**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

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

**For the quarterly period ended June30, 2002**

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

**For the transition periodfrom         to**

**Commission File No. 000-20698**

 

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

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

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    Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that 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 26, 2002, 12,243,826 shares of common stock, $.01 par value per share,were outstanding.

 

 

 

 

 

 

**BROOKTROUT, INC.FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002**

**TABLE OF CONTENTS**
| PART I             | FINANCIAL  INFORMATION                                                                                                                   |   |   |
|--------------------|------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|               |                                                                                                                                     |   |   |
|  Item 1. | Condensed  Consolidated Financial Statements                                                                                             |   | 3      |
|               |                                                                                                                                     |   |   |
|               | Unaudited  Condensed Consolidated Balance Sheets as of June 30, 2002 and  December 31, 2001                                         |   | 3      |
|               |                                                                                                                                     |   |   |
|               | Unaudited  Condensed Consolidated Statements of Operations for the Three and Six Months  Ended June 30, 2002 and June 30, 2001           |   | 4      |
|               |                                                                                                                                     |   |   |
|               | Unaudited  Condensed Consolidated Statements of Comprehensive Income for the Three and  Six Months Ended June 30, 2002 and June 30, 2001 |   | 5      |
|               |                                                                                                                                     |   |   |
|               | Unaudited  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June  30, 2002 and June 30, 2001                     |   | 6      |
|               |                                                                                                                                     |   |   |
|               | Notes  to Unaudited Condensed Consolidated Financial Statements                                                                          |   | 7      |
|               |                                                                                                                                     |   |   |
|  Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                              |   | 12     |
|               |                                                                                                                                     |   |   |
|               | Introduction                                                                                                                             |   | 12     |
|               |                                                                                                                                     |   |   |
|               | Critical Accounting  Policies                                                                                                            |   | 13     |
|               |                                                                                                                                     |   |   |
|               | Three Months  Ended June 30, 2002 and 2001                                                                                               |   | 13     |
|               |                                                                                                                                     |   |   |
|               | Six Months  Ended June 30, 2002 and 2001                                                                                                 |   | 14     |
|               |                                                                                                                                     |   |   |
|               | Liquidity and Capital  Resources                                                                                                         |   | 15     |
|               |                                                                                                                                     |   |   |
|               | Risk Factors                                                                                                                             |   | 16     |
|               |                                                                                                                                     |   |   |
|  Item 3. | Quantitative  and Qualitative Disclosures about Market Risk                                                                              |   | 20     |
|               |                                                                                                                                     |   |   |
| PART II       | OTHER  INFORMATION                                                                                                                       |   | 21     |
|               |                                                                                                                                     |   |   |
|  Item 4. | Submission  of Matters to a Vote of Security Holders                                                                                     |   | 21     |
|               |                                                                                                                                     |   |   |
|  Item 6. | Exhibits and  Reports on Form 8-K                                                                                              |   | 21     |
|               |                                                                                                                                     |   |   |
|               | Signatures                                                                                                                               |   | 22     |
|               |                                                                                                                                     |   |   |
|               | Exhibit Index                                                                                                                            |   | 23     |

 

 

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**Brooktrout, Inc.Unaudited Condensed ConsolidatedBalance Sheets *(in thousands, except share and per sharedata)***
|                                                                                                                                    |   | **June  30,**

**2002** |   | **December  31,**

** 2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------------|--------|
| ASSETS                                                                                                                                  |   |                    |   |                              |   |
| Current assets:                                                                                                                         |   |                    |   |                              |   |
| Cash and cash equivalents                                                                                                               |   | $                       | 30,299 |                              | $      | 26,218 |   |
| Marketable securities                                                                                                                   |   | 12,389                  |   | 11,907                            |   |
| Accounts receivable (less allowances of $2,009 in  2002 and $2,074 in 2001)                                                             |   | 8,926                   |   | 8,870                             |   |
| Inventory                                                                                                                               |   | 8,016                   |   | 11,954                            |   |
| Income tax receivable                                                                                                                   |   | 4,618                   |   | 4,635                             |   |
| Deferred tax assets                                                                                                                     |   | 8,258                   |   | 9,168                             |   |
| Prepaid expenses                                                                                                                        |   | 1,096                   |   | 1,022                             |   |
| Total current assets                                                                                                                    |   | 73,602                  |   | 73,774                            |   |
|                                                                                                                                    |   |                    |   |                              |   |
| Equipment and furniture, less accumulated  depreciation and amortization                                                                |   | 3,999                   |   | 5,136                             |   |
| Deferred tax assets                                                                                                                     |   | 6,746                   |   | 6,981                             |   |
| Intangible assets, less accumulated amortization                                                                                        |   | 8,178                   |   | 8,944                             |   |
| Investments                                                                                                                             |   | —                  |   | 1,451                             |   |
| Other assets                                                                                                                            |   | 1,863                   |   | 2,601                             |   |
| Total assets                                                                                                                            |   | $                       | 94,388 |                              | $      | 98,887 |   |
|                                                                                                                                    |   |                    |   |                              |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                              |   |                    |   |                              |   |
|                                                                                                                                    |   |                    |   |                              |   |
| Current liabilities:                                                                                                                    |   |                    |   |                              |   |
| Accounts payable                                                                                                                        |   | $                       | 6,187  |                              | $      | 6,436 |   |
| Accrued expenses                                                                                                                        |   | 7,517                   |   | 7,303                             |   |
| Accrued compensation and commissions                                                                                                    |   | 2,467                   |   | 2,858                             |   |
| Customer deposits                                                                                                                       |   | 653                     |   | 697                               |   |
| Accrued warranty costs                                                                                                                  |   | 644                     |   | 789                               |   |
| Net liabilities related to discontinued operations                                                                                      |   | 278                     |   | 990                               |   |
| Total current liabilities                                                                                                               |   | 17,746                  |   | 19,073                            |   |
|                                                                                                                                    |   |                    |   |                              |   |
| Deferred rent                                                                                                                           |   | 215                     |   | 242                               |   |
| Total liabilities                                                                                                                       |   |                    | 17,961 |                              |   | 19,315 |   |
|                                                                                                                                    |   |                    |   |                              |   |
| Stockholders’ equity:                                                                                                              |   |                    |   |                              |   |
| Preferred stock, $1.00 par value; authorized,  100,000 shares; issued and outstanding, none                                             |   | —                  |   | —                            |   |
| Common stock, $0.01 par value; authorized,  40,000,000 shares; issued and outstanding 12,499,210 shares in 2002 and  12,462,242 in 2001 |   | 125                     |   | 125                               |   |
| Additional paid-in capital                                                                                                              |   | 64,020                  |   | 63,841                            |   |
| Notes receivable — officers                                                                                                        |   | (11,760                 | )      | (11,760                           | )      |
| Accumulated other comprehensive (loss)                                                                                                  |   | (56                     | )      | (52                               | )      |
| Retained earnings                                                                                                                       |   | 27,858                  |   | 31,178                            |   |
| Treasury stock, 255,384 shares in 2002 and 2001, at  cost                                                                               |   | (3,760                  | )      | (3,760                            | )      |
| Total stockholders’ equity                                                                                                         |   | 76,427                  |   | 79,572                            |   |
| Total liabilities and stockholders’ equity                                                                                         |   | $                       | 94,388 |                              | $      | 98,887 |   |

See notes to unaudited condensed consolidatedfinancial statements.

 

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**Brooktrout, Inc.Unaudited Condensed ConsolidatedStatements of Operations*****(in thousands, exceptper share data)***
|                                                  |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |    |
|------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|---------|
|                                                       |   | **2002**                         |   | **2001**                       |    | **2002** |   | **2001** |   |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Revenue                                                    |   | $                                | 18,798 |                           | $       | 17,844 |   | $ | 37,220 |   | $ | 44,907 |   |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Costs and expenses:                                        |   |                             |   |                           |    |   |   |   |   |
| Cost of product sold                                       |   | 8,732                            |   | 8,449                          |    | 17,530 |   | 19,644 |   |
| Research and development                                   |   | 5,508                            |   | 5,716                          |    | 11,127 |   | 11,194 |   |
| Selling, general and administrative                        |   | 7,534                            |   | 7,766                          |    | 15,015 |   | 17,474 |   |
| Total costs and expenses                                   |   | 21,774                           |   | 21,931                         |    | 43,672 |   | 48,312 |   |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Operating loss                                             |   | (2,976                           | )      | (4,087                         | )  | (6,452 | ) | (3,405 | )  |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Other income (expense):                                    |   |                             |   |                           |    |   |   |   |   |
| Equity in loss of affiliates                               |   | —                           |   | (342                           | )  | — |   | (1,397 | )  |
| Interest income, net and other                             |   | 369                              |   | 306                            |    | 590 |   | 616 |   |
| Total other income (expense)                               |   | 369                              |   | (36                            | )       | 590 |   | (781 | ) |
| Loss before income taxes                                   |   | (2,607                           | )      | (4,123                         | )  | (5,862 | ) | (4,186 | )  |
| Income tax (benefit)                                       |   | (1,095                           | )      | (1,388                         | )  | (2,462 | ) | (1,021 | )  |
| Loss from continuing  operations                           |   | (1,512                           | )      | (2,735                         | )  | (3,400 | ) | (3,165 | )  |
|                                                       |   |                             |   |                           |    |   |   |   |   |
|  Discontinued operations:                             |   |                             |   |                           |    |   |   |   |   |
| Gain on disposal of discontinued operations, net of  taxes |   | —                           |   | 4,423                          |    | 80 |   | 6,073 |   |
| Net income (loss)                                          |   | $                                | (1,512 | )                              | $       | 1,688 |   | $ | (3,320 | ) | $ | 2,908 |   |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Income (loss) per common share:                            |   |                             |   |                           |    |   |   |   |   |
| Loss from continuing operations, basic and diluted         |   | $                                | (0.12  | )                              | $       | (0.23 | )  | $ | (0.28 | ) | $ | (0.26 | )  |
| Net income (loss), basic and diluted                       |   | $                                | (0.12  | )                              | $       | 0.14 |   | $ | (0.27 | ) | $ | 0.24 |   |
|                                                       |   |                             |   |                           |    |   |   |   |   |
| Shares for basic and diluted                               |   | 12,209                           |   | 12,131                         |    | 12,208 |   | 12,129 |   |

See notes to unaudited condensed consolidatedfinancial statements.

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

 
|                                                               |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |    |
|--------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|---------|
|                                                               |   | **2002**                         |   | **2001**                       |    | **2002** |   | **2001** |   |
| Net income (loss)                                                  |   | $                                | (1,512 | )                              | $       | 1,688 |   | $ | (3,320 | ) | $ | 2,908 |   |
| Unrealized gains (losses) on marketable securities                 |   | 18                               |   | (150                           | )  | (6 | ) | (144 | ) |
| Foreign currency translation adjustments                           |   | —                           |   | (119                           | )       | — |   | (115 | ) |
| Comprehensive income (loss) before income tax provision  (benefit) |   | (1,494                           | )      | 1,419                          |    | (3,326 | ) | 2,649 |   |
| Income tax provision (benefit)                                     |   | 6                                |   | (53                            | )  | (2 | ) | (56 | ) |
| Comprehensive income (loss)                                        |   | $                                | (1,500 | )                              | $       | 1,472 |   | $ | (3,324 | ) | $ | 2,705 |   |

 

See notes to unaudited condensed consolidatedfinancial statements.

 

5

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**Brooktrout, Inc.Unaudited Condensed Consolidated Statements of Cash Flows*****(in thousands)***
|                                                                                  |   | **Six  Months Ended June 30,** |    |
|---------------------------------------------------------------------------------------|--------|--------------------------------|---------|
|                                                                                  |   | **2002**                       |    | **2001** |   |
| **Cash  flows from operating activities:**                                            |   |                           |    |   |   |
| Net income (loss)                                                                     |   | $                              | (3,320  | ) | $ | 2,908 |   |
| Adjustments to reconcile net income (loss) to cash  provided by operating activities: |   |                           |    |   |   |
| (Gain) loss on disposal of discontinued operations                                    |   | 705                            |    | (11,089 | ) |
| Depreciation and amortization                                                         |   | 2,195                          |    | 2,605 |   |
| Equity in loss of affiliates                                                          |   | —                         |    | 1,397 |   |
| Deferred income taxes                                                                 |   | 632                            |    | 3,945 |   |
| Increase (decrease) in cash from changes in:                                          |   |                           |    |   |   |
| Accounts receivable                                                                   |   | (56                            | )       | 12,415 |   |
| Inventory                                                                             |   | 3,938                          |    | 1,776 |   |
| Prepaid expenses and other assets                                                     |   | 368                            |    | 439 |   |
| Amortization of acquired software                                                     |   | 726                            |    | 271 |   |
| Liabilities                                                                           |   | (506                           | )  | (9,377 | ) |
| Cash provided by operating activities                                                 |   | 4,682                          |    | 5,290 |   |
|                                                                                  |   |                           |    |   |   |
| **Cash  flows from investing activities:**                                            |   |                           |    |   |   |
| Proceeds from the sale of a business segment                                          |   | —                         |    | 4,927 |   |
| Expenditures for equipment and furniture                                              |   | (292                           | )       | (672 | ) |
| Acquired software and other investing                                                 |   | —                         |    | (115 | ) |
| Sales and maturities of marketable securities                                         |   | 3,789                          |    | 1,000 |   |
| Purchases of marketable securities                                                    |   | (4,277                         | )       | (2,534 | )  |
| Cash (used in) provided by investing activities                                       |   | (780                           | )       | 2,606 |   |
|                                                                                  |   |                           |    |   |   |
| **Cash  flows from financing activities:**                                            |   |                           |    |   |   |
| Proceeds from the sale of common stock                                                |   | 179                            |    | 294 |   |
| Cash provided by financing activities                                                 |   | 179                            |    | 294 |   |
| Increase in cash and cash equivalents                                                 |   | 4,081                          |    | 8,190 |   |
| Cash and cash equivalents, beginning of period                                        |   | 26,218                         |    | 23,294 |   |
| Cash and cash equivalents, end of period                                              |   | $                              | 30,299  |   | $ | 31,484 |   |

See notes to unaudited condensed consolidatedfinancial statements.

 

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

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

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

                Brooktrout, Inc. (the “Company”or “Brooktrout”) develops, manufactures and sells communications hardware andsoftware products that enable the development of communications applicationsand systems in five targeted markets, including enhanced services platforms,wireless infrastructure, voice over packet gateways and switches, unifiedcommunications, and contact centers. The Company sells its products to systemvendors, service providers, enterprise customers, original equipmentmanufacturers (“OEMs”), and value-added resellers (“VARs”), both domesticallyand internationally, through a direct sales force and a two-tiered distributionsystem. Prior to February 8, 2001, the Company was organized and reportedthe results of its operations in the following three business segments: BrooktroutTechnology, Inc. (“Brooktrout Technology”), Brooktrout Software, Inc.(“Brooktrout Software”), and Interspeed, Inc. (“Interspeed”). Thesesegments were differentiated based upon the products provided to themarketplace, the customers served, and the distribution channels utilized. Twoof these segments have been discontinued and are classified as discontinuedoperations for the periods presented in these condensed consolidated financialstatements. (See Note 2). Following the discontinuance of the BrooktroutSoftware and Interspeed segments, the Company’s operations consist of onereportable segment, Brooktrout Technology.

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

                Accounting policies, methods andestimates are an integral part of the condensed consolidated financial statementsand are based upon management’s current judgments. These policies, methods, andestimates affect the reported amounts of assets and liabilities and disclosureof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenue and expenses during the reporting periods.The judgments made by management are based on knowledge and experience withregard to past and current events and assumptions about future events that arebelieved to be reasonable under the circumstances. On an on-going basis, theCompany’s management evaluates its estimates and assumptions and adjusts themif expectations concerning events, including future events, affecting themdiffer markedly from management’s current judgments.

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

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

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

***(d) Revenue Recognition***

                Revenue from product sales isgenerally recognized upon shipment to the customers provided that persuasive evidenceof an arrangement exists, the fee is fixed or determinable, delivery hasoccurred, and collection is considered probable. The Company records aprovision for estimated sales returns and allowances on product sales in thesame period as the related revenue is recorded. These estimates are based onhistorical sales returns, analysis of credit memo data and other known factors.The Company provides for estimated costs of warranty repairs at the time ofsale of the related products. Revenue from sales to distributors is recognizedon a “sell-through” basis, that is, when the distributors report to the Companythat resale of the product has occurred.

 

7

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

                The Company sells its productsto various customers in the high technology industry. The Company generallyrequires no collateral; however, to reduce credit risk, the Company performsongoing credit evaluations of its customers. The Company maintains allowancesfor doubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments. At June 30, 2002 and December 31, 2001,17% and 13%, respectively, of the Company’s net accounts receivable were fromone customer.

***(f) Inventory***

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

***(g) Intangible Assets***

                Intangible assets includeacquired technology, customer base, and trademarks associated with purchasedbusiness combinations.  Acquired technology is being amortized on astraight-line basis over five to ten years, while all other intangiblesare being amortized over periods of three to five years.  Accumulatedamortization at June 30, 2002 and December 31, 2001 was $6,648 and $5,882,respectively.  Intangible assets are reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying value may not berecoverable.

***(h) Income Taxes***

                Deferred tax assets andliabilities are recognized for the estimated future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases and operatingloss carry forwards. These assets and liabilities are measured using theenacted rates and laws that are expected to be in effect when the differencesreverse.  The Company believes that itis more likely than not that future operations will generate sufficient taxableincome to realize the deferred tax assets.

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

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

                Potentialcommon shares are antidilutive for the three and six months ended June 30, 2002and 2001 and are excluded from the calculation.  Stock options to purchase3,539,221 and 2,681,637 shares were not included in the computation of dilutedearnings per share in 2002 and 2001, respectively.

*** (j) Reclassifications***

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

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

                The Company has adopted SFAS No.141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other IntangibleAssets.” These pronouncements provide guidance on how to account for theacquisition of businesses and intangible assets, including goodwill, whicharise from such activities. SFAS No. 141 affirms that only one method ofaccounting may be applied to a business combination, the purchase method. SFASNo. 141 also provides guidance on the allocation of purchase price to theassets acquired. SFAS No. 142 provides that goodwill resulting from businesscombinations can no longer be amortized to expense, but rather requires anannual assessment of impairment and, if necessary, adjustments to the carryingvalue of goodwill.  The adoption of SFASNos. 141 and 142 did not have a material effect on the Company's consolidated financialstatements.  As of January 1, 2002, theCompany had no intangible assets with indefinite useful lives.

                The Company has adopted SFAS No.144 “Accounting for the Impairment of Disposal of Long-Lived Assets.” SFAS No.144 establishes a single accounting model for impairment or disposal of long-livedassets, including discontinued operations. The

 

8

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adoptionof SFAS No. 144 did not have a material effect on the Company’s consolidatedfinancial statements and had no effect on the accounting applied to thediscontinued businesses described in Note 2.

**2.  Discontinued Operations**

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

                *Brooktrout Software, Inc.—*OnMarch 12, 2002, the Company and Sonexis, Inc. (“Sonexis”) reached anagreement resolving various post-closing adjustments and indemnification claimsof both parties that had been asserted in connection with the sale ofBrooktrout Software. As part of this agreement, the Company agreed to exchangethe Sonexis shares, received by the Company as partial consideration for thesale of Brooktrout Software, for an immediate and final resolution and releaseof substantially all claims related to the sale of Brooktrout Software. The Sonexis shares had been classified in the Company’s financial statements asa cost basis investment at December 31, 2001.  The effect of thissettlement was a pre-tax non-cash charge to discontinued operations in thefirst quarter of 2002 of $943.  This pre-tax non-cash charge wassubstantially offset by an income tax benefit of $915.  The income taxbenefit related primarily to net deferred tax liabilities, which are no longerrequired due to the final settlement of the transaction.  As a result, theCompany recognized a net loss from discontinued operations for the six monthsended June 30, 2002 of $28.  As of June 30, 2002, “Net liabilities relatedto discontinued operations” consists of $86 for accruals of anticipated finalexpenses related to Brooktrout Software.

 

                *Interspeed, Inc.—* In January 2001,the Board of Directors of Interspeed announced that it was curtailingoperations and liquidating the remaining assets for the benefit ofcreditors.  The Company is a creditor of Interspeed.  In the threemonths ended March 31, 2002, the Company received net proceeds from theInterspeed creditors’ trust of $238.  These proceeds, net of income taxexpense of $130, resulted in a net gain from discontinued operations for thesix months ended June 30, 2002, of $108.  As of June 30, 2002, “Netliabilities related to discontinued operations” consists of $192 of anticipatedfinal expenses associated with the Interspeed business.

                Details of the gain on disposal,and basic and diluted per share amounts for discontinued operations are asfollows: 

 
|                                                                                                                                                                                                                          |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| Gain (loss) on disposal of discontinued operations:                                                                                                                                                                           |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| Brooktrout Software, net of income tax expense  of  $3,984 in the three months ended  June 30, 2001, and income tax expense (benefit) of ($915) and $5,017 in the  six months ended June 30, 2002 and 2001, respectively |   | $                                | — |                           | $      | 4,423 |   | $ | (28 | ) | $ | 6,073 |   |
| Interspeed, net of income tax expense of $130 in  2002                                                                                                                                                                        |   | —                           |   | —                         |   | 108 |   | — |   |
| Total gain on disposal of discontinued operations                                                                                                                                                                             |   | $                                | — |                           | $      | 4,423 |   | $ | 80 |   | $ | 6,073 |   |
|                                                                                                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Gain on disposal per common share:                                                                                                                                                                                            |   |                             |   |                           |   |   |   |   |   |
| Basic and diluted                                                                                                                                                                                                             |   | $                                | — |                           | $      | 0.36 |   | $ | 0.01 |   | $ | 0.50 |   |
|                                                                                                                                                                                                                               |        |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**3.** ** Inventory**

                Inventory consisted of thefollowing at: 
|            |   | **June  30, 2002** |   | **December 31,  2001** |   |
|-----------------|--------|--------------------|--------|-----------------------------|--------|
| Raw materials   |   | $                  | 961    |                        | $      | 3,763 |   |
| Work in process |   | 1,292              |   | 621                         |   |
| Finished goods  |   | 5,763              |   | 7,570                       |   |
| Total           |   | $                  | 8,016  |                        | $      | 11,954 |   |
|                 |        |                    |        |                             |        |  |  |  |  |

 

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**4.  Equipment and Furniture**

                Equipment and furnitureconsisted of the following at: 
|                                                                           |   |    | **June  30, 2002** |    |   | **December  31, 2001** |   |
|--------------------------------------------------------------------------------|--------|---------|--------------------|---------|--------|------------------------|--------|
| Computer equipment                                                             |   | $       | 8,067              |    | $      | 7,987                  |   |
| Furniture and office equipment                                                 |   | 9,015   |               | 8,805   |   |
| Total equipment and furniture                                                  |   | 17,082  |               | 16,792  |   |
| Less accumulated depreciation and amortization                                 |   | (13,083 | )                  | (11,656 | )      |
| Total equipment and furniture, less accumulated  depreciation and amortization |   | $       | 3,999              |    | $      | 5,136                  |   |

** **

**5.  Bank Line of Credit**

                For the period ended June 30,2002 the Company had a line of credit under which it could borrow up to $5,000on a secured basis, subject to compliance with certain covenants. Any amountsborrowed under the line of credit bear interest at the lender’s prime rate. Asof June 30, 2002, letters of credit issued against the Company’s existing linetotaled $1,000, representing the collateral required for certain leaseobligations. Other than the issuance of letters of credit, there have been noborrowings under the line during the past three years.  The line of creditexpired at the end of June 2002.  The Company is currently in the processof renewing the line of credit and anticipates that the line of credit will berenewed on substantially the same terms as the existing line of credit.

**6.  Income Taxes**

                The Company’s tax provision in2002 is based on the estimated effective tax rate for the full year. TheCompany’s effective tax benefit rate on continuing operations was 42% for thesix months ended June 30, 2002.  The Company received a tax refund of$4,393 during the six months ended June 30, 2002.

**7.  Investments**

                The Company has an investment inPelago Networks, Inc. (“Pelago”), which it has previously accounted for underthe equity method of accounting.  The Company’s investment in Pelago hadbeen written down to zero as of December 31, 2001 as the Companyrecognized its share of Pelago’s losses. The Company has no further funding commitment and has ceased recordingits share of Pelago’s losses.  In thethree months ended March 31, 2002, Pelago closed on an additional round ofequity financing of its Series B preferred shares in which the Company didnot participate.  As a result of thisfinancing, the Company’s ownership percentage was reduced below 20% and theCompany now accounts for this investment on the cost method basis.

                In the six months ended June 30,2002, the reduction in the value of investments was due to the preferred equitysecurities that constituted the Company’s investment in Sonexis being exchangedwith Sonexis as part of the settlement discussed in Note 2.

**8.  Segment Reporting**

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

                *ProductSales*—Brooktrout Technology’s products are sold for applications inthe New NetworkTM and for applications in Today’s Network. Today’s Networkinvolves core technologies and platforms that are primarily used in businesspremise products such as fax, LAN fax, and voice mail. The New Networkapplications expand the capabilities of communications networks to allow data,voice and fax information to be distributed using packet-based data networks,such as the Internet, for portions of the transmission and also allowinformation to be distributed using the traditional circuit-switched telephonenetwork. For the three months ended June 30, 2002, sales of products for use inthe New Network accounted for approximately 36% of total revenue as compared to33% of total revenue in the three months ended June 30, 2001.  For the six months ended June 30, 2002,sales of products

 

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for usein the New Network accounted for approximately 35% of total revenue as comparedto 44% of total revenue for the six months ended June 30, 2001.

*                MajorCustomers—*One customeraccounted for approximately 15% and 16% of revenue for the three months endedJune 30, 2002 and 2001, respectively. The same customer accounted forapproximately 14% and 10% of revenue for the six months ended June 30, 2002 and2001, respectively.  A differentcustomer represented 12% of sales for the six months ended June 30, 2001;however, revenue from this customer represented less than 1% of total revenuefor the six months ended June 30, 2002.

                *InternationalSales—*International sales, principally exports from the UnitedStates, accounted for approximately 19% and 24% of revenue for the three monthsended June 30, 2002 and 2001, respectively, and approximately 20% of revenuefor the six months ended June 30, 2002 and 2001.

**9.  Contingencies**

                *Litigation*—TheCompany is a party to a number of legal actions that have arisen in the normalcourse of business.  The Company, takinginto account advice of counsel, does not believe the eventual outcome of thesematters will have a material effect on the Company's consolidated financialcondition or results of operations.

 

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** **

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

**Results of Operations**

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

                This quarterly report onForm 10-Q contains certain statements that are “forward-lookingstatements” as that term is defined under the Private Securities LitigationReform Act of 1995 and releases issued by the Securities and ExchangeCommission. The words “believes,” “expects,” “anticipates,” “intends,”“estimates,” “assumes,” “will,” “should” and other expressions that arepredictions of or indications of future events and trends and that do notrelate to historical matters, identify forward-looking statements.  You should not rely on forward-lookingstatements because they involve known and unknown risks, uncertainties andother factors, some of which are 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 suchforward-looking statements. These forward-looking statements were based oninformation, plans, and estimates at the date of this document and the Companyundertakes no obligation to update any forward-looking statement, whether as aresult of new information, future events or otherwise.  In particular, (i) our revenue would bematerially adversely affected if our largest customer does not continue toprovide more than 10% of our overall revenue; (ii) the Company could beadversely affected if gross margins for the next several quarters do not remainsimilar to the gross margin for the quarter ended June 30, 2002, as expected;(iii) the Company’s financial condition and results of operations could beadversely affected if actual expenses for research and development and selling,general and administrative expenses are higher or lower than expected; (iv) theCompany could be adversely affected if not successful in renewing its line ofcredit or if the line of credit is not renewed on as favorable terms as theexisting line of credit; and (v) the Company could be adversely affected in theevent that future operations do not generate sufficient taxable income torealize the deferred tax assets.

                The future operating results andperformance trends of the Company may be affected by a number of factors,including, without limitation, risks related to the following: (i) thedownturn in the economy generally, and the slowdown in the telecommunicationssector in particular; (ii) market growth, market acceptance of theCompany’s products and product demand; (iii) rapid changes in technologyand the evolution of the telecommunications hardware and software market; and(iv) the impact of competition. In addition to the foregoing, theCompany’s actual future results could differ materially from those projected inthe forward-looking statements as a result of the “Risk Factors” set forthherein and in the Company’s various filings with the Securities and ExchangeCommission and of changes in general economic conditions and changes in theassumptions used in making such forward-looking statements.

**Introduction**

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

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

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

 

 

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**Critical Accounting Policies**

 

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

                The Company’s revenuerecognition policy requires that revenue generally be recognized at the time ofshipment to customers if there is persuasive evidence that an arrangementexists, the price is fixed or determinable, delivery has occurred, andcollection is considered probable. The Company recognizes revenue from sales totwo-tiered distributors of the Company’s products when the distributor has soldtheproducts totheir customers. The Company records a provision for estimated sales returnsand allowances on product sales in the same period as the related revenue isrecorded. These estimates are based on historical sales returns, analysis ofcredit memo data and other known factors. Actual results could differ fromthese estimates.

                As the Company adheres to itsconcentration of credit risk policy, management makes estimates concerning therealizable value of accounts receivable assets. The current and future economicenvironment affects these estimates. The Company maintains allowances fordoubtful accounts for estimated losses resulting from the inability of itscustomers to make required payments. If the financial condition of Brooktrout’scustomers were to deteriorate, additional allowances would likely be required.

                As the Company adheres to itsinventory valuation policy, management makes estimates concerning therealizable value of inventory. The current and future economic environment affectsthese estimates. The Company reduces the value of its inventory for estimatedobsolescence or unmarketable inventory equal to the difference between the costof inventory and the estimated market value based upon assumptions about futuredemand and market conditions. If actual market conditions are less favorablethan those projected by management, additional inventory write-downs may berequired.

                The Company reviews itsintangible assets for impairment whenever events or changes in circumstances indicatethat the carrying value may not be recoverable. Any evaluation of intangibleassets would include assumptions regarding estimated future cash flows andother factors to determine the fair value of the respective assets. If theseestimates or their related assumptions change in the future, the Company couldbe required to record impairment charges for these assets.

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

                The Company recorded estimatesfor expenses associated with Brooktrout Software, along with the expensesrelated to Interspeed, as liabilities associated with discontinued operations.(See Note 2 to condensed consolidated financial statements). These estimatesare based on certain judgments by management about the likelihood of futureevents and any amounts expected to be paid. If actual results differ from theseestimates, an adjustment to the amounts recorded as liabilities could berequired in future periods.

**ThreeMonths Ended June 30, 2002 and 2001*******(in thousands)*

                Revenue for the three monthsended June 30, 2002 increased by approximately 5% to $18,798, up from $17,844for the three months ended June 30, 2001. The increase in revenue resultedprimarily from sales of products for applications in the New Network, specificallythose sold to enterprise customers for messaging applications. For the threemonths ended June 30, 2002, sales of products for applications in the NewNetwork accounted for approximately 36% of total revenue, as compared to 33% oftotal revenue for the three months ended June 30, 2001.

                Revenue from one customeraccounted for approximately 15% of total revenue for the three months endedJune 30, 2002, compared to 16% from this same customer for the three monthsended June 30, 2001. The Company expects that revenue from this customer willcontinue to be greater than 10% of total revenue for the foreseeable future.

 

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                Cost of product sold was $8,732,or 46% of revenue, for the three months ended June 30, 2002, compared to$8,449, or 47% of revenue, for the three months ended June 30, 2001. Grossmargin percent for the three months ended June 30, 2002 was 54% compared with53% for the three months ended June 30, 2001. The higher gross margin percent in2002 was primarily due to an increase in higher margin products sold togetherwith a reduction in the manufacturing costs for certain products throughidentification of alternative manufacturing sources.  The Company expects that the gross margin for the next severalquarters will be similar to the gross margin for the three months ended June30, 2002.

                Research and development expensewas $5,508, or 29% of revenue, for the three months ended June 30, 2002,compared with $5,716, or 32% of revenue, for the three months ended June 30,2001.  The decline in this expense is primarily the result of reducedspending for consulting, contract labor and variable incentive compensation.The Company’s continuing development efforts are focused on hardware and softwarethat make up its network interface products, media processing products,messaging products and IP telephony products. The Company intends to continueto commit significant resources to product development and would expect thatresearch and development expense in 2002 would be similar to the 2001 spending.

                Selling, general andadministrative expense was $7,534, or 40% of revenue, for the three monthsended June 30, 2002, compared with $7,766, or 44% of revenue, for the threemonths ended June 30, 2001. The decline in this expense is primarily the resultof reduced spending for variable incentive compensation, advertising andpromotions. The Company expects that selling, general and administrativeexpense in 2002 will be similar to the 2001 spending.

                There was no equity in loss ofaffiliates for the three months ended June 30, 2002, as compared to $342 ofequity in loss of affiliates from both Pelago Networks, Inc. (“Pelago”) andTelchemy, Incorporated (“Telchemy”) for the three months ended June 30, 2001. TheCompany’s investment in Pelago had been written down to zero as of December 31,2001, and since the Company has no further funding commitment, it has ceasedrecording its share of Pelago’s losses. The Company will not recognizeadditional losses related to Telchemy, as the Company disposed of its equityinterest in Telchemy on December 31, 2001.

                Interest income, net and otherwas $369 for the three months ended June 30, 2002, as compared with $306 forthe three months ended June 30, 2001. The increase in interest income, net andother was the result of an increase in cash and marketable securities balances,as well as gains of $81 from favorable Euro currency exchange rates during thethree months ended June 30, 2002.

                Theeffective tax benefit rate was 42% for the three months ended June 30, 2002.For the three months ended June 30, 2001, the effective tax expense rate was34%. This tax rate for the second quarter of 2001 was the result of treatingequity in loss of affiliates expense as a non-deductible item in the income taxprovision calculation. Excluding the impact of equity in loss of affiliates,the effective tax expense rate would have been 37% for the three months endedJune 30, 2001.

**SixMonths Ended June 30, 2002 and 2001*******(in thousands)*

                Revenue for the six months endedJune 30, 2002 decreased by approximately 17% to $37,220, compared to $44,907for the six months ended June 30, 2001. The decline in revenue resultedprimarily from the overall economic slowdown in the United States and internationaleconomies and, in particular, the softening in the telecommunications market.The slowdown the Company is experiencing extends across most product lines andmarkets.  Sales of products forapplications in the New Network, specifically those sold to OEMs for useby large service providers, have declined most significantly for the six monthsended June 30, 2002, even though New Network sales increased during the threemonths ended June 30, 2002. For the six months ended June 30, 2002, sales ofproducts for applications in the New Network accounted for approximately 35% oftotal revenue, as compared to 44% of total revenue for the six months endedJune 30, 2001.

                Revenue from one customeraccounted for approximately 14% of total revenue for the six months ended June30, 2002, compared to 10% from this same customer for the six months ended June30, 2001. The Company expects that revenue from this customer will continue tobe greater than 10% of total revenue for the foreseeable future. A differentcustomer represented 12% of sales for the six months ended June 30, 2001;however, revenue from this customer represented less than 1% of total revenuefor the six months ended June 30, 2002. For the foreseeable future, the Companyexpects that revenue from this customer will continue to be significantly lessthan that of prior years.

                Cost of product sold was$17,530, or 47% of revenue, for the six months ended June 30, 2002, compared to$19,644, or 44% of revenue, for the six months ended June 30, 2001. Gross marginpercent for the six months ended June 30, 2002 was 53% compared with 56% forthe six months ended June 30, 2001. The lower gross margin percent for the sixmonths ended June 30, 2002, was primarily due to unabsorbed manufacturingexpenses along with the reduction in higher margin products sold for the sixmonths ended June 30, 2002, even though the sales of higher margin productsincreased during the three months ended June 30, 2002.  The

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Company’smanufacturing expenses, which are primarily fixed, represented a largerpercentage of cost of product sold in 2002 in comparison to 2001.

                Research and development expensewas $11,127, or 30% of revenue, for the six months ended June 30, 2002,compared with $11,194, or 25% of revenue, for the six months ended June 30,2001.  A decrease in spending for consulting, contract labor and variableincentive compensation was partially offset by an increase in expensesassociated with new product design and testing.  The Company’s continuing development efforts are focused onhardware and software that make up its network interface products, mediaprocessing products, messaging products and IP telephony products.

                Selling, general andadministrative expense was $15,015, or 40% of revenue, for the six months endedJune 30, 2002, compared with $17,474, or 39% of revenue, for the six monthsended June 30, 2001. The decline in dollars spent is primarily the result ofreduced spending for variable incentive compensation, consulting and contractlabor, advertising and promotion expenses, travel and entertainment expenses,employee recruiting expenses, and expendable materials and supplies.

                There was no equity in loss ofaffiliates for the six months ended June 30, 2002, as compared to $1,397 ofequity in loss of affiliates from both Pelago and Telchemy for the six monthsended June 30, 2001.

                Interest income, net and otherwas $590 for the six months ended June 30, 2002, as compared with $616 for thesix months ended June 30, 2001. The decrease in interest income, net and otherwas the result of a decline in short-term interest rates, which offset thefavorable impact that increased cash and marketable securities balances had oninterest income.

                Theeffective tax benefit rate was 42% for the six months ended June 30, 2002. Forthe six months ended June 30, 2001, the effective tax expense rate was 24%.This tax rate for the six months ended June 30, 2001 was the result of treatingequity in loss of affiliates expense as a non-deductible item in the income taxprovision calculation. Excluding the impact of equity in loss of affiliates,the effective tax expense rate would have been 37% for the six months endedJune 30, 2001.

 

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

 

                Forthe six months ended June 30, 2002, the Company funded its operationsprincipally through cash provided by operating activities. Cash provided byoperating activities for the six months ended June 30, 2002 was $4,682 and wasgenerated primarily from tax refunds received of $4,393.  Cash used ininvesting activities for the six months ended June 30, 2002 was $780 andconsisted of purchases of marketable securities and capital equipment. Working capital increased to $55,856 at June 30, 2002 from $54,701 at December 31,2001.

                For the period ended June 30,2002, the Company had a line of credit under which it could borrow up to $5,000on a secured basis, subject to compliance with certain covenants. Any amountsborrowed under the line of credit bear interest at the lender’s prime rate. Asof June 30, 2002, letters of credit issued against the Company’s existing linetotaled $1,000, representing the collateral required for certain leaseobligations. Other than the issuance of letters of credit, there have been no borrowingsunder the line during the past three years.  The line of credit expired atthe end of June 2002.  The Company is currently in the process of renewingthe line of credit and anticipates that the line of credit will be renewed onsubstantially the same terms as the existing line of credit.

                The Company believes that thecurrent economic conditions will continue during this year and as a result,expects to have a loss from continuing operations for the year endingDecember 31, 2002. During the twelve months ended December 31, 2001, theCompany had an operating loss of $9,460, but during the same period increasedits cash and marketable securities balances by $12,138, of which $4,927 wasfrom the sale of Brooktrout Software. The Company believes available cashresources will support its operations and capital needs for at least the nexttwelve months, and if the current economic climate worsens beyond the nexttwelve months, the Company may need to utilize funds available under therenewed line of credit or seek other sources of financing.  In the event that the line of credit is notrenewed, the Company may also be required to seek other sources of financing.The terms of any future equity financings may be dilutive to the Company’sstockholders and the terms of any future debt financings may containrestrictive covenants, which could limit the Company’s ability to pursuecertain courses of action.  It ispossible that, should the need arise, the Company will not be able to obtainadditional financing, or that the financing made available to the Company willnot be on acceptable terms.

                For the six months ended June30, 2002, the Company purchased approximately $292 in equipment. The Companycurrently has no material commitments for additional capital expenditures.

 

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            The pricing of theCompany’s products and costs of its goods are generally determined by currentmarket conditions, as well as value to the customer. Market conditions can beimpacted by inflation; however, the Company believes that inflation has not hada significant effect on its operations to date.

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

**RiskFactors**

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

                As a result of recent unfavorableeconomic conditions affecting most technology sectors and thetelecommunications sector in particular, many of our customers are aggressivelyincreasing efficiency in their supply chains and reducing inventory levels.Additionally, we expect the growth of data traffic and the use of the Internetwill continue to have a significant impact on traditional voice networks, whichis driving the convergence of data and telephony and giving rise to the demandfor New Network applications. We cannot be sure what the rate of suchconvergence will be due to the slowdown in the communications industry and theresulting decrease in spending by our customers. The current economicconditions have adversely impacted the Company’s business and operating results,including a reduction in revenue of $7,687,000 for the six months ended June30, 2002, or 17% compared to the six months ended June 30, 2001. If currenteconomic conditions continue for an extended period of time or worsen, or if awider economic slowdown occurs, the Company may experience additional adverseeffects on its business, operating results, and financial condition.Specifically, as the rate at which the Company’s customers order productsdecreases, the more likely it is that current inventories will be exposed totechnological obsolescence, thus requiring the Company to reduce the value ofthat inventory on the balance sheet.

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

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

| • | the Company’s ability  to cope with difficult conditions in the economy in general, and the  telecommunications market in particular;                                                                    |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | the Company’s ability  to formulate and implement effective strategies to respond to changing market  requirements and conditions;                                                                       |
| • | cancellation or  rescheduling of orders for the Company’s products;                                                                                                                                      |
| • | the Company’s ability  to collect accounts receivable from customers that have been adversely  impacted by the difficult economic conditions;                                                            |
| • | the Company’s ability  to develop, manufacture, market and support its products and product  enhancements;                                                                                               |
| • | the timing and number  of orders for the Company’s products, which have historically been weighted  more heavily toward the last month of each quarter and the second and fourth  quarters of each year; |
| • | the Company typically  experiences lower revenue in the third quarter, due to customer summer  vacation schedules, particularly in Europe, and to a lesser extent, the first  quarter of each year;           |
| • | the Company’s ability  to hire, train and retain key management, sales and marketing and engineering  personnel;                                                                                         |
| • | announcements or  technological innovations by the Company’s competitors or in competing  technologies;                                                                                                  |
| • | the Company’s ability  to obtain sufficient supplies of sole or limited source components for the  Company’s products;                                                                              |
| • | a decrease in the  average selling prices of the Company’s products;                                                                                                                                     |
| • | changes in costs of  components that the Company includes in its products;                                                                                                                                    |
| • | the mix of products  that the Company sells and the mix of distribution channels through which  they are sold; and                                                                                            |
| • | a decrease in the  demand for the Company’s common stock.                                                                                                                                                |

 

 

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

***The Company hashistorically derived a significant portion of its revenue from a small numberof 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. One customer accounted for approximately 15% of theCompany’s revenue for the three months ended June 30, 2002, compared to 16% forthe three months ended June 30, 2001. The loss of any one of the Company’smajor customers or the delay of significant orders from such customers, even ifonly temporary, has or could reduce or delay the Company’s revenue, could harmthe Company’s reputation in the industry and could reduce the Company’s abilityto accurately predict cash flow, and, as a consequence, could seriously harmthe Company’s business, financial condition and results of operations.

***Thetelecommunications markets are highly competitive, and the Company may not beable to compete successfully against new entrants and established companieswith 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 notallocate sufficient resources to achieve the technological advances necessaryto compete successfully with existing competitors or new entrants.

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

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

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

                The telecommunications hardwareand software market is characterized by:

| • | rapid technological  advances;                               |
|--------|--------------------------------------------------------------|
| • | evolving industry  standards;                                |
| • | changes in customer  requirements;                           |
| • | frequent new product  introductions;                         |
| • | declining prices;                                            |
| • | intense competition;  and                                    |
| • | evolving offerings by  telecommunications service providers. |

                The Company believes that itsfuture success will depend, in part, on its ability to offer products thataddress the sophisticated and varied needs of its current and prospectivecustomers and to respond to technological advances and evolving industrystandards on a timely and cost-effective basis. The Company intends to continueto invest significantly in product and technology development. The developmentof new or enhanced products is a complex and uncertain process. The Company mayexperience design, manufacturing, marketing and other difficulties that coulddelay or prevent its development, introduction or marketing of new products andenhancements. The Company may also not be able to incorporate new technologieson a cost-effective or timely basis. This may result in unexpected expenses.Additionally, the Company may need to reduce its prices to remain competitive,which could affect its profitability. The introduction of new or enhancedproducts also requires that the Company 

 

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managethe transition from older products so as to minimize the disruption tocustomers and ensure that adequate supplies of new products can be delivered tomeet anticipated customer demand. The Company’s inability to develop on atimely basis new products or enhancements to existing products, or the failureof such new products or enhancements to achieve market acceptance, could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

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

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

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

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

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

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

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

 

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

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

| • | the right of the Board  of Directors, 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.                                                            |

 

                In addition, the Board ofDirectors adopted a Shareholder Rights Plan in September 1998.  These provisions discourage potentialtakeover attempts and the ability of stockholders to change management and theBoard of Directors. These anti-takeover measures could adversely affect themarket price of the Company’s common stock. In addition, even if you desired toparticipate in a tender offer, change of control or takeover attempt of theCompany that the Company’s management and Board of Directors opposed, theseprovisions may prevent you from doing so.

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

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

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

                In the telecommunicationsbusiness, there is frequent litigation based on allegations of patentinfringement. As the number of entrants in the Company’s market increases andthe functionality of its products is enhanced and overlaps with the products ofother companies, the Company may become subject to claims of infringement ormisappropriation of the intellectual property rights of others. As a result,from time to time, third parties may claim exclusive patent or otherintellectual property rights to technologies that the Company uses. Althoughthe Company believes that it does not face material liability related toinfringement of the intellectual property of others, any claims asserting thatthe Company’s products infringe or may infringe proprietary rights of thirdparties, if determined adversely to the Company, could have a material adverseeffect on its business, financial condition or results of operations. Anyclaims, with or without merit, could be time-consuming, result in costlylitigation, divert the efforts of the Company’s engineering and managementpersonnel, cause delays in product shipments or require the Company to enterinto royalty or licensing agreements, any of which could have a materialadverse effect upon the Company’s operating results. If any legal actionclaiming patent infringement is commenced against it, the Company cannot assureyou that it would prevail in such litigation given the complex technical issuesand inherent uncertainties in patent litigation. In addition, the Company maybe required to obtain a license or royalty agreement under the intellectual propertyrights of those parties claiming the infringement. In the event a claim againstthe Company was successful, and it could not obtain a license on acceptableterms or license a substitute technology or redesign to avoid infringement, theCompany may be unable to market its affected products. This could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

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

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

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

***If the Company isunable to attract or retain key personnel, it may be unable to successfullyoperate 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. There has been intensecompetition in the Company’s industry for qualified personnel, and, at times,the Company has experienced difficulty in recruiting qualified personnel. TheCompany may not be able to attract and retain the necessary personnel toaccomplish its business objectives, and it may experience constraints that willadversely affect its ability to satisfy customer demand in a timely fashion orto support its customers and operations. The Company’s inability to hirequalified personnel on a timely basis, or to retain its key personnel, couldmaterially adversely affect the Company’s business, financial condition andresults of operations.

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

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

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

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

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

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

                The Company’s exposure to marketrisk from changes in interest rates and currency exchange rates has not changedmaterially from its exposure at year-end 2001. The Company’s market riskassociated with investments in equity securities of privately held technologycompanies was reduced in 2002 since the investment in the preferred equitysecurities that constituted the Company’s investment in Sonexis was exchangedwith Sonexis as part of the settlement discussed in Note 2 to the condensedconsolidated financial statements.

 

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**PART II.  OTHERINFORMATION**

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

On May 9, 2002, the Companyheld its 2002 Annual Meeting of Stockholders (the “Annual Meeting”). At theAnnual Meeting, stockholders of the Company were asked to consider proposals(the “Proposals”) (i)to elect two Class I directors, each to serve for a three-year term until the2005 annual meeting of stockholders and until his successor is duly elected andqualified; (ii) to ratify the selection of Deloitte & Touche LLP as theCompany’s independent auditors for the fiscal year ending December 31, 2002;and (iii) to consider and act upon any other matters that may properly bebrought before the annual meeting and any adjournments or postponements thereof.

 

With regard to the electionof directors, David L. Chapman and David W. Duehren were nominated to serve asClass I Directors of the Company until the 2005 annual meeting.  The other directors of the Company whose termsof office as directors continued after the Annual Meeting are as follows:  W. Brooke Tunstall (Class II Director),Robert G. Barrett (Class III Director) and Eric R. Giler (Class III Director).

 

Withrespect to the Proposals, the stockholders of the Company voted at the AnnualMeeting as hereinafter described.  By avote of 10,549,165 votes of Common Stock in favor of David L. Chapman, aplurality of the eligible votes, and 1,095,031 votes withheld for Mr. Chapman,Mr. Chapman was elected as a Class I Director of the Company.  By a vote of 10,978,752 votes of CommonStock in favor of David W. Duehren, a plurality of the eligible votes, and665,444 votes withheld for Mr. Duehren, Mr. Duehren was elected as a Class IDirector of the Company.

 

The stockholders of theCompany ratified and approved the selection of Deloitte & Touche LLP as theCompany’s independent auditors for the current fiscal year by a vote of11,523,898 votes in favor, in excess of a majority of eligible votes, with107,896 votes against and 12,402 votes abstaining.

 

**Item 6.  Exhibits andReports on Form 8-K**

                (a)Exhibits

 

99.1                           Certification of Chief Executive Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofSarbanes-Oxley Act of 2002.

 

99.2                           Certification of Chief Financial Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofSarbanes-Oxley Act of 2002.

 

(b)Reports on Form 8-K

      None.

 

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 **SIGNATURES**

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

 
|                         | BROOKTROUT, INC. |                                                                                                          |
|------------------------------|-----------------------|---------------------------------------------------------------------------------------------------------------|
|                         |                  |                                                                                                          |
|  Date: August 14,  2002 | By:                   | /s/ ERIC R.  GILER                                                                                            |
|                         |                  | Eric R. Giler

*President*

*(Principal  Executive Officer)*                                                  |
|                         |                  |                                                                                                          |
|  Date: August 14,  2002 | By:                   | /s/ ROBERT C.  LEAHY                                                                                          |
|                         |                  | Robert C. Leahy

*Vice  President of Finance and Operations*

*(Principal  Financial and Accounting Officer)* |
|                              |                       |                                                                                                               |  |

 

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**EXHIBIT INDEX**

 

99.1                           Certification of Chief Executive Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofSarbanes-Oxley Act of 2002.

 

99.2                           Certification of Chief Financial Officerpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 ofSarbanes-Oxley Act of 2002.

 

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