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**SECURITIESAND EXCHANGE COMMISSION********Washington, D.C. 20549**

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**FORM10-Q**

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

**Forthe quarterly period ended June 30, 2001**

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

**Forthe transition period from               to               **

**CommissionFile No. 000-20698**

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**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 number) |
| **250 First Avenue,  Suite 300  Needham, Massachusetts**    | ** ** | **02494-2814**                           |
| (Address of principal  executive offices)                        |       | (Zip code)                               |

Registrant's telephonenumber, including area code:**  (781) 449-4100**

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

    Asof July 31, 2001, 12,426,028 shares of Common Stock, $.01 par value per share,were outstanding.

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**BROOKTROUT, INC.FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001**

**TABLE OF CONTENTS**

    

| PART  I            | FINANCIAL  INFORMATION                                                                                                                   |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------|
|               |                                                                                                                                     |
|  Item 1. | Condensed  Consolidated Financial Statements                                                                                             |
|               |                                                                                                                                     |
|               | Unaudited  Condensed Consolidated Balance Sheets as of June 30, 2001 and  December 31, 2000                                         |
|               |                                                                                                                                     |
|               | Unaudited  Condensed Consolidated Statements of Operations for the Three and Six Months  Ended June 30, 2001 and June 30, 2000           |
|               |                                                                                                                                     |
|               | Unaudited  Condensed Consolidated Statements of Comprehensive Income for the Three and  Six Months Ended June 30, 2001 and June 30, 2000 |
|               |                                                                                                                                     |
|               | Unaudited  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June  30, 2001 and June 30, 2000                     |
|               |                                                                                                                                     |
|               | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                          |
|               |                                                                                                                                     |
|  Item 2. | Management's  Discussion and Analysis of Financial Condition and Results of Operations                                                   |
|               |                                                                                                                                     |
|               | Introduction                                                                                                                             |
|               |                                                                                                                                     |
|               | Three  Months Ended June 30, 2001 and June 30, 2000                                                                                      |
|               |                                                                                                                                     |
|               |  Six Months Ended June 30, 2001 and June 30,  2000                                                                                  |
|               |                                                                                                                                     |
|               | Liquidity and Capital  Resources                                                                                                         |
|               |                                                                                                                                     |
|               | Risk Factors                                                                                                                             |
|               |                                                                                                                                     |
|  Item 3. | Quantitative  and Qualitative Disclosures about Market Risk                                                                              |
|               |                                                                                                                                     |
|  PART II | OTHER  INFORMATION                                                                                                                       |
|               |                                                                                                                                     |
|  Item 1. | Legal  Proceedings                                                                                                                       |
|               |                                                                                                                                     |
|  Item 4. | Submission  of Matters to a Vote of Security Holders                                                                                     |
|               |                                                                                                                                     |
|  Item 6. | Exhibits and  Reports on Form 8-K                                                                                              |
|               |                                                                                                                                     |
|               | Signatures                                                                                                                               |

 

 

**Brooktrout, Inc.Unaudited CondensedConsolidated Balance Sheets(In thousands, except share data)**

|                                                                     |                                                                                                                |    |         |    |
|--------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------|---------|--------------|---------|
|                                                                     | June 30,                                                                                                            |    | December 31, |    |
|                                                                     | 2001                                                                                                                |    | 2000         |    |
|                                                                     |                                                                                                                     |    |              |    |
| ASSETS                                                                   |                                                                                                                |    |         |    |
| Current  assets:                                                         |                                                                                                                |    |         |    |
|                                                                     | Cash  and equivalents                                                                                               | $       | 31,484       |    | $ | 23,294 |   |
|                                                                     | Marketable  securities                                                                                              | 4,083   |         | 2,693   |   |
|                                                                     | Accounts  receivable (less allowance for doubtful accounts and sales returns of $2,504  in 2001 and $2,647 in 2000) | 9,405   |         | 21,820  |   |
|                                                                     | Inventory                                                                                                           | 17,833  |         | 19,609  |   |
|                                                                     | Deferred  tax assets                                                                                                | 6,207   |         | 7,873   |   |
|                                                                     | Prepaid  expenses and other current assets                                                                          | 3,270   |         | 3,749   |   |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     | Total  current assets                                                                                               | 72,282  |         | 79,038  |   |
|                                                                     |                                                                                                                |    |         |    |   |
| Equipment  and furniture, less accumulated depreciation and amortization | 6,360                                                                                                               |    | 7,574        |    |
| Deferred  taxes                                                          | 4,361                                                                                                               |    | 6,584        |    |
| Intangible  assets, less accumulated amortization                        | 10,314                                                                                                              |    | 11,186       |    |
| Investments                                                              | 6,627                                                                                                               |    | 2,660        |    |
| Other  assets                                                            | 2,093                                                                                                               |    | 2,171        |    |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     | Total  assets                                                                                                       | $       | 102,037      |    | $ | 109,213 |   |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     |                                                                                                                |    |         |    |   |
|                                                                     | LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                           |    |         |    |   |
|                                                                     |                                                                                                                |    |         |    |   |
| Current  liabilities:                                                    |                                                                                                                |    |         |    |
|                                                                     | Accounts  payable and other accruals                                                                                | $       | 9,331        |    | $ | 15,171 |   |
|                                                                     | Accrued  compensation and commissions                                                                               | 3,876   |         | 3,442   |   |
|                                                                     | Customer  deposits                                                                                                  | 565     |         | 558     |   |
|                                                                     | Accrued  warranty costs                                                                                             | 1,269   |         | 1,499   |   |
|                                                                     | Net  liabilities related to discontinued operations                                                                 | 1,483   |         | 6,024   |   |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     | Total  current liabilities                                                                                          | 16,524  |         | 26,694  |   |
|                                                                     |                                                                                                                |    |         |    |   |
| Deferred  rent                                                           | 255                                                                                                                 |    | 260          |    |
| Contingencies  (note 7)                                                  |                                                                                                                |    |         |    |
|                                                                     |                                                                                                                |    |         |    |   |
| Shareholders’  equity:                                              |                                                                                                                |    |         |    |
|                                                                     | Common  stock, $0.01 par value; authorized, 40,000,000                                                              |    |         |    |   |
|                                                                     | shares;  issued and outstanding 12,426,028 shares in                                                                |    |         |    |   |
|                                                                     | 2001  and 12,366,927 in 2000                                                                                        | 124     |         | 124     |   |
|                                                                     | Additional  paid-in capital                                                                                         | 63,642  |         | 63,348  |   |
|                                                                     | Loans  to officers                                                                                                  | (11,760 | )            | (11,760 | ) |
|                                                                     | Accumulated  other comprehensive loss                                                                               | (391    | )            | (188    | ) |
|                                                                     | Retained  earnings                                                                                                  | 37,403  |         | 34,495  |   |
|                                                                     | Treasury  stock, 255,384 shares in 2001 and 2000                                                                    | (3,760  | )            | (3,760  | ) |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     | Total  shareholders’ equity                                                                                    | 85,258  |         | 82,259  |   |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                     | Total  liabilities and shareholders’ equity                                                                    | $       | 102,037      |    | $ | 109,213 |   |
|                                                                     |                                                                                                                |         |         |         |   |
|                                                                          |                                                                                                                     |         |              |         |  |  |  |  |

See notes to unaudited condensed consolidatedfinancial statements.

**Brooktrout, Inc.**

**Unaudited CondensedConsolidated Statements of Operations**

**(Inthousands, except per share data)**

|                                      | Three Months Ended   June 30,                              |   | Six Months Ended   June 30, |   |
|-------------------------------------------|------------------------------------------------------------|--------|-----------------------------|--------|
|                                      |                                                            |        |                             |   |  |  |  |   |
|                                      | 2001                                                       |   | 2000                        |   | 2001 |   | 2000 |   |
|                                      |                                                            |   |                             |   |  |   |  |   |
| Revenue                                   | $                                                          | 17,844 |                        | $      | 37,024 |   | $ | 44,907 |   | $ | 70,493 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Cost  and expenses:                       |                                                       |   |                        |   |   |   |   |   |
|                                      | Cost  of product sold                                      | 8,449  |                        | 12,948 |   | 19,644 |   | 25,885 |   |
|                                      | Research  and development                                  | 5,716  |                        | 5,611  |   | 11,194 |   | 11,397 |   |
|                                      | Selling,  general and administrative                       | 7,766  |                        | 10,269 |   | 17,474 |   | 19,659 |   |
|                                      |                                                       |        |                        |        |   |  |   |  |   |
|                                      | Total  cost and expenses                                   | 21,931 |                        | 28,828 |   | 48,312 |   | 56,941 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Operating  income (loss)                  | (4,087                                                     | )      | 8,196                       |   | (3,405 | ) | 13,552 |   |
| Other  income (expense):                  |                                                       |   |                        |   |   |   |   |   |
|                                      | Interest  income, net                                      | 306    |                        | 523    |   | 616 |   | 1,129 |   |
|                                      | Equity  in loss of affiliates                              | (342   | )                           | (1,400 | ) | (1,397 | ) | (1,400 | ) |
|                                      |                                                            |   |                             |   |  |   |  |   |
|                                      | Total  other income (expense)                              | (36    | )                           | (877   | ) | (781 | ) | (271 | ) |
|                                      |                                                            |   |                             |   |  |   |  |   |
| Income  (loss) before income taxes        | (4,123                                                     | )      | 7,319                       |   | (4,186 | ) | 13,281 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Income  tax provision (benefit)           | (1,388                                                     | )      | 2,799                       |   | (1,021 | ) | 5,073 |   |
|                                      |                                                            |   |                             |   |  |   |  |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Income  (loss) from continuing operations | (2,735                                                     | )      | 4,520                       |   | (3,165 | ) | 8,208 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Discontinued  operations:                 |                                                       |   |                        |   |   |   |   |   |
|                                      | Loss  from discontinued operations, net of taxes           | -      |                        | (3,018 | ) | - |   | (6,356 | ) |
|                                      | Gain  on disposal of discontinued operations, net of taxes | 4,423  |                        | -      |   | 6,073 |   | - |   |
|                                      |                                                            |   |                             |   |  |   |  |   |
|                                      | Total  gain (loss) from discontinued operations            | 4,423  |                        | (3,018 | ) | 6,073 |   | (6,356 | ) |
|                                      |                                                       |   |                        |   |   |   |   |   |
| Net  income                               | $                                                          | 1,688  |                        | $      | 1,502 |   | $ | 2,908 |   | $ | 1,852 |   |
|                                      |                                                            |   |                             |   |  |   |  |   |
| Income  (loss) per common share:          |                                                       |   |                        |   |   |   |   |   |
|                                      | Continuing  operations, basic                              | $      | (0.23                       | )      | $ | 0.38 |   | $ | (0.26 | ) | $ | 0.71 |   |
|                                      | Continuing  operations, diluted                            | (0.23  | )                           | 0.35   |   | (0.26 | ) | 0.65 |   |
|                                      | Net  income, basic                                         | 0.14   |                        | 0.13   |   | 0.24 |   | 0.16 |   |
|                                      | Net  income, diluted                                       | 0.14   |                        | 0.12   |   | 0.24 |   | 0.15 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |   |
|                                      | Shares  for basic                                          | 12,131 |                        | 11,959 |   | 12,129 |   | 11,597 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |   |
|                                      | Shares  for diluted                                        | 12,131 |                        | 12,804 |   | 12,129 |   | 12,678 |   |
|                                      |                                                       |   |                        |   |   |   |   |   |
|                                           |                                                            |        |                             |        |  |  |  |  |  |  |  |  |  |  |

See notes to unaudited condensed consolidatedfinancial statements.

**Brooktrout, Inc.**

**UnauditedCondensed Consolidated Statements of Comprehensive Income**

**(Inthousands)**

|        | Three Months Ended   June 30,                                |   | Six Months Ended   June 30, |   |
|-------------|--------------------------------------------------------------|--------|-----------------------------|--------|
|        |                                                              |   |                             |   |
|        | 2001                                                         |   | 2000                        |   | 2001 |   | 2000 |   |
|        |                                                              |   |                             |   |  |   |  |   |
| Net  income | $                                                            | 1,688  |                        | $      | 1,502 |   | $ | 2,908 |   | $ | 1,852 |   |
|        |                                                         |   |                        |   |   |   |   |   |
|        | Unrealized  losses on marketable securities                  | (150   | )                           | — |   | (144 | ) | (14 | ) |
|        |                                                         |   |                        |   |   |   |   |   |   |
|        | Foreign  currency translation adjustment                     | (119   | )                           | (62    | ) | (115 | ) | (70 | ) |
|        |                                                         |        |                        |        |   |  |   |  |   |
|        | Comprehensive  income before income tax benefit              | 1,419  |                        | 1,440  |   | 2,649 |   | 1,768 |   |
|        |                                                         |   |                        |   |   |   |   |   |   |
|        | Income  tax benefit related to items of comprehensive income | (53    | )                           | — |   | (56 | ) | (5 | ) |
|        |                                                         |        |                        |        |   |  |   |  |   |
|        | Comprehensive  income                                        | $      | 1,472                       |   | $ | 1,440 |   | $ | 2,705 |   | $ | 1,773 |   |
|        |                                                              |   |                             |   |  |   |  |   |

 

See notes to unaudited condensed consolidatedfinancial statements.

**Brooktrout, Inc.**

**Unaudited CondensedConsolidated Statements of Cash Flows**

**(Inthousands)**

|                                             | Six Months Ended   June 30,                                                              |   |
|--------------------------------------------------|------------------------------------------------------------------------------------------|--------|
|                                             |                                                                                          |   |
|                                             | 2001                                                                                     |   | 2000 |   |
|                                             |                                                                                          |   |  |   |
| Cash  flows from operating activities:           |                                                                                     |   |   |   |
|                                             | Net  income                                                                              | $      | 2,908 |   | $ | 1,852 |   |
|                                             | Adjustments  to reconcile net income to cash provided by (used in) operating activities: |   |      |   |      |
|                                             | Gain  on disposal of discontinued operations                                             | (6,073 | ) | - |   |
|                                             | Depreciation  and amortization                                                           | 2,876  |   | 3,055 |   |
|                                             | Equity  in loss of affiliates                                                            | 1,397  |   | 16 |   |
|                                             | Non-cash  compensation and warrants                                                      | -      |   | 1,700 |   |
|                                             | Tax  benefit of stock options                                                            | -      |   | 1,562 |   |
|                                             | Minority  interest                                                                       | -      |   | (4,186 | ) |
|                                             | Deferred  income taxes and other                                                         | (1,227 | ) | 381 |   |
|                                             | Increase  (decrease) in cash from:                                                       |   |   |   |   |
|                                             | Accounts  receivable                                                                     | 12,415 |   | (5,168 | ) |
|                                             | Inventory                                                                                | 1,776  |   | (10,811 | ) |
|                                             | Prepaid  expenses and other current assets                                               | 595    |   | 81 |   |
|                                             | Accounts  payable and other accruals                                                     | (9,377 | ) | 1,286 |   |
|                                             |                                                                                     |        |   |  |   |
| Cash  provided by (used in) operating activities | 5,290                                                                                    |   | (10,232 | ) |
|                                             |                                                                                          |   |  |   |
| Cash  flows from investing activities:           |                                                                                     |   |   |   |
|                                             | Proceeds  from the sale of a business segment                                            | 4,927  |   | - |   |
|                                             | Expenditures  for equipment and furniture                                                | (672   | ) | (3,071 | ) |
|                                             | Expenditures  for acquired software                                                      | -      |   | (1,982 | ) |
|                                             | Purchases  of marketable securities                                                      | (1,534 | ) | (1,000 | ) |
|                                             | Investment  and other assets                                                             | (115   | ) | (2,772 | ) |
|                                             |                                                                                          |   |  |   |
| Cash  provided by (used in) investing activities | 2,606                                                                                    |   | (8,825 | ) |
|                                             |                                                                                          |   |  |   |
| Cash  flows from financing activities:           |                                                                                     |   |   |   |
|                                             | Proceeds  from the sale of common stock                                                  | 294    |   | 3,854 |   |
|                                             | Proceeds  from exercise of Interspeed options and warrants                               | -      |   | 326 |   |
|                                             | Purchase  of treasury stock                                                              | -      |   | (25 | ) |
|                                             |                                                                                          |   |  |   |
| Cash  provided by financing activities           | 294                                                                                      |   | 4,155 |   |
|                                             |                                                                                          |   |  |   |
| Increase  (decrease) in cash and equivalents     | 8,190                                                                                    |   | (14,902 | ) |
| Cash  and equivalents, beginning of period       | 23,294                                                                                   |   | 48,541 |   |
|                                             |                                                                                          |   |  |   |
| Cash  and equivalents, end of period             | $                                                                                        | 31,484 |   | $ | 33,639 |   |
|                                             |                                                                                          |   |  |   |
|                                                  |                                                                                          |        |  |  |  |  |  |  |  |  |

See notes to unaudited condensed consolidatedfinancial statements.

**Brooktrout, Inc.**

**Notesto Unaudited Condensed Consolidated Financial Statements**

**(inthousands, except share and per share data)**

**1.  Summary ofSignificant Accounting Policies and Practices**

**(a) Description of Business**

    Brooktrout, Inc.(the "Company" or "Brooktrout") delivers communicationshardware and software products that enable the development of applicationsranging from Internet Protocol ("IP") telephony and embeddedvoicemail to wireless messaging for the new global communications network. TheCompany sells its products to system vendors, service providers, enterprisecustomers, original equipment manufacturers ("OEMs"), and value-addedresellers ("VARs") through a direct sales force and a two-tiereddistribution system.  The Company’soperations consist of one reportable operating segment, Brooktrout Technology,Inc. ("Brooktrout Technology"). Prior to February 8, 2001, the Company was organized and reportedthe results of its operations in the following three business segments:Brooktrout Technology, Brooktrout Software, Inc. ("BrooktroutSoftware"), and Interspeed, Inc. ("Interspeed").  Two of these segments have been classifiedas discontinued operations for the periods presented in these condensedconsolidated financial statements (see note 2).

**(b) Principles ofConsolidation and Basis of Presentation**

    Theaccompanying unaudited condensed consolidated financial statements have beenprepared 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, 2000.

    Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements have been prepared on the same basis as the auditedconsolidated financial statements and include all adjustments (except asdisclosed in note 2), consisting only of normal recurring adjustments, necessaryfor a fair presentation of the interim periods presented.

    Theoperating results for the interim periods presented are not necessarilyindicative of the results that could be expected for the full year.

**(c) DiscontinuedOperations**

    Thecondensed consolidated statements of operations for periods prior to 2001 havebeen reclassified to separately report the results of discontinued operationsand the results of continuing operations. Disclosures included herein pertainto the Company's continuing operations unless otherwise indicated (seenote 2).

**(d) 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 net income by the sum of the weighted average numberof common shares outstanding, plus all additional common shares that would havebeen outstanding if potentially dilutive securities had been issued, using thetreasury method.

 

    Forthe three and six months ended June 30, 2001 and 2000, the Company isutilizing income (loss) from continuing operations as the "controlnumber" for purposes of determining whether potential common shares aredilutive for all per share calculations in accordance with SFAS 128. As aresult, the net income per share in 2000 includes dilutive potential commonshares in the calculation, and net income per share in 2001 excludes potentialcommon shares in the calculation.

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

|                                 | Three Months Ended   June 30, |   | Six Months Ended   June 30, |   |
|--------------------------------------|-------------------------------|--------|-----------------------------|--------|
|                                 |                               |   |
|                                 | 2001                          |   | 2000                        |   | 2001 |   | 2000 |   |
|                                 |                               |   |                             |   |  |   |  |   |
| Weighted  average shares for basic   | 12,131,000                    |   | 11,959,000                  |   | 12,129,000 |   | 11,597,000 |   |
| Dilutive  effect of stock options    | -                             |   | 845,000                     |   | - |   | 1,081,000 |   |
|                                 |                               |   |                             |   |  |   |  |   |
| Weighted  average shares for diluted | 12,131,000                    |   | 12,804,000                  |   | 12,129,000 |   | 12,678,000 |   |
|                                 |                               |   |                             |   |  |   |  |   |

    Stockoptions to purchase 2,681,637 shares and 65,325 shares were not included in thecomputation of diluted earnings per share in 2001 and 2000, respectively,because to do so would have been antidilutive.

** (e) Recent Accounting Pronouncements**

    InJune of 1998, the Financial Accounting Standards Board released Statementof Financial Accounting Standards (SFAS) No. 133, "Accounting forDerivative Instruments and Hedging Activities."  SFAS No. 133, as amended by SFAS No. 137,establishes new standards of accounting and reporting for derivativeinstruments and hedging activities. The Company adopted SFAS No. 133,as amended, on January 1, 2001, and determined its effect on the condensedconsolidated financial statements to be immaterial.

    In June of 2001, the Financial AccountingStandards Board issued SFAS No. 141, “Business Combinations" and SFAS No.142, "Goodwill and Other Intangible Assets.” SFAS No. 141 requires thatall business combinations initiated after June 30, 2001 be accounted for underthe purchase method and addresses the initial recognition and measurement ofgoodwill and other intangible assets acquired in a business combination.  For business combinations with anacquisition date before July 1, 2001 and that were accounted for using thepurchase accounting method, any reclassifications between intangible assets andgoodwill resulting from the implementation of SFAS No. 141 will take place asof the date that SFAS No. 142 is initially applied in its entirety.  SFAS No. 142 addresses the initialrecognition and measurement of intangible assets acquired outside of a businesscombination and the accounting for goodwill and other intangible assetssubsequent to their acquisition. SFAS No. 142 provides that intangible assetswith finite useful lives be amortized and that goodwill and intangible assetswith indefinite lives will not be amortized, but will rather be tested at leastannually for impairment.  Any impairmentloss incurred subsequent to initial adoption of SFAS No. 142 is recorded as acharge to current period earnings.  SFASNo.142 is effective for fiscal years beginning after December 15, 2001, withearly adoption permitted for companies with fiscal years beginning after March15, 2001 if their first quarter financial statements have not previously beenissued.  The Company is currentlyevaluating the provisions of SFAS No. 141 and SFAS No. 142 and has not yetdetermined the effect that adoption of these standards will have on itsconsolidated financial statements.

**2.  DiscontinuedOperations**

    OnFebruary 8, 2001, the Company adopted formal plans to discontinue itsBrooktrout Software and Interspeed segments. Accordingly, the results of thesesegments are presented as discontinued operations in the accompanying condensedconsolidated financial statements. At the time the formal plans were adopted,the Company estimated the cost to discontinue these businesses and accountedfor these costs in 2000 in accordance with Accounting Principles BoardNo. 30 ("APB 30").

    OnApril 16, 2001, the Company sold Brooktrout Software to eYak, Inc.("eYak") for approximately $4,927 in cash and 3,374,054 shares ofeYak preferred stock, which represents approximately 6 percent of eYak'saggregate outstanding shares. The 3,374,054 shares of eYak preferred stock,which are not marketable securities, have been independently valued at $5,364 ($1.59 per share) and are classified as a cost basis, long-term investment as ofJune 30, 2001.  eYak was subsequentlyrenamed Sonexis, Inc.

    Thesale of Brooktrout Software resulted in a net gain during the three and sixmonths ended June 30, 2001 of $4,423 and $6,073, respectively, net of taxes.

    Asof June 30, 2001, the balance of net liabilities related to discontinuedoperations consists of $945 for accruals of expenses related to the sale ofBrooktrout Software, and $538 of liabilities associated with the Interspeedbusiness. 

|                                                             | **Three Months Ended****June 30,** |       | **Six Months Ended****June 30,** |   |
|------------------------------------------------------------------|------------------------------------|------------|----------------------------------|--------|
|                                                             | ****                               | ** ** |
|                                                             | **2001**                           |       | **2000**                         |   | **2001** |   | **2000** | ** ** |
|                                                             |                                    |       |                                  |   |  |   |  |   |
| Loss  from discontinued operations per common   share:           |                               |       |                             |   |   |   |   |   |
|                                                             | Basic                              | $          | —                           |   | $ | (0.25 | ) | $ | — |   | $ | (0.55 | ) |
|                                                             | Diluted                            | —     |                             | (0.24  | ) | — |   | (0.50 | ) |
|                                                             |                               |       |                             |   |   |   |   |   |
| Gain  on disposal of discontinued operations per   common share: |                               |       |                             |   |   |   |   |   |
|                                                             | Basic                              | $          | 0.36                             |   | $ | — |   | $ | 0.50 |   | $ | — |   |
|                                                             | Diluted                            | 0.36       |                             | — |   | 0.50 |   | — |   |
|                                                             |                               |       |                             |   |   |   |   |   |

**3.** ** Inventory**

     Inventoryis carried at the lower of cost or market, on a first-in first-out basis, andconsisted of the following: 

|            | **June 30,  2001** |   | **December 31,  2000** |
|-----------------|--------------------|--------|-----------------------------|
|            | ****               |   | ****                        |
| Raw materials   | $                  | 3,564  |                        | $ | 3,008 |
| Work in process | 758                |   | 1,576                       |
| Finished goods  | 13,511             |   | 15,025                      |
|            |                    |   |                             |
|            | Total              | $      | 17,833                      |   | $ | 19,609 |
|            |                    |   |                             |
|                 |                    |        |                             |  |  |  |

**4.  Income Taxes**    

     TheCompany's tax provision in 2001 is based on the estimated effective tax ratefor the full year. The Company's effective tax rate on continuing operations,excluding the effect of non-deductible equity in loss of affiliates, was 37%for the six months ended June 30, 2001.

**5.  Investments**

    Investmentsincludes investments in Pelago Networks, Inc. ("Pelago",formerly known as Beacon Networks, Inc.) and Telchemy, Inc.("Telchemy"), which are accounted for under the equity method.  The Company's ownership interest in Pelagoand Telchemy was approximately 28% and 25%, respectively, as of June 30,2001.  The Company is no longer carryinga value for its investment in Pelago since its original investment was reducedto zero by its share of equity losses incurred by Pelago.  Investments also includes two investmentsrecorded under the cost method with a carrying value of $6,364 as of June 30,2001.

    Duringthe first quarter of 2000, the Company owned 100% of Pelago and accounted forits investment under the consolidation method. As a result of the subsequentissuance of Pelago shares in an equity financing on June 29, 2000, theCompany's ownership percentage in Pelago was reduced to 28%. Accordingly, theCompany accounts for its investment under the equity method of accountingbeginning in the second quarter of 2000.

    TheCompany’s Board of Directors has authorized an equity investment of up to$3,050, in one or more tranches, in Pelago. On August 6, 2001, the Companypurchased 1,525,000 preferred shares for $1,525.  If Pelago meets certain performance or financing milestones, theCompany is obligated to purchase up to an additional 1,525,000 preferred sharesin September or October, 2001.

**6. Segment Reporting**

    TheCompany's continuing operations represent one reportable operating segment,Brooktrout Technology, which provides enabling technologies that allowcustomers to deliver voice, fax and data solutions for the electronic communicationsmarket.  The rapid evolution of theworld's telecommunication systems has created important market opportunitiesfor the Company. One opportunity consists of core technologies and platformsprimarily for business premise products such as fax, LanFax, and voicemail—Today's Network.  Anotheropportunity—the New NetworkTM—is the result of the global investments that arebeing made to expand the capabilities of today's communication networks. Thesenew capabilities allow data, voice, and fax information to be distributed usingpacket-based data networks, such as the Internet, for portions of thetransmission and also allow such information to be distributed using thetraditional circuit switched telephone network.

*    Product Sales*—BrooktroutTechnology groups its product sales based on their applications in the NewNetworkTM and their applications in Today's Network. For the three months endedJune 30, 2001, sales of products for use in the New Network accounted forapproximately 33% of total revenue as compared to 56% of total revenue for thesame period in the prior year.  For thesix months ended June 30, 2001, sales of products for use in the New Networkaccounted for approximately 44% of total revenue compared to 55% of totalrevenue for the same period in the prior year.

*    Major Customers**—*One customer accounted for approximately 16% and 6%of revenue for the three months ended June 30, 2001 and June 30, 2000,respectively.  A different customeraccounted for 23% of revenue for the quarter ended June 30, 2000; however, thiscustomer represented less than 1% of revenue in the quarter ended June 30,2001.  The two above-mentioned customersaccounted for approximately 10% and 12% of revenue respectively for the sixmonths ended June 30, 2001, and 5% and 18% of revenue respectively, for the sixmonths ended June 30, 2000.

*    International Sales**—*International sales, principally exports from theUnited States, accounted for approximately 24% and 15% of revenue for the threemonths ended June 30, 2001 and June 30, 2000, respectively.  International sales accounted forapproximately 20% and 16% of revenue for the six months ended June 30, 2001 andJune 30, 2000, respectively.

    Prior to its February 8, 2001decision to discontinue its Brooktrout Software and Interspeed segments, theCompany was organized and reported the results of its operations in thefollowing three business segments: Brooktrout Technology, Brooktrout Softwareand Interspeed (see note 2).

**7. Contingencies**

*    Litigation**—*In October 2000, several shareholder classaction complaints were filed in the United States District Court for theDistrict of Massachusetts (the "Court") by certain shareholders ofInterspeed and of the Company. Certain of the complaints named, among others,the Company and certain of its current directors and certain current and formerofficers as defendants. The lawsuits were filed after Interspeed'sOctober 6, 2000 announcement that it would be restating its unauditedfinancial results for certain prior quarters of its fiscal year 2000. Thecomplaints included allegations that the Company or certain of its officers anddirectors participated in and approved the issuance of the financial statementsof Interspeed, that defendants are "controlling persons" ofInterspeed, and that the defendants made false or misleading statementsregarding the Company's own consolidated financial results. Followingsettlement discussions among the parties, (i) complaints filed byshareholders of the Company were voluntarily dismissed in April 2001 and(ii) the Court entered final approval of the settlement of the litigationbrought by shareholders of  Interspeedin July 2001. The dismissal and settlement of these actions will not have amaterial adverse effect on the Company's financial position or results ofoperations.

**8. Purchase of In-ProcessResearch and Development**

    The Company recorded a one-time charge of$2,550 in 2000 for the purchased research and development rights in STS-1technology, which has not yet reached technological feasibility, has noalternative future use, and for which successful development is uncertain.

    The Company expects to complete this project byDecember 31, 2001, and expects to benefit from this technology in 2002.  The remaining efforts to complete thisproject consist of the completion of the design of the hardware platform andsoftware development.  The costs tocomplete this project are expected to be in the range of $900 and $1,400.  Some of the risks and uncertainties inherentin the estimated costs to complete and the attainment of completion, includethe difficulty of predicting the duration of product development and the risksthat changes in the product requirements will result in unexpected redesignactivity.

**ITEM 2.  MANAGEMENT'SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**Results of Operations**

*Safe Harbor Statement Underthe Private Securities Litigation Reform Act of 1995*

    ThisQuarterly Report contains certain statements that are "forward-lookingstatements" as that term is defined under the Private SecuritiesLitigation Reform Act of 1995 and releases issued by the Securities andExchange Commission. The words "believes," "expects,""anticipates," "intends," "estimates" and otherexpressions that are predictions of or indications of future events and trendsand that do not relate to historical matters, identify forward-lookingstatements. You should not rely on forward-looking statements because theyinvolve known and unknown risks, uncertainties and other factors, some of whichare beyond the control of Brooktrout, Inc. (the "Company" or"Brooktrout"), which may cause the actual results, performance orachievements of the Company to differ materially from anticipated futureresults, performance or achievements expressed or implied by such forward-lookingstatements. These forward-looking statements were based on information, plans,and estimates at the date of this document and the Company undertakes noobligation to update any forward-looking statement, whether as a result of newinformation, future events or otherwise.

    Thefuture operating results and performance trends of the Company may be affectedby a number of factors, including, without limitation, risks related to thefollowing: (i) the current telecommunications market slowdown and its impacton our customers' business and financial strength; (ii) uncertaintiesregarding the future value of and the lack of liquidity of the Sonexis, Inc.(formerly known as eYak, Inc.) stock received in connection with the saleof Brooktrout Software; (iii) the Company's historical dependence on asmall number of customers; (iv) market growth, market acceptance of theCompany's products and product demand; (v) rapid changes in technology andthe ability to keep pace with the evolution of the telecommunications hardwareand software market; (vi) the impact of competition; and (vii) the impactof changes to regulations affecting the telecommunications and Internetindustries. In addition to the foregoing, the Company's actual future resultscould differ materially from those projected in the forward-looking statementsas a result of the risk factors set forth herein and in the Company's variousfilings with the Securities and Exchange Commission and of changes in generaleconomic conditions and changes in the assumptions used in making suchforward-looking statements.

**Introduction**

    Brooktroutdelivers communications hardware and software products that enable thedevelopment of applications ranging from Internet Protocol ("IP")telephony and embedded voicemail to wireless messaging for the new globaltelecommunications network. The Company's strategy is to collaborate with itspartners to help them increase existing business, expand into new markets andaccelerate the delivery of new applications and services. The Company sells itsproducts to system vendors, service providers, enterprise customers, originalequipment manufacturers ("OEMs"), and value-added resellers("VARs"), both domestically and internationally, through a directsales force and a two-tiered distribution system.

    Therapid evolution of the world's telecommunications systems has created importantmarket opportunities for the Company. One opportunity involves coretechnologies and platforms that are primarily used in business premise productssuch as fax, LanFax, and voice mail—Today's Network.   Anotheropportunity—the New NetworkTM—is the result of the global investments that arebeing made to expand the capabilities of today's communications networks. Thesenew capabilities allow data, voice and fax information to be distributed usingpacket-based data networks, such as the Internet, for portions of thetransmission and also allow such information to be distributed using thetraditional circuit-switched telephone network.

    Priorto February 8, 2001, the Company was organized and reported the results ofits operations in three operating segments, Brooktrout Technology, Inc.("Brooktrout Technology"), Brooktrout Software, Inc.("Brooktrout Software"), and Interspeed, Inc.("Interspeed"). On February 8, 2001, the Company's Board of Directorsadopted formal plans to discontinue its Brooktrout Software and Interspeedsegments. Accordingly, the Company has reclassified the accompanying condensedconsolidated financial statements to reflect the discontinuance of these twosegments. (See note 1(c) and note 2 to the condensed consolidatedfinancial statements). The following discussion focuses on the Company'sresults from continuing operations; the historical information presented hasbeen revised to conform to the reclassified condensed consolidated financialstatement presentation.

**Three Months Ended June 30 2001and 2000*(in thousands except share and per sharedata)***

    Revenueduring the three months ended June 30, 2001 decreased by approximately 52% to$17,844, down from $37,024 for the three months ended June 30, 2000. Thedecline in revenue resulted primarily from the overall economic slowdown in theUnited States and international economies and the resulting softening in thetelecommunications market. The slowdown the Company is experiencing extendsacross most product lines and markets, though sales of products forapplications in the New Network, specifically those sold to OEM’s for use bylarge service providers, have declined most significantly.  Duringthe three months ended June 30, 2001, sales of products for applications in theNew Network accounted for approximately 33% of total revenue, as compared to56% of total revenue for the same period in 2000.

    Revenue from one customer accounted forapproximately 16% of total revenue in the current quarter compared to 6% forthis same customer in the prior year. The Company expects that revenue from this customer will continue to besignificant for the foreseeable future. A different customer, one typically considered a New Network customer,represented 23% of sales during the three months ended June 30, 2000; however,revenue from this customer represented less than 1% of total revenue for thethree months ended June 30, 2001. For the foreseeable future, the Companyexpects that revenue from this customer will continue to be significantly lessthan that of prior comparative periods.

    Costof product sold was $8,449, or 47% of revenue, for the three months ended June30, 2001, compared to $12,948, or 35% of revenue, for the quarter ended June30, 2000. The lower gross margin during the three months ended June 30, 2001was primarily due to decreased sales volumes across most product lines,especially those of New Network products that tend to have higher grossmargins.  Increases in other costs ofproduct sold, principally reserves for inventory obsolescence, also contributedto lower gross margins for the three months ended June 30, 2001.

    Researchand development expense was $5,716 or 32% of revenue, compared with $5,611 or15% of revenue, for the three months ended June 30, 2001 and 2000,respectively. The dollar increase when compared to the same period in the prioryear is primarily attributable to increases in full time staffing relatedexpenses, partially offset by decreased spending for expendable materials andsupplies, and temporary help. The Company's continuing development efforts arefocused on its switching and access products that allow customers to create theinfrastructure to support the New Network; messaging products that allowintegration of voice, fax and e-mail into one location; and IP telephonyproducts. The Company intends to continue to commit significant resources toproduct development.

    Selling,general and administrative expense was $7,766 or 44% of revenue, compared with$10,269 or 28% of revenue, for the three months ended June 30, 2001 and 2000,respectively.  The decline in dollarexpense is primarily the result of reduced spending for sales commissions, advertising,temporary help, discretionary travel, and expendable materials and supplies.

    Otherexpense was $36 compared to other expense of $877 for the three months endedJune 30, 2001 and June 30, 2000, respectively. During the three months endedJune 30, 2001, the Company recognized equity in loss of affiliates of $342related to its investment in Telchemy, Inc. (“Telchemy”).  Equity in loss of affiliates recognizedduring the three months ended June 30, 2000 was $1,400 and related exclusivelyto Pelago Networks, Inc. (“Pelago”). The Company is no longer carrying a value for its investment in Pelagosince its original investment was reduced to zero, in the first quarter of2001, by its share of equity losses incurred by Pelago. In addition, interestand other income was $306 for the three months ended June 30, 2001 as comparedwith $523 for the same period in 2000, reflecting lower short-term interestrates.

    TheCompany's effective tax rate for continuing operations, excluding the effect ofnon-deductible equity losses in affiliates, was 37% for the quarter ended June30, 2001.

**Six Months Ended June 30 2001and 2000*(in thousands except share and per sharedata)***

    Revenueduring the six months ended June 30, 2001 decreased by approximately 36% to$44,907, down from $70,493 for the six months ended June 30, 2000. The declinein revenue resulted primarily from the overall economic slowdown in the UnitedStates and international economies and the resulting softening in thetelecommunications market. The slowdown the Company is experiencing extendsacross most product lines and markets, though sales of products forapplications in the New Network, specifically those sold to OEM’s for use bylarge service providers, have declined most significantly.  Duringthe six months ended June 30, 2001, the sales of products for applications inthe New Network accounted for approximately 44% of total revenue, as comparedto 55% of total revenue for the same period in 2000.

    Revenue from one customer accounted forapproximately 10% of total revenue for the six months ended June 30, 2001,compared to 5% from this same customer for the same period in the prioryear.  The Company expects that revenuefrom this customer will continue to be significant for the foreseeablefuture.  A different customer, one typicallyconsidered a New Network customer, represented 12% of sales during the sixmonths ended June 30, 2001, and 18% of revenue for the same period in 2000. Forthe foreseeable future, the Company expects that revenue from this customerwill continue to be significantly less than that of prior comparative periods.

    Costof product sold was $19,644, or 44% of revenue, for the six months ended June30, 2001, compared to $25,885, or 37% of revenue, for the six months ended June30, 2000. The lower gross margin in the six months ended June 30, 2001 wasprimarily due to decreased sales volumes across most product lines, especiallythose of New Network products that tend to have higher gross margins.  Increases in other costs of product sold,principally reserves for inventory obsolescence, also contributed to lowergross margins for the six months ended June 30, 2001.

    Researchand development expense was $11,194 or 25% of revenue, compared with $11,397 or16% of revenue, for the six months ended June 30, 2001 and 2000, respectively.The dollar decrease when compared to the same period in the prior year isprimarily attributable to decreased spending for expendable materials andsupplies, and temporary help.  These decreaseswere partially offset by increases in full time staffing related expenses.  The Company's continuing development effortsare focused on its switching and access products that allow customers to createthe infrastructure to support the New Network; messaging products that allowintegration of voice, fax and e-mail into one location; and IP telephonyproducts. The Company intends to continue to commit significant resources toproduct development.

    Selling,general and administrative expense was $17,474 or 39% of revenue, compared with$19,659 or 28% of revenue, for the six months ended June 30, 2001 and 2000,respectively.  The decline in dollarexpense is primarily the result of reduced spending for sales commissions,advertising, temporary help, discretionary travel, and expendable materials andsupplies.

    Otherexpense was $781 compared to other expense of $271 for the six months endedJune 30, 2001 and June 30, 2000, respectively. During the six months ended June30, 2001, the Company recognized equity in loss of affiliates of $1,397 relatedto its investments in Pelago and Telchemy. Equity in losses of affiliates recognized during the six months endedJune 30, 2000 were $1,400 and related exclusively to Pelago.  The Company is no longer carrying a valuefor its investment in Pelago since the original investment has been reduced tozero, in the first quarter of 2001, by its share of equity losses incurred byPelago. In addition, interest and other income was $616 for the six monthsended June 30, 2001 as compared with $1,129 for the same period in 2000,reflecting lower short-term interest rates.

    TheCompany's effective tax rate for continuing operations, excluding the effect ofnon-deductible equity losses in affiliates, was 37% for the six months endedJune 30, 2001.

**Liquidity and Capital Resources*****(in thousands, except share and per sharedata)***

    Forthe six months ended June 30, 2001, the Company funded its operationsprincipally through operating revenue. Working capital increased to $55,758 atJune 30, 2001 from $52,344 at December 31, 2000, primarily due to cash receivedfrom the sale of Brooktrout Software of $4,927 and conversion of customeraccounts receivable balances, partly offset by decreases in accounts payableand other current liabilities. Cash generated by operating activities for thesix months ended June 30, 2001 was approximately $5,290 and was primarilygenerated through the reduction of accounts receivable.

    TheCompany is currently negotiating a renewal of its working capital line ofcredit. Under the line of credit, the Company could borrow up to $10,000 on anunsecured basis, all of which could be used for issuance of letters of credit,subject to compliance with certain covenants. Any amounts borrowed under theline of credit were subject to interest at the lender's prime rate. The Companyanticipates that the renewed line of credit will be on similar terms, but willlikely be for less than $10,000 given the current economic climate.  At June 30, 2001, there were no commitmentsoutstanding on letters of credit; and no borrowings have been made in the pastthree years.

    Duringthe six months ended June 30, 2001, the Company purchased approximately $672 inequipment. The Company currently has no material commitments for additionalcapital expenditures.

    Thepricing of the Company's products and costs of its goods are generallydetermined by current market conditions. Market conditions can be impacted byinflation; however, the Company believes that inflation has not had asignificant effect on its operations to date.

    TheCompany has operating lease commitments for its office and manufacturingfacilities expiring through 2006. Certain lease agreements require the Companyto pay all of the building's taxes, insurance and maintenance costs.

    OnApril 16, 2001, the Company sold Brooktrout Software to eYak, Inc.("eYak"), a privately held company, for approximately $4,927 in cashand 3,374,054 shares of eYak preferred stock, which represent approximately 6percent of eYak's aggregate outstanding shares. The sale of Brooktrout Softwareresulted in a gain of $6,073, net of a provision for income taxes of $5,017,during the six months ended June 30, 2001. eYak was subsequently renamed Sonexis.

    The Company’s Board of Directors hasauthorized an equity investment of up $3,050, in one or more tranches, inPelago.   On August 6, 2001, the Companypurchased 1,525,000 preferred shares for $1,525.  If Pelago meets certain performance or financing milestones, theCompany is obligated to purchase up to an additional 1,525,000 preferred sharesin September or October, 2001.

    The Company anticipates that current cashand marketable securities balances, together with revenues and funds availableunder the Company's line of credit, will be sufficient to meet the Company'sworking capital and capital equipment expenditure requirements for the nexttwelve months.

**Risk Factors**

***The Company's operating results are likely to fluctuatesignificantly and cause the Company's stock price to be volatile, which couldcause the value of your investment to decline.***

    TheCompany's operating results are likely to fluctuate in the future due to avariety of factors, many of which are outside of its control. If the Company'soperating results do not meet the expectations of securities analysts, thetrading price of the Company's common stock could significantly decline. Thismay cause the value of your investment in the Company to decline. In addition,the value of your investment could be impacted by investor perception of the Company'sindustry or its prospects generally, independent of the operating performanceof the Company. Some of the factors that could affect the Company's operatingresults or impact the market price of the common stock include:

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

•the timing and number of orders for the Company's products, which are generallyweighted more heavily toward the last month of each quarter;

•cancellation or rescheduling of orders for the Company's products;

•the Company's ability to hire, train and retain key management, sales andmarketing and engineering personnel;

•announcements or technological innovations by the Company's competitors or incompeting technologies;

•the Company's ability to obtain sufficient supplies of sole or limited sourcecomponents for the Company's products;

•conditions in the domestic or global economy generally, and in thetelecommunications industry specifically;

•a decrease in the demand for the Company's stock;

•a decrease in the average selling prices of the Company's products;

•changes in costs of components that the Company includes in its products; and

•the mix of products that the Company sells and the mix of distribution channelsthrough which they are sold.

    Dueto these and other factors, revenue, expenses and results of operations couldvary significantly in the future, and period-to-period comparisons should notbe relied upon as indications of future performance.

***The Company is exposed to general economic conditions, andthe slowdown in some sectors of the telecommunications industry in particular.***

    Asa result of recent unfavorable economic conditions affecting most technologysectors and the telecommunications sector in particular, many of our customersare aggressively increasing efficiency in their supply chains and reducinginventory levels. Additionally, we expect the growth of data traffic and theuse of the Internet will continue to have a significant impact on traditionalvoice networks, which is driving the convergence of data and telephony andgiving rise to the demand for New Network applications. We cannot be sure whatthe rate of such convergence will be due to the slowdown in the communicationsindustry and the resulting decrease in spending by our customers. The currenteconomic conditions have adversely impacted the Company’s business andoperating results.  If the economicconditions worsen or if a wider economic slowdown occurs, the Company mayexperience a material adverse impact on its business, operating results, andfinancial condition.

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

    TheCompany's failure to generate as much revenue as expected from what hashistorically been a relatively small number of customers or the failure ofthese customers to purchase the Company's products could seriously harm theCompany's business. For the quarter ended June 30, 2001, one customer accountedfor approximately 16% of the Company's revenue. A different customer accountedfor 23% of revenue for the quarter ended June 30, 2000; however, this customerrepresented less than 1% of revenue in the quarter ended June 30, 2001.  The decline in expected revenue from thiscustomer, as well as the loss of any one of the Company's other major customersor the delay of significant orders from such customers, even if only temporary,has or could reduce or delay the Company's revenue, could harm the Company'sreputation in the industry and could reduce the Company's ability to accuratelypredict cash flow, and, as a consequence, could seriously harm the Company'sbusiness, financial condition and results of operations.

    Presentand future customers may also terminate their purchasing arrangements with theCompany, significantly reduce or delay their orders or seek to renegotiatetheir agreements on terms less favorable to the Company. Furthermore, in anyfuture negotiations, the Company may be subject to the perceived or actualleverage the customers may have, given their relative size and importance tothe Company. Any termination, change, reduction or delay in orders couldseriously harm the Company's business, financial condition and results ofoperations. Accordingly, unless and until the Company can diversify and expandits customer base, the Company's future success will significantly depend uponthe timing and size of future purchases by the Company's largest customers andthe financial and operational success of these customers.

***The telecommunications markets are highly competitive, andthe Company may not be able to compete successfully against new entrants andestablished companies with greater resources.***

    Themarket for telecommunications equipment is highly competitive. If the Companyis unable to differentiate its products from existing and future offerings ofits competitors, and thereby effectively compete in the market fortelecommunications equipment, the Company's results of operations could bematerially adversely affected. Many of the Company's current and potentialcompetitors have significantly greater selling and marketing, technical,manufacturing, financial, and other resources. Moreover, the Company'scompetitors may have greater access to components necessary to manufacturetheir products. The strength and capabilities of the Company's competitors maybe increased as a result of the trend toward consolidation in thetelecommunications market. Capitalizing on and maintaining the Company'stechnological advantage will require a continued high level of

investment inresearch and development, marketing and customer service and support. Due tothe rapidly evolving markets in which the Company competes, additionalcompetitors with significant market presence and financial resources may enterthose markets, thereby further intensifying competition. The Company may nothave sufficient resources to continue to make the investments or achieve thetechnological advances necessary to compete successfully with existingcompetitors or new entrants.

***Internal development efforts by the Company's customers mayadversely affect demand for its products.***

    Manyof the Company's customers, including the large OEMs on which the Companyfocuses a significant portion of its sales and marketing efforts, have thetechnical and financial ability to design and produce components replicating orimproving on the functionality of most of the Company's products. Thesecustomers often consider in-house development of technologies and products asan alternative to doing business with the Company. The Company cannot assureyou that its existing customers or potential customers will do business withthe Company, rather than attempting to develop similar technology and productsinternally or obtaining them through acquisition. The Company cannot be certainthat it will be able to find customers to replace the revenue lost as a resultof customers developing technologies or products in-house. Any such occurrencecould have a material adverse effect on the Company's business, financialcondition or results of operations.

***Unless the Company is able to keep pace with the evolutionof the telecommunications hardware and software market, the Company's businessmay be adversely impacted.***

    Thetelecommunications hardware and software market is characterized by:

•rapid technological advances:

•evolving industry standards;

•changes in customer requirements;

•frequent new product introductions;

•intense competition; and

•evolving offerings by telecommunications service providers.

    TheCompany believes that its future success will depend, in part, on its abilityto offer products that address the sophisticated and varied needs of itscurrent and prospective customers and to respond to technological advances andevolving industry standards on a timely and cost-effective basis. The Companyintends to continue to invest significantly in product and technologydevelopment. The development of new or enhanced products is a complex anduncertain process. The Company may experience design, manufacturing, marketingand other difficulties that could delay or prevent its development,introduction or marketing of new products and enhancements. The Company mayalso not be able to incorporate new technologies on a cost-effective or timelybasis. This may result in unexpected expenses. The introduction of new orenhanced products also requires that the Company manage the transition fromolder products so as to minimize the disruption to customers and ensure thatadequate supplies of new products can be delivered to meet anticipated customerdemand. The Company's inability to develop on a timely basis new products orenhancements to existing products, or the failure of such new products orenhancements to achieve market acceptance, could have a material adverse effecton the Company's business, financial condition and results of operations.

***The Company's dependence on sole and single source suppliersand independent manufacturers exposes it to supply interruptions that couldresult in product delivery delays.***

    Althoughthe Company generally uses standard parts and components for its products, somekey components are purchased from sole or single source vendors for whichalternative sources are not currently available or are difficult to obtain. TheCompany's inability to obtain sufficient quantities of these components mayresult in future delays or reductions in product shipments that couldmaterially adversely affect its business, financial condition and results ofoperations. The Company currently purchases proprietary components from anumber of suppliers for which there are no direct substitutes. These componentscould be replaced with alternatives from other suppliers, but that couldinvolve redesign of the Company's products. If such redesign was required, theCompany would incur considerable delay and expenses. The Company currentlyenters into purchase orders with its suppliers for materials based on forecastsof need, but has no guaranteed supply arrangements with these suppliers.

    Inaddition, the Company currently uses a number of independent manufacturers tomanufacture printed circuit boards, chassis and subassemblies in accordancewith the Company's design and specification. The Company's reliance onindependent manufacturers involves a number of risks, including the potentialfor inadequate capacity of, unavailability of, or interruptions in access to,process technologies, and reduced control over delivery schedules,manufacturing yields and costs. If the Company's manufacturers are unable orunwilling to continue manufacturing its components in required quantities or tothe Company's quality expectations, the Company will have to transfermanufacturing to acceptable alternative manufacturers that it has identified,which could result in significant delays in shipment of products to customers.Moreover, the manufacture of these components is extremely complex, and theCompany's reliance on the suppliers of these components exposes it to potentialproduction difficulties and quality variations, which could negatively impactthe cost and timely delivery of its products. The Company currently enters intopurchase orders with independent manufacturers of materials based on forecastsof need, but has no guaranteed arrangements with these manufacturers. Anysignificant interruption in the supply, or degradation in the quality, of anycomponent would have a material adverse effect on the Company's business,financial condition and results of operations.

***Defects in the Company's products or problems arising fromthe use of its products may seriously harm its business and reputation.***

    Productsas complex as the Company's may contain known and undetected errors orperformance problems. Defects are frequently found during the periodimmediately following introduction and initial implementation of new productsor enhancements to existing products. Although the Company attempts to resolveall errors that it believes would be considered serious by its customers beforeimplementation, the Company's products may not be error-free. The Company alsoprovides warranties against defects in materials and workmanship on itsproducts that range, depending on the product, generally from twelve months tofive years. However, errors or performance problems could result in lostrevenue or customer relationships and could be detrimental to the Company'sbusiness and reputation generally. Additionally, reduced market acceptance ofthe Company's services due to errors or defects in its technology would harmits business by reducing its revenue and damaging its reputation. In addition,the Company's customers generally use its products together with their ownproducts and products from other vendors. As a result, when problems occur, itmay be difficult to identify the source of the problem. These problems maycause the Company to incur significant warranty and repair costs, divert theattention of its engineering personnel from the Company's product developmentefforts and cause significant customer relations problems. To date, defects inthe Company's products or those of other vendors' products with which itsproducts are used by its

customers havenot had a material adverse effect on its business. However, the Company cannotbe certain that defects will not materially adversely affect the Company’sbusiness in the future.

***Changes to regulations affecting the telecommunications orInternet industries could reduce demand for the Company's products or increaseits costs.***

    Lawsand regulations governing telecommunications, electronic commerce and theInternet are beginning to emerge, but remain largely unsettled, even in theareas where there has been some legislative action. Regulation may focus on,among other things, assessing access or settlement charges, or imposing tariffsor regulations based on the characteristics and quality of products andservices, either of which could restrict the Company's business or increase itscost of doing business. Any changes to existing laws or the adoption of newregulations by federal or state regulatory authorities or any legal challengesto existing laws or regulations relating to the telecommunications industrycould materially adversely affect the market for the Company's products. Moreover,the Company's VARs or other customers may require, or the Company may otherwisedeem it necessary or advisable, that the Company alter its products to addressactual or anticipated changes in the regulatory environment. The Company'sinability to alter its products or address any regulatory changes could have amaterial adverse effect on its business, financial condition or results ofoperations.

***Provisions in the Company's corporate charter may discouragetakeover attempts and, thus, depress the market price of the common stock.***

    Provisionsin the Company's Charter may have the effect of delaying or preventing a changeof control or changes in the Company's management or Board of Directors. Theseprovisions include:

|   | • | the right of the Board of Directors, without  stockholder approval, to issue shares of preferred stock and to establish the  voting rights, preferences, and other terms thereof; |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                              |
|   | • | the  right of the Board of Directors to elect a director to fill a vacancy created  by the expansion of the Board of Directors;                                                   |
|   |   |                                                                                                                                                                              |   |
|   | • | the  ability of the Board of Directors to alter the Company's by-laws without  prior stockholder approval;                                                                        |
|   |   |                                                                                                                                                                              |   |
|   | • | the  election of three classes of directors to each serve three-year staggered  terms;                                                                                            |
|   |   |                                                                                                                                                                              |   |
|   | • | the  elimination of stockholder voting by consent;                                                                                                                                |
|   |   |                                                                                                                                                                              |   |
|   | • | the  removal of directors only for cause;                                                                                                                                         |
|   |   |                                                                                                                                                                              |   |
|   | • | the  vesting of exclusive authority in the Board of Directors (except as otherwise  required by law) to call special meetings of stockholders; and                                |
|   |   |                                                                                                                                                                              |   |
|   | • | certain  advance notice requirements for stockholder proposals and nominations for  election to the Board of Directors.                                                           |

    Theseprovisions discourage potential takeover attempts and the ability ofstockholders to change management and the Board of Directors. These anti-takeovermeasures could adversely affect the market price of the Company's common stock.In addition, even if you desired to participate in a tender offer, change ofcontrol or takeover attempt of the Company that the Company's management andBoard of Directors opposed, these provisions may prevent you from doing so.

***Limitations on the Company's ability to adequately protectits proprietary rights may prevent it from retaining its competitive advantageand negatively impact its future operating results.***

    TheCompany's success and its ability to compete are dependent, in part, upon itsproprietary technology. Taken as a whole, the Company believes its intellectualproperty rights are significant and

any failure toadequately protect the unauthorized use of its proprietary rights could resultin the Company's competitors offering similar products, potentially resultingin loss of a competitive advantage and decreased revenue. The Company reliesupon a combination of patents, trademark law, trade secret protections,copyright law and confidentiality agreements with consultants and third partiesto protect its proprietary rights. Notwithstanding its efforts, third partiesmay infringe or misappropriate the Company's proprietary rights. In addition,each employee of the Company has executed a proprietary information agreementdesigned to protect the trade secrets of the Company, inventions created in thecourse of employment with the Company and other proprietary information of theCompany. Moreover, effective patent, trademark, copyright or trade secretprotections may not be available in every country in which the Company operatesor intends to operate to the same extent as the laws of the United States.Also, it may be possible for unauthorized third parties to copy or reverseengineer aspects of the Company's products, develop similar technologyindependently or otherwise obtain and use information that the Company regardsas proprietary. Furthermore, detecting unauthorized use of the Company'sproprietary rights is difficult. Litigation may be necessary in the future toenforce the Company's proprietary rights. Such litigation could result in theexpenditure of significant financial and managerial resources and could have amaterial adverse effect on the Company's future operating results.

***Intellectual property claims against the Company can becostly and negatively impact the Company's business.***

    Inthe telecommunications business, there is frequent litigation based onallegations of patent infringement. As the number of entrants in the Company'smarket increases and the functionality of its products is enhanced and overlapswith the products of other companies, the Company may become subject to claimsof infringement or misappropriation of the intellectual property rights ofothers. As a result, from time to time, third parties may claim exclusivepatent or other intellectual property rights to technologies that the Companyuses.  Although the Company believes thatit does not face material liability related to infringement of the intellectualproperty of others, any claims asserting that the Company's products infringeor may infringe proprietary rights of third parties, if determined adversely tothe Company, could have a material adverse effect on its business, financialcondition or results of operations. Any claims, with or without merit, could betime-consuming, result in costly litigation, divert the efforts of theCompany's engineering and management personnel, cause delays in productshipments or require the Company to enter into royalty or licensing agreements,any of which could have a material adverse affect upon the Company's operatingresults. If any legal action claiming patent infringement is commenced againstit, the Company cannot assure you that it would prevail in such litigationgiven the complex technical issues and inherent uncertainties in patentlitigation. In addition, the Company may be required to obtain a license orroyalty agreement under the intellectual property rights of those partiesclaiming the infringement. In the event a claim against the Company wassuccessful, and it could not obtain a license on acceptable terms or license asubstitute technology or redesign to avoid infringement, the Company may beunable to market its affected products. This could have a material adverseeffect on the Company's business, financial condition and results ofoperations.

***Certain of the Company's products depend upon the continuedavailability of licensed technology from third parties.***

    TheCompany currently licenses and will continue to license certain technologyintegral to certain of its products from third parties. For example, theCompany has obtained licenses from third parties for software for certain ofits voice and fax products. While the Company believes that much of thistechnology is available from multiple sources, any difficulties in acquiringthird-party technology licenses, or integrating the related third-partytechnology into its products, could result in delays in product development orupgrade until equivalent technology can be identified, licensed and integrated.

The Company mayrequire new licenses in the future as its business grows and technologyevolves. The Company cannot assure you that these licenses will continue to beavailable to it on commercially reasonable terms, if at all, which could have amaterial adverse effect on the Company's business, financial condition andresults of operations.

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

    TheCompany's success depends in large part upon the continued contributions of itskey management, sales and marketing, and engineering personnel, many of whoperform important functions and would be difficult to replace. The Company doesnot have employment contracts with its key personnel. In addition, in order togrow its business, the Company must increase the number of engineering, sales,customer support and administrative personnel. There is intense competition inthe Company's industry for qualified personnel, and, at times, the Company hasexperienced difficulty in recruiting qualified personnel. The Company may notbe able to attract and retain the necessary personnel to accomplish its businessobjectives, and it may experience constraints that will adversely affect itsability to satisfy customer demand in a timely fashion or to support itscustomers and operations. The Company's inability to hire qualified personnelon a timely basis, or to retain its key personnel, could materially adverselyaffect the Company's business, financial condition and results of operations.

***The Company's products typically have long sales cycles,causing the Company to expend significant resources before recognizing revenue.***

    Thelength of the Company's 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 theCompany's products and integrate them into larger systems. This evaluationperiod is often prolonged due to delays associated with approval processes thattypically accompany the design and testing of new communications equipment bythe Company's customers.

    Inaddition, the rapidly emerging and evolving nature of the markets in which theCompany and its 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 the Company's customers areevaluating whether to place an order with the Company, it often incurssubstantial sales and marketing expenses, without any assurance of futureorders or their timing. Even after a customer places an order with the Companyand its product is expected to be utilized in a product or service offeringbeing developed by our customer, the timing of the development, introductionand implementation of those products is controlled by, and can varysignificantly with the needs of, the Company's customers. In somecircumstances, the customer will not require the product for several months.This complicates the Company's planning processes and reduces thepredictability of the Company's earnings.

***The Company derives a significant portion of its revenuefrom international sales; international business operations entail additionalrisks.***

    Risksarising from the Company's international business include currency fluctuation,political instability in other countries, the imposition of trade and tariffregulations by foreign governments, and the difficulties in managing operationsacross disparate geographic areas. In addition, most countries requiretechnical approvals from their telecommunications regulatory agencies for productsthat operate in conjunction with the telephone system. Obtaining theseapprovals is generally a prerequisite for sales in a given jurisdiction.Obtaining requisite approvals may require from two months to a year or moredepending on the product and the jurisdiction. These or other factors may limitthe Company's ability to sell its products and services in other countries,which could have a material adverse effect on the Company's business, financialcondition and results of operations.

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

    TheCompany's exposure to market risk from changes in interest rates, foreigncurrency exchange rates, and equity prices has not changed materially from itsexposure at year-end 2000.

**Part II.****  OTHER INFORMATION**

**Item 1.  Legal Proceedings**

    InOctober 2000, several shareholder class action complaints were filed inthe United States District Court for the District of Massachusetts (the"Court") by certain shareholders of Interspeed and of the Company.Certain of the complaints named, among others, the Company and certain of itscurrent directors and certain current and former officers as defendants. Thelawsuits were filed after Interspeed's October 6, 2000 announcement thatit would be restating its unaudited financial results for certain priorquarters of its fiscal year 2000. The complaints included allegations that theCompany or certain of its officers and directors participated in and approvedthe issuance of the financial statements of Interspeed, that defendants are"controlling persons" of Interspeed, and that the defendants madefalse or misleading statements regarding the Company's own consolidatedfinancial results. Following settlement discussions among the parties,(i) complaints filed by shareholders of the Company were voluntarilydismissed in April 2001 and (ii) the Court entered final approval of thesettlement of the litigation brought by shareholders of  Interspeed in July 2001. The dismissal andsettlement of these actions will not have a material adverse effect on theCompany's financial position or results of operations.

**Item4. Submission of Matters to a Vote of Security Holders**

   On May 10, 2001, the Company held its 2001 Annual Meeting ofStockholders (the "Annual Meeting"). At the Annual Meeting,stockholders of the Company were asked to consider proposals (the"Proposals") (i) to elect two Class III directors, each to serve fora three-year term until the 2004 annual meeting of stockholders and until hissuccessor is duly elected and qualified; (ii) to consider and act upon aproposal to approve adoption of the Company’s 2001 Stock Option and IncentivePlan (the ‘‘Stock Option and Incentive Plan’’); (iii) to consider and act upona proposal to approve an amendment to the Company’s Amended and Restated 1992Stock Purchase Plan (the ‘‘Purchase Plan’’) to increase the number of shares ofthe Company’s common stock subject to issuance under the Purchase Plan; (iv) toratify the selection of Deloitte & Touche LLP as the Company’s independentauditors for the fiscal year ending December 31, 2001; and (v) to consider andact upon any other matters that may properly be brought before the annualmeeting and any adjournments or postponements thereof.

   With regard to the election of directors, Eric R. Giler and Robert G.Barrett, were nominated to serve as Class III Directors of the Company untilthe 2004 annual meeting.  The otherdirectors of the Company whose terms of office as directors continued after theAnnual Meeting are as follows:  David L.Chapman (Class I Director), David W. Duehren (Class I Director), and W. BrookeTunstall (Class II Director).

   With respect to the Proposals, the stockholders of the Company voted atthe Annual Meeting as hereinafter described. By a vote of 10,683,324 votes of common stock in favor of Eric R. Giler,a plurality of the eligible votes, and 940,806 votes withheld for Mr. Giler,Mr. Giler was elected as a Class III Director of the Company.  By a vote of 11,060,215 votes of commonstock in favor of Robert G. Barrett, a plurality of the eligible votes, and563,915 votes withheld for Mr. Barrett, Mr. Barrett was elected as a Class IIIDirector of the Company.

   The stockholders of the Company approved adoption of the Stock Optionand Incentive Plan by a vote of 4,548,651 votes in favor, in excess of amajority of eligible votes, with 2,637,842 votes against, 85,288 votesabstaining and 4,352,349 broker non-votes.

   The stockholders of the Company approved an amendment to the PurchasePlan by a vote of 6,561,121 votes in favor, in excess of a majority of eligiblevotes, with 628,967 votes against, 81,693 votes abstaining and 4,352,349 brokernon-votes.

    The stockholders of the Company ratifiedand approved the selection of Deloitte & Touche LLP as the Company’sindependent auditors for the current fiscal year by a vote of 11,491,234 votesin favor, in excess of a majority of eligible votes, with 90,500 votes againstand 42,396 votes abstaining.

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

             (a)Exhibits

    2.1—Agreementand Plan of Merger among eYak, Inc., Sonexis Technologies, Inc.,Brooktrout Software, Inc., Brooktrout Business Trust andBrooktrout, Inc. is hereby incorporated by reference from Exhibit 2.1to the Company's Current Report on Form 8-K filed with the Securities andExchange Commission on April 25, 2001 (File No. 000-20698).

(b)Reports on Form 8-K

    OnApril 25, 2001, the Company filed a Current Report on Form 8-K datedApril 16, 2001 with respect to the sale of its Brooktrout Software, Inc.subsidiary.

    OnMay 4, 2001, the Company filed a Current Report on Form 8-K datedMay 4, 2001 with respect to certain pro forma financial data voluntarilyprovided pursuant to Regulation FD.

 

**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 thereuntoduly authorized. 

|                        | BROOKTROUT, INC. |
|-----------------------------|-----------------------|
|                        |
|  Date: August 14, 2001 | By:                   | /s/ ERIC R. GILER |
|                        |                  |  |
|                        |                  | Eric R. Giler*President (Principal Executive Officer)* |
|                        |                  |   |
|  Date: August 14, 2001 | By:                   | /s/ ROBERT C.  LEAHY  |
|                        |                  |  |
|                        |                  | Robert C. Leahy*Vice President of Finance and   Operations, and Treasurer   (Principal Financial and Accounting Officer)* |