. We currently expect the revenuefor each of the remaining quarters of 2004 to exceed the revenue in thecorresponding quarters of 2003.

 

Despite the general economic conditions, we were able to increase ourcash and marketable debt securities balances from $41.8 million atDecember 31, 2002 to $58.4 million at March 31, 2004. This wasaccomplished primarily through income tax refunds, operating expensereductions, inventory reductions, and the sale of a business segment.  Ifeconomic conditions do not continue to improve or if they weaken again, we mayexperience adverse effects on our business, operating results, and cash andmarketable 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 the condensedconsolidated financial statements that affect the reported amounts of assetsand 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.

 

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:

 

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•                  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, we refer the reader to the discussion on thosepolicies in our Annual Report on Form 10-K for the year ended December 31,2003 and to Note 1 to the condensed consolidated financial statements in Part1, Item 1 of this report.

 

**Results of Operations**

 

Thetable below sets forth certain condensed consolidated statements of operationsdata as a percentage of total revenue for the periods presented.

 
|                                |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------|--------|-----------------------------------------|--------|
|                                |   | **2004**                                |   | **2003** |   |
| Domestic revenue                    |   | 77                                      | %      | 73 | % |
| International revenue               |   | 23                                      |   | 27 |   |
| Total revenue                       |   | 100                                     |   | 100 |   |
| Cost of product sold                |   | 32                                      |   | 41 |   |
| Gross profit                        |   | 68                                      |   | 59 |   |
| Operating expenses:                 |   |                                    |   |   |   |
| Research and development            |   | 24                                      |   | 29 |   |
| Selling, general and administrative |   | 43                                      |   | 47 |   |
| Total operating expenses            |   | 67                                      |   | 76 |   |
| Operating income (loss)             |   | 1                                       |   | (17 | ) |
| Other income, net                   |   | 1                                       |   | 1 |   |
| Income (loss) before income taxes   |   | 2                                       |   | (16 | ) |
| Income tax provision (benefit)      |   | 1                                       |   | (5 | ) |
| Net income (loss)                   |   | 1                                       | %      | (11 | )% |

 

***Revenue***

 

Thefollowing table presents our domestic and international revenue:

 
|                                      |   | **Three  Months Ended March 31,** |   |
|-------------------------------------------|--------|----------------------------------------|--------|
|                                      |   | **2004**                               |   | **2003** |   |
|                                      |   | **(dollars  in thousands)**            |   |
| Domestic revenue                          |   | $                                      | 14,335 |   | 77 | % | $ | 11,282 |   | 73 | % |
| International revenue, principally export |   | 4,358                                  |   | 23 |   | 4,252 |   | 27 |   |
|                                      |   |                                   |   |   |   |   |   |   |   |
| Total revenue                             |   | $                                      | 18,693 |   | 100 | % | $ | 15,534 |   | 100 | % |

 

Revenue in the three months ended March 31, 2004 was$18.7 million compared to $15.5 million in the corresponding periodof 2003, an increase of approximately 20%. 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 three months ended March 31, 2003, internationalrevenue for the corresponding period of 2004 increased by $0.1 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 $0.4million decrease in sales to European customers is net of a $0.1 millionincrease in revenue due to favorable foreign currency exchange rates forEuropean sales.  During the three monthsended March 31, 2004, revenue from enterprise customers accounted forapproximately 85% of total revenue, as compared to 79% of total revenue for thethree months ended March 31, 2003. The remaining revenue was attributable to sales to service providercustomers.

 

In the three months ended March 31, 2004, approximately 30 of ourcustomers each purchased over $100,000 of products, in aggregate representing74% of total revenue for the quarter. In the three months ended March 31, 2003, approximately 30 of ourcustomers each purchased over $100,000 of products, in aggregate representingapproximately 70% of total revenue for the quarter.  Total customers in the first quarter of 2004 decreased to

 

13

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approximately335 from approximately 400 in the first quarter of 2003, primarily due to adecline in the number of customers that purchased $5,000 or less in thequarter.  Revenue from one customeraccounted for 16% of total revenue in the three months ended March 31,2004, compared to 14% in the corresponding period of 2003. We expect thatrevenue from this customer will be greater than 10% of total revenue for 2004.

 

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

 

Thefollowing table presents cost of product sold and gross profit information:

 
|                    |   | **Three  Months Ended March 31,** |   |
|-------------------------|--------|----------------------------------------|--------|
|                    |   | **2004**                               |   | **2003** |   |
|                    |   | **(dollars  in thousands)**            |   |
| Cost of product sold    |   | $                                      | 5,968  |   | $ | 6,330 |   |
| Gross profit            |   | $                                      | 12,725 |   | $ | 9,204 |   |
| Gross profit percentage |   | 68                                     | %      | 59 | % |

 

Thedecrease in cost of product sold in the three months ended March 31, 2004,compared to the corresponding period in 2003, was the result of changes inproduct mix, increased sales of our digital fax products (which have highermargins), and reduced inventory obsolescence and manufacturing expenses.  Our inventory obsolescence expensedecreased by $0.3 million in the first quarter of 2004 relative to the sameperiod of 2003, primarily due to reduced reserve requirements for serviceprovider product inventory.  Ourmanufacturing expenses decreased by $0.1 million in the first quarter of 2004relative to the same period of 2003, primarily due to reduced costs formanufacturing supplies.  Our change inproduct mix to higher margin products contributed to a significant improvementin the gross profit percentage in the first quarter of 2004, compared to thefirst quarter of 2003.

 

***Operating Expenses***

 

Thefollowing table presents our operating expenses:

 
|                                |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------|--------|-----------------------------------------|--------|
|                                |   | **2004**                                |   | **2003** |   |
|                                |   | **(in  thousands)**                     |   |
| Research and development            |   | $                                       | 4,485  |   | $ | 4,586 |   |
| Selling, general and administrative |   | 8,118                                   |   | 7,269 |   |
|                                |   |                                    |   |   |   |
| Total operating expenses            |   | $                                       | 12,603 |   | $ | 11,855 |   |

 

Researchand development expense

 

Research and development expense represented 24% of revenue in thefirst quarter of 2004, compared with 29% of revenue in first quarter of 2003.The $0.1 million decrease in research and development expense in the firstquarter of 2004 relative to the corresponding period of 2003 was primarily theresult of reduced consulting and contract labor expenses of $0.1 million anddecreased depreciation expense of $0.1 million, offset by increases in equipmentpurchases and maintenance expenses of $0.1 million. Our continuing developmentefforts are focused on hardware and software for media processing products(voice, fax and data), network interface products, call control products andsignal processing products.  Researchand development expense for the second quarter of 2004, including the impact ofthe Snowshore Networks acquisition on April 5, 2004, is expected to beapproximately 25% to 27% of revenue.

 

Selling,general and administrative expense

 

Selling, general and administrative expense represented 43% of revenuein the first quarter of 2004, compared with 47% of revenue in the first quarterof 2003.  The $0.8 million increase inselling, general and administrative expense in the first quarter of 2004relative to the corresponding period of 2003 was primarily due to expenseincreases related to our new Japan sales operation of $0.3 million, increasesin professional fees of $0.2 million, and increases in marketing expenses of$0.1 million, offset by a decrease in depreciation and amortization expense of$0.2 million.  Selling, general andadministrative expense for the second quarter of 2004, including the impact ofthe Snowshore Networks acquisition, is expected to be approximately 43% to 45%of revenue.

 

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***Other Income, Net***

 

Otherincome, net, was $0.2 million in both the three months ended March 31,2004 and 2003.  A slight increase ininterest income, which was due to our increased cash and marketable debtsecurities balances, was offset by foreign currency exchange losses.

 

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

 

Thefollowing table presents our income tax provision (benefit) and effective taxrate:

 
|                           |   | **Three  Months Ended  March 31,** |   |
|--------------------------------|--------|-----------------------------------------|--------|
|                           |   | **2004**                                |   | **2003** |   |
|                           |   | **(dollars  in thousands)**             |   |
| Income tax provision (benefit) |   | $                                       | 122    |   | $ | (788 | ) |
| Effective tax rate             |   | 40                                      | %      | (32 | )% |
|                                |        |                                         |        |  |  |  |  |

 

We recorded an income tax provision in the three months endedMarch 31, 2004, compared with an income tax benefit in the three monthsended March 31, 2003, as a result of earning a pre-tax profit.  The effective tax rate for the secondquarter of 2004, excluding the impact of the Snowshore Networks one-timein-process research and development charge of approximately $2.3 million to$2.8 million, is expected to be approximately 35% to 40%.   Including the impact of the in-processresearch and development charge, the effective tax rate for the second quarterof 2004 is expected to be (1)% to (10)%.

 

**Liquidityand Capital Resources**

 

Cash flows forthe three months ended March 31, 2004 and 2003

 

Cash flows from operating activities were $0.7 million in the threemonths ended March 31, 2004. This primarily resulted from net tax refundsof $0.3 million, reductions in accounts receivable, and net income for thequarter, all of which were partially offset by an increase in inventory and adecrease in accounts payable and accrued expenses.  Both the decrease inaccounts receivable and increase in inventory were attributable to lower thanexpected sales activity.  Cash flowsfrom operating activities were $4.1 million in the three months endedMarch 31, 2003. This primarily resulted from net income tax refunds of$6.0 million and reductions in accounts receivable, offset by a decreasein current liabilities.

 

Cash used in investing activities was $2.8 million in the three monthsended March 31, 2004.  Thisprimarily resulted from net purchases of marketable debt securities of$1.9 million and the purchase and license of technology for $0.6 millionto be used in the development of new products and the modification of existingproducts.  Cash used in investingactivities was $5.8 million in the three months ended March 31, 2003.This primarily resulted from net purchases of marketable debt securities of$5.7 million.

 

Cash from financing activities was $2.7 million in the three monthsended March 31, 2004.  This wasprimarily attributable to proceeds from the sale of common stock issued underour employee stock option plans.  Cashfrom financing activities was $0.03 million in the three months endedMarch 31, 2003, all of which was attributable to proceeds from the sale ofcommon stock under our employee stock purchase plan.

 

ContractualObligations and Capital Expenditures

 

Thefollowing table presents our future contractual obligations and commercialcommitments as of March 31, 2004:

 
|             |   | **Total**           |   | **Remainder  of 2004** |   | **2005** |   | **2006** |   | **2007** |   | **2008** |   | **Thereafter** |   |
|------------------|--------|---------------------|--------|------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|
|             |   | **(in  thousands)** |   |
| Operating leases |   | $                   | 5,891  |                   | $      | 2,266    |   | $        | 2,085  |     | $      | 803      |   | $              | 228    |   | $ | 228 |   | $ | 281 |   |
|                  |        |                     |        |                        |        |          |        |          |        |          |        |          |        |                |        |  |  |  |  |  |  |  |

 

Wehave operating lease commitments for our primary office and manufacturingfacilities that expire between 2005 and 2006. In addition, 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.

 

Wepurchased $0.3 million and $0.08 million of capital equipment in the threemonths ended March 31, 2004 and 2003, respectively.  We currently have no material commitmentsfor additional capital expenditures.  Inthe three months ended March 31, 2004, we acquired technology, andcontingent upon satisfactory performance by the seller and our finalacceptance, we will be obligated to purchase engineering services of  $1.2 million.  We have

 

15

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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 materialadverse impact on our financial results.

 

Wehad no long-term debt as of March 31, 2004 or May 7, 2004.

 

Cashand Cash Liquidity Position

 

Thefollowing table presents our cash and liquidity position as of March 31,2004 and December 31, 2003:

 
|                             |   | **March 31,  2004**    |   | **December 31,  2003** |   |
|----------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                             |   | **(dollars  in thousands)** |   |
| Cash and cash equivalents        |   | $                           | 28,724 |                        | $      | 28,081 |   |
| Marketable debt securities       |   | 29,723                      |   | 27,869                      |   |
| Total                            |   | $                           | 58,447 |                        | $      | 55,950 |   |
|                             |   |                        |   |                        |   |
| Working capital                  |   | $                           | 65,192 |                        | $      | 62,485 |   |
| Quick ratio                      |   | 5.0                         |   | 4.6                         |   |
| Maximum available line of credit |   | $                           | 5,000  |                        | $      | 5,000 |   |

 

Cash, cash equivalents and marketable debt securities increased to$58.4 million as of March 31, 2004 from $56.0 million as ofDecember 31, 2003, primarily due to $0.7 million from operating activitiesand $2.7 million of cash proceeds from employee stock transactions, offset by a$0.6 million payment for acquired technology and $0.3 million of capitalequipment expenditures in the first quarter of 2004. Working capitalincreased by $2.7 million from December 31, 2003 to March 31,2004. This increase in working capital was the result of a 4% increase in cashand marketable debt securities and a decrease in accounts payable and accruedliabilities, partially offset by decreases in accounts receivable and prepaidexpenses.  Our quick ratio improved from4.6 at December 31, 2003 to 5.0 at March 31, 2004, due primarily to a4% increase in cash and marketable debt securities and a modest decrease in currentliabilities.  Quick ratio is calculatedas current assets minus inventory, income tax receivable and deferred taxassets divided by current liabilities, and is an indicator of a company’sability to meet short-term financial obligations.

 

On April 5, 2004, we completed our acquisition of the outstandingcapital stock of SnowShore Networks, for an aggregate purchase price ofapproximately $9.0 million in cash.  Weused our cash and marketable debt securities to fund the purchase price, andwill account for the acquisition as a purchase transaction.  As of the acquisition date, SnowShoreNetworks’ cash and marketable debt securities were approximately $1.0 million.

 

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 ofMarch 31, 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 andmarketable debt securities balances.  Asof March 31, 2004, we had not repurchased any shares under the program.

 

We believe that our cash and marketable debt securities are likely tomeet our needs for the foreseeable future.  Though we do not expect tomake any major capital expenditures in the remainder of 2004, we are alwayslooking for opportunities to expand the business, which could includeacquisitions or organic expansion into new markets. If we find that our cashand cash equivalents, marketable debt securities and funds available from ourbank 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.

 

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**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 consolidated financial statements and related notes. Therisks and uncertainties described below are those that we currently believe maymaterially affect us. Additional risks and uncertainties that we are unawareof, or that we currently deem immaterial, also may become important factorsthat affect us.

 

**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 increase efficiencyin their supply chains and reduce their inventory levels. Additionally, theslowdown in the telecommunications industry and the resulting decrease inspending by companies in our target markets have reduced the rate of growth ofdata traffic and the use of the Internet, which are driving the convergence ofdata and telephony that we expect will give rise to demand for New Networkapplications. The economic downturn adversely affected our business andoperating results for the year ended December 31, 2003, and even more sofor the years ended December 31, 2002 and 2001. While we believe theeconomic condition may be improving somewhat, if current economic conditions donot continue 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. If weare unable to differentiate our products from existing and future offerings ofour 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. We expect our current competitors to continueto improve the design and performance of their existing products and tointroduce new products and enhancements with improved price and performancecharacteristics. Our product sales may be threatened by new technologies,products or market trends, and we may have to reduce the prices of our productsto stay competitive. In addition, new competitors may emerge in the markets weserve. An acquisition of, or by, one of our competitors may result in asubstantially strengthened competitor with greater financial, engineering,manufacturing, marketing, and customer service and support resources than wehave. If our current or future competitors enter into strategic relationshipswith leading manufacturers covering products similar to those sold or beingdeveloped by us, our ability to sell products to those manufacturers may be adverselyaffected.

 

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 assure you 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.

 

***If we fail todevelop and sell new or enhanced products for the telecommunications hardwareand software market, we will not be able to compete effectively.***

 

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The telecommunications hardware and software market is characterizedby:

 

*•**                                         *rapidtechnological advances;

 

*•**                                         *evolvingindustry standards;

 

*•**                                         *changesin customer requirements and product life cycles;

 

*•**                                         *frequentnew product introductions or innovations;

 

*•**                                         *decliningprices;

 

*•**                                         *intensecompetition; 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 may also 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 be requiredto collaborate with third parties to develop products and may not be able to doso on a timely and cost-effective basis, if at 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 sales cycles,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.

 

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 the customer’s product or service using ourproduct is controlled by, and can vary significantly with the needs of, thecustomer. In some circumstances, the customer will not require the product forseveral months. This continuing uncertainty can complicate our planningprocesses and reduce the predictability of our earnings and cash flows.

 

***Our business andoperating results could be adversely affected by downturns in economicconditions in countries outside the United States and other risks associatedwith international operations.***

 

18

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Sales of our products to customers outside the United States accountedfor 23% of our revenue in the quarter ended March 31, 2004. We anticipatethat international sales will continue to account for a significant portion ofour revenue. International sales are subject to a number of risks, including:

 

•                                          volatilityin currency exchange rates;

 

•                                          politicaland economic instability in other countries;

 

•                                          theimposition of trade restrictions, trade barriers, and tariff regulations byforeign governments;

 

•                                          difficultiesin accounts receivable collections;

 

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

 

*•**                                         *potentiallyadverse tax consequences; and

 

*•**                                         *difficultiesin managing and/or expanding operations across disparate 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 Networks,Inc., a provider of voice over IP communications infrastructure products forthe media 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 and consolidateany acquired businesses or assets with our existing operations. Managing anacquired business entails numerous operational and financial risks, includingdifficulties in integrating disparate administrative, accounting and finance,and information systems, difficulties in assimilating acquired operations andnew personnel, diversion of management’s attention from other businessconcerns, and potential loss of key employees or customers of any acquiredoperations. Accordingly, we may be unable to successfully identify, consummateand integrate future acquisitions or operate acquired businesses profitably. Ifwe are unable to integrate an acquired company successfully, our future growthmay suffer, and our results of operations could be harmed.

 

***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

 

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our products.We currently enter into purchase orders with independent manufacturers ofmaterials based on forecasts of need, but have no guaranteed capacityarrangements with these manufacturers. Any significant interruption in thesupply, or degradation in the quality, of any component could cause us to losesales, incur additional costs 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 are frequently found during theperiod immediately following introduction and initial implementation of newproducts or enhancements to existing products. Although it is our objective toresolve all bugs that we believe would be considered serious by our customersbefore implementation, our products may not be bug-free. We also providewarranties against defects in materials and workmanship on our hardwareproducts for five years. Errors, bugs or performance problems, however, couldresult in lost revenue or customer relationships and could be detrimental toour business and reputation generally. In addition, our customers generally useour products together with their own products and products from other vendors.As a result, when problems occur, it may be difficult to identify the source ofthe problem. These problems may cause us to incur significant warranty andrepair costs, divert the attention of our engineering personnel from ourproduct development efforts and cause significant 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 of whichcould restrict our business or increase our cost of doing business. Any changesto existing laws or the adoption of new regulations by federal or stateregulatory authorities or any legal challenges to existing laws or regulationsrelating to the telecommunications industry could materially adversely affectthe market for our products. Moreover, our value-added resellers or othercustomers may require, or we may otherwise deem it necessary or advisable, forus to alter our products to address actual or anticipated changes in theregulatory environment. Our inability to alter our products or address anyregulatory changes could have a material adverse effect on our business,financial condition or operating results.

 

***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.Notwithstanding our efforts, third parties may infringe or misappropriate ourproprietary rights. In addition, we generally require each of our employees toexecute a proprietary information agreement designed to protect our tradesecrets, our inventions created in the course of employment with us and otherproprietary information of our company. Moreover, effective patent, trademark,copyright or trade secret protections may not be available in every country inwhich we operate or intend to operate to the same extent as the laws of the UnitedStates. Also, it may be possible for unauthorized third parties to copy orreverse engineer aspects of our products, develop similar technologyindependently or otherwise obtain and use information that we regard asproprietary. Furthermore, detecting unauthorized use of our proprietary rightsis difficult. Litigation may be necessary to enforce our proprietary rights.Such litigation could result in the expenditure of significant financial andmanagerial resources and could have a material adverse effect on our futureoperating 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

 

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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 in such litigation given the complex technical issues andinherent uncertainties in patent litigation. In the event a claim against uswas successful, and we could not obtain a license on acceptable terms orlicense a substitute technology or redesign to avoid infringement, we may beunable to market our affected products. This could have a material adverseeffect on our business, financial condition 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 certain technologyintegral to certain of our products from third parties. 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.

 

***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 whomperform important functions and would be difficult to replace. If we lose oneor more members of our senior management team our business and operatingresults would be harmed. We do not have employment contracts with our keypersonnel. 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 safetyregulations relating to matters such as reductions in the use of harmfulsubstances, comprehensive risk management in manufacturing activities and finalproducts, the use of lead-free soldering, and the recycling of products andpackaging materials. On February 13, 2003 the European Parliament and theCounsel of the European Union published directives on waste electrical andelectronic equipment and on the restriction of the use of certain hazardoussubstances in electrical and electronic equipment. These directives willgenerally require electronics producers after August 2005 to bear the costof collection, treatment, recovery and safe disposal of past and futureproducts from end-users and to ensure after June 2006 that new electricaland electronic equipment does not contain specified hazardous substances. Whilethe cost of these directives to us cannot be determined before regulations areadopted in individual member states of the European Union, it may besubstantial and may divert resources, which could detract from our ability todevelop new products. We may not be able to comply in all cases with applicableenvironmental and other regulations, and if we do not, we may incur remediationcosts or we may not be able to offer our products for sale in certaincountries, which could adversely 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:

 

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*•**                                         *ourability to cope with difficult conditions in the economy in general, and thetelecommunications market in particular;

 

*•**                                         *ourability to formulate and implement effective strategies to respond to changingmarket requirements and conditions;

 

*•**                                         *cancellationor rescheduling of orders for our products;

 

*•**                                         *ourability to collect accounts receivable from customers that have been adverselyaffected by the difficult economic conditions;

 

*•**                                         *ourability to develop, manufacture, market and support our products and productenhancements;

 

*•**                                         *thetiming and number of orders for our products, which have historically beenweighted more heavily toward the last month of each quarter and the second andfourth quarters of each year;

 

*•**                                         *wetypically experience lower revenue in the third quarter, due to customer summervacation schedules, particularly in Europe, and to a lesser extent, the firstquarter of each year;

 

*•**                                         *ourability to hire, train and retain key management, sales, marketing andengineering personnel;

 

*•**                                         *announcementsor technological innovations by our competitors or in competing technologies;

 

*•**                                         *ourability to obtain sufficient supplies of sole or limited source components forour products;

 

*•**                                         *adecrease in the average selling prices of our products;

 

*•**                                         *changesin costs of components that we include in our products;

 

*•**                                         *themix of products that we sell;

 

*•**                                         *anyinterruptions in the flow of our products through our resellers or ourtwo-tiered distribution system; and

 

*•**                                         *adecrease 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:

 

*•**                                         *futureannouncements concerning our business, technology, acquisitions, strategicpartnerships, management, customers or competitors;

 

*•**                                         *introductionof new products or changes in product pricing policies by us, our competitorsor our customers;

 

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

 

*•**                                         *changesin market valuations of similar companies;

 

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

 

*•**                                         *theeconomic and competitive conditions in the telecommunications sectors in whichour customers operate; and

 

*•**                                         *generaleconomic conditions and stock market trends.

 

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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.

 

***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 the future,and any additional financing may result in restrictions on our operations orsubstantial 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 convertible securities,the issuance could result in substantial dilution to existing stockholders. Ifwe raise additional funds through the issuance of debt securities or preferredstock, these new securities would have rights, preferences and privilegessenior to those of the holders of our common stock. The terms of thesesecurities, as well as any borrowings under our bank line of credit agreement,could impose restrictions on our operations.

 

**Item 3****. Quantitative and Qualitative Disclosures AboutMarket 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 ofMarch 31, 2004.  Based on thisevaluation, our chief executive officer and chief financial officer concludedthat, as of March 31, 2004, our disclosure controls and procedures were(1) designed to ensure that material information relating to our company,including our consolidated subsidiaries, is made known to our chief executiveofficer and chief financial officer by others within those entities,particularly during the period in which this report was being prepared and (2)effective, in that they provide reasonable assurance that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms.

 

(b) Changes ininternal control over financial reporting.

 

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 March 31, 2004 that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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# **PART II** OTHER INFORMATION

# ** **

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

 

In October 2003, the Board of Directors authorized the repurchaseof up to 1,000,000 shares of the Company’s common stock from time to time onthe open market or in privately negotiated transactions.  The program expires in October 2004. Asof March 31, 2004, there have been no shares repurchased under this program.

 

**Item 6****.  Exhibits andReports 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, 1999 filed with the SEC on March 30, 2000 (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, 1999 filed with the SEC on  March 30, 2000 (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 3.3 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).  |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.4    |   | 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                                                                                                                                                                                                                                                                                                   |

 

OnFebruary 17, 2004, we filed a current report on Form 8-K, datedFebruary 17, 2004, furnishing under Item 12 our press release announcingfinancial results for the quarter and year ended December 31, 2003.

 

OnMarch 26, 2004, we filed a current report on Form 8-K, datedMarch 25, 2004, announcing that we had entered into an agreement toacquire the outstanding capital stock of SnowShore Networks, Inc.

 

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 under Item 2 the completion of the acquisition of theoutstanding capital stock 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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**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: May 7, 2004 | By:                       | /s/  ERIC R. GILER |   |
|              |                      | Eric  R. Giler*President  (Principal Executive Officer)* |   |
|              |                      |   |   |
| Date: May 7, 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, 1999 filed with the SEC on March 30, 2000 (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, 1999 filed with the SEC on  March 30, 2000 (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 3.3 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).  |
|   |   |                                                                                                                                                                                                                                                                                                                       |
| 3.4    |   | 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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