**SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

----

**FORM 10-Q**

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

**For the quarterly period ended September 30, 2001**

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

**For the transition period from ____ to ____**

**Commission File No. 000-20698**

**BROOKTROUT, INC.******(Exact name of registrant as specified in its charter) 

| **Massachusetts**                                                |   | **04-2814792**                            |
|------------------------------------------------------------------|--------|-------------------------------------------|
| (State  or other jurisdiction  of incorporation or organization) |   | (I.R.S.  employer  identification number) |
|                                                             |   |                                      |
| **250 First  Avenue, Suite 300**                            |   | **02494-2814**                            |
| **Needham,  Massachusetts**                                      |
| (Address  of principal executive offices)                        |   | (Zip  code)                               |

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

----

    Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

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

 

 

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

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

 

 

**Brooktrout, Inc.Unaudited Condensed ConsolidatedBalance Sheets (In thousands, except share data)**
|                                                                                                                                   |   | **September  30,  2001** |          | **December  31,  2000** |          |
|----------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------------|-------------------------|---------------|
|                                                                                                                                   |   |                     |          |                    |          |
| ASSETS                                                                                                                                 |   |                     |          |                    |          |
| Current assets:                                                                                                                        |   |                     |          |                    |          |
| Cash and equivalents                                                                                                                   |   | $                        | 28,092        |                    | $             | 23,294 |   |
| Marketable securities                                                                                                                  |   | 7,041                    |          | 2,693                   |          |
| Accounts receivable, net                                                                                                               |   | 8,426                    |          | 21,820                  |          |
| Inventory                                                                                                                              |   | 15,697                   |          | 19,609                  |          |
| Deferred tax assets                                                                                                                    |   | 6,047                    |          | 7,873                   |          |
| Prepaid expenses and other current assets                                                                                              |   | 4,869                    |          | 3,749                   |          |
| Total current assets                                                                                                                   |   | 70,172                   |          | 79,038                  |          |
|                                                                                                                                   |   |                     |          |                    |          |
| Equipment and furniture, less accumulated depreciation and  amortization                                                               |   | 5,795                    |          | 7,574                   |          |
| Deferred taxes                                                                                                                         |   | 4,361                    |          | 6,584                   |          |
| Intangible assets, less accumulated amortization                                                                                       |   | 9,872                    |          | 11,186                  |          |
| Investments                                                                                                                            |   | 6,597                    |          | 2,660                   |          |
| Other assets                                                                                                                           |   | 2,442                    |          | 2,171                   |          |
| Total assets                                                                                                                           |   | $                        | 99,239        |                    | $             | 109,213 |   |
|                                                                                                                                   |   |                     |          |                    |          |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                             |   |                     |          |                    |          |
|                                                                                                                                   |   |                     |          |                    |          |
| Current liabilities:                                                                                                                   |   |                     |          |                    |          |
| Accounts payable and other accruals                                                                                                    |   | $                        | 12,562        |                    | $             | 15,171 |   |
| Accrued compensation and commissions                                                                                                   |   | 3,488                    |          | 3,442                   |          |
| Customer deposits                                                                                                                      |   | 607                      |          | 558                     |          |
| Accrued warranty costs                                                                                                                 |   | 1,103                    |          | 1,499                   |          |
| Net liabilities related to discontinued operations                                                                                     |   | 914                      |          | 6,024                   |          |
| Total current liabilities                                                                                                              |   | 18,674                   |          | 26,694                  |          |
|                                                                                                                                   |   |                     |          |                    |          |
| Deferred rent                                                                                                                          |   | 251                      |          | 260                     |          |
| Contingencies (note 9)                                                                                                                 |   |                     |          |                    |          |
|                                                                                                                                   |   |                     |          |                    |          |
| Shareholders’ equity:                                                                                                             |   |                     |          |                    |          |
| Common stock, $0.01 par value; authorized, 40,000,000 shares; issued  and outstanding 12,426,028 shares in 2001 and 12,366,927 in 2000 |   | 124                      |     | 124                     |     |
| Additional paid-in capital                                                                                                             |   | 63,642                   |          | 63,348                  |          |
| Loans to officers                                                                                                                      |   | (11,760                  | )             | (11,760                 | )             |
| Accumulated other comprehensive loss                                                                                                   |   | (147                     | )             | (188                    | )             |
| Retained earnings                                                                                                                      |   | 32,215                   |          | 34,495                  |          |
| Treasury stock, 255,384 shares in 2001 and 2000                                                                                        |   | (3,760                   | )             | (3,760                  | )             |
| Total shareholders’ equity                                                                                                        |   | 80,314                   |          | 82,259                  |          |
| Total liabilities and shareholders’ equity                                                                                        |   | $                        | 99,239        |                    | $             | 109,213 |   |

See notes to unauditedcondensed consolidated financial statements.

**Brooktrout, Inc.Unaudited Condensed Consolidated Statements of Operations****(Inthousands, except per share data)**

 
|                                                      |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-----------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                      |   | **2001**                               |   | **2000**                              |   | **2001** |   | **2000** |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Revenue                                                   |   | $                                      | 17,213 |                                  | $      | 38,684 |   | $ | 62,120 |   | $ | 109,177 |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Cost and expenses:                                        |   |                                   |   |                                  |   |   |   |   |   |
| Cost of product sold                                      |   | 8,268                                  |   | 14,394                                |   | 27,912 |   | 40,279 |   |
| Research and development                                  |   | 5,171                                  |   | 6,045                                 |   | 16,365 |   | 17,442 |   |
| In-process research and development                       |   | -                                      |   | 2,550                                 |   | - |   | 2,550 |   |
| Selling, general and administrative                       |   | 7,661                                  |   | 9,358                                 |   | 25,135 |   | 29,017 |   |
| Total cost and expenses                                   |   | 21,100                                 |   | 32,347                                |   | 69,412 |   | 89,288 |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Operating income (loss)                                   |   | (3,887                                 | )      | 6,337                                 |   | (7,292 | ) | 19,889 |   |
| Other income (expense):                                   |   |                                   |   |                                  |   |   |   |   |   |
| Interest income, net                                      |   | 312                                    |   | 469                                   |   | 928 |   | 1,598 |   |
| Equity in loss of affiliates                              |   | (3,081                                 | )      | (596                                  | )      | (4,478 | ) | (1,996 | ) |
| Total other income (expense)                              |   | (2,769                                 | )      | (127                                  | )      | (3,550 | ) | (398 | ) |
| Income (loss) before income taxes                         |   | (6,656                                 | )      | 6,210                                 |   | (10,842 | ) | 19,491 |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Income tax provision (benefit)                            |   | (1,468                                 | )      | 2,372                                 |   | (2,489 | ) | 7,445 |   |
| Income (loss) from continuing operations                  |   | (5,188                                 | )      | 3,838                                 |   | (8,353 | ) | 12,046 |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Discontinued operations:                                  |   |                                   |   |                                  |   |   |   |   |   |
| Loss from discontinued operations, net of taxes           |   | —                                 |   | (5,993                                | )      | — |   | (12,349 | ) |
| Gain on disposal of discontinued operations, net of taxes |   | —                                 |   | —                                |   | 6,073 |   | — |   |
| Total gain (loss) from discontinued operations            |   | —                                 |   | (5,993                                | )      | 6,073 |   | (12,349 | ) |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Net loss                                                  |   | $                                      | (5,188 | )                                     | $      | (2,155 | ) | $ | (2,280 | ) | $ | (303 | ) |
| Income (loss) per common share:                           |   |                                   |   |                                  |   |   |   |   |   |
| Continuing operations, basic                              |   | $                                      | (0.43  | )                                     | $      | 0.32 |   | $ | (0.69 | ) | $ | 1.03 |   |
| Continuing operations, diluted                            |   | (0.43                                  | )      | 0.29                                  |   | (0.69 | ) | 0.94 |   |
| Net loss, basic                                           |   | (0.43                                  | )      | (0.18                                 | )      | (0.19 | ) | (0.03 | ) |
| Net loss, diluted                                         |   | $                                      | (0.43  | )                                     | $      | (0.16 | ) | $ | (0.19 | ) | $ | (0.02 | ) |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Shares for basic                                          |   | 12,171                                 |   | 12,030                                |   | 12,143 |   | 11,742 |   |
|                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Shares for diluted                                        |   | 12,171                                 |   | 13,147                                |   | 12,143 |   | 12,766 |   |

See notes to unauditedcondensed consolidated financial statements.

**Brooktrout, Inc.Unaudited Condensed Consolidated Statements of Comprehensive Income****(Inthousands)**

 
|                                                                  |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-----------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                  |   | **2001**                               |   | **2000**                              |   | **2001** |   | **2000** |   |
| Net loss                                                              |   | $                                      | (5,188 | )                                     | $      | (2,155 | ) | $ | (2,280 | ) | $ | (303 | ) |
| Unrealized gains (losses) on marketable securities                    |   | 11                                     |   | 9                                     |   | (133 | ) | (5 | ) |
| Foreign currency translation adjustment                               |   | 245                                    |   | (30                                   | )      | 130 |   | (100 | ) |
| Comprehensive loss before income tax benefit                          |   | (4,932                                 | )      | (2,176                                | )      | (2,283 | ) | (408 | ) |
| Income tax provision (benefit) related to items of comprehensive loss |   | 12                                     |   | 3                                     |   | (44 | ) | (2 | ) |
| Comprehensive loss                                                    |   | $                                      | (4,944 | )                                     | $      | (2,179 | ) | $ | (2,239 | ) | $ | (406 | ) |

 

See notes to unauditedcondensed consolidated financial statements.

**Brooktrout, Inc.Unaudited Condensed Consolidated Statements of Cash Flows****(Inthousands)**
|                                                                                     |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                     |   | **2001**                              |   | **2000** |   |
|                                                                                     |   |                                  |   |   |   |
| Cash flows from operating activities:                                                    |   |                                  |   |   |   |
| Net loss                                                                                 |   | $                                     | (2,280 | ) | $ | (303 | ) |
| Adjustments to reconcile net income to cash provided by (used in)  operating activities: |   |                                  |   |   |   |
| Gain on disposal of discontinued operations                                              |   | (6,073                                | )      | — |   |
| Depreciation and amortization                                                            |   | 4,209                                 |   | 4,646 |   |
| Equity in loss of affiliates                                                             |   | 4,478                                 |   | 610 |   |
| Non-cash compensation and warrants                                                       |   | —                                |   | 1,766 |   |
| Tax benefit of stock options                                                             |   | —                                |   | 1,562 |   |
| Minority interest                                                                        |   | —                                |   | (7,945 | ) |
| Deferred income taxes and other                                                          |   | (924                                  | )      | (508 | ) |
| Increase (decrease) in cash from:                                                        |   |                                  |   |   |   |
| Accounts receivable                                                                      |   | 13,394                                |   | (4,312 | ) |
| Inventory                                                                                |   | 3,912                                 |   | (15,273 | ) |
| Prepaid expenses and other current assets                                                |   | (1,056                                | )      | (1,427 | ) |
| Accounts payable and other accruals                                                      |   | (8,693                                | )      | 7,645 |   |
| Cash provided by (used in) operating activities                                          |   | 6,967                                 |   | (13,539 | ) |
|                                                                                     |   |                                  |   |   |   |
| Cash flows from investing activities:                                                    |   |                                  |   |   |   |
| Purchases of investments                                                                 |   | (1,525                                | )      | (3,574 | ) |
| Proceeds from the sale of a business segment                                             |   | 4,927                                 |   | — |   |
| Expenditures for equipment and furniture                                                 |   | (940                                  | )      | (4,642 | ) |
| Expenditures for acquired software                                                       |   | (455                                  | )      | (1,982 | ) |
| Purchases of marketable securities                                                       |   | (4,481                                | )      | (1,000 | ) |
| Other investing                                                                          |   | 11                                    |   | (444 | ) |
|                                                                                     |   |                                  |   |   |   |
| Cash used in investing activities                                                        |   | (2,463                                | )      | (11,642 | ) |
|                                                                                     |   |                                  |   |   |   |
| Cash flows from financing activities:                                                    |   |                                  |   |   |   |
| Proceeds from the sale of common stock                                                   |   | 294                                   |   | 4,767 |   |
| Proceeds from exercise of Interspeed options and warrants                                |   | —                                |   | 726 |   |
| Purchase of treasury stock                                                               |   | —                                |   | (311 | ) |
| Cash provided by financing activities                                                    |   | 294                                   |   | 5,182 |   |
| Increase (decrease) in cash and equivalents                                              |   | 4,798                                 |   | (19,999 | ) |
| Cash and equivalents, beginning of period                                                |   | 23,294                                |   | 48,541 |   |
| Cash and equivalents, end of period                                                      |   | $                                     | 28,092 |   | $ | 28,542 |   |

See notes to unauditedcondensed consolidated financial statements.

 

**Brooktrout, Inc.Notes to Unaudited Condensed Consolidated Financial Statements****(inthousands, except share and per share data)**

**1.  Summaryof Significant Accounting Policies and Practices**

**(a)Description of Business**

    Brooktrout, Inc. (the"Company" or "Brooktrout") delivers communications hardwareand software products that enable the development of applications ranging fromInternet Protocol ("IP") telephony and embedded voicemail to wirelessmessaging for the new global communications network. The Company sells itsproducts to system vendors, service providers, enterprise customers, originalequipment manufacturers ("OEMs"), and value-added resellers("VARs") through a direct sales force and a two-tiered distributionsystem.  The Company’s operations consist of one reportable operatingsegment, Brooktrout Technology, Inc. ("Brooktrout Technology"). Prior to February 8, 2001, the Company was organized and reported theresults of its operations in the following three business segments: BrooktroutTechnology, Brooktrout Software, Inc. ("Brooktrout Software"),and Interspeed, Inc. ("Interspeed").  Two of these segmentshave been classified as discontinued operations for the periods presented inthese condensed consolidated financial statements (see note 2).

**(b) Principlesof Consolidation and Basis of Presentation**

    The accompanying unauditedcondensed consolidated financial statements have been prepared by the Companypursuant to the rules and regulations of the Securities and ExchangeCommission regarding interim financial reporting. These unaudited condensedconsolidated financial statements should be read in conjunction with the auditedconsolidated financial statements included in the Company's Annual Report onForm 10-K, as amended, for the fiscal year ended December 31, 2000.

    In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements have been prepared on the same basis as the audited consolidatedfinancial statements and include all adjustments, consisting only of normalrecurring adjustments, necessary for a fair presentation of the interim periodspresented.

    The operating results forthe interim periods presented are not necessarily indicative of the resultsthat could be expected for the full year.

**(c) DiscontinuedOperations**

    The condensed consolidatedstatements of operations for periods prior to 2001 have been reclassified toseparately report the results of discontinued operations and the results ofcontinuing operations. Disclosures included herein pertain to the Company'scontinuing operations unless otherwise indicated (see note 2).

**(d) EarningsPer Share**

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

    For the three and ninemonths ended September 30, 2001 and 2000, the Company is utilizing income(loss) from continuing operations as the "control number" forpurposes of determining whether potential common shares are dilutive for allper share calculations in accordance with SFAS 128. As a result, the netincome (loss) per share in 2000 includes dilutive potential common shares inthe calculation, and net loss per share in 2001 excludes potential commonshares in the calculation.

 

    A reconciliation of weightedaverage shares used for the basic and diluted computations is as follows: 
|                                |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                |   | **2001**                               |   | **2000**                              |   | **2001** |   | **2000** |   |
| Weighted average shares for basic   |   | 12,171,000                             |   | 12,030,000                            |   | 12,143,000 |   | 11,742,000 |   |
| Dilutive effect of stock options    |   | —                                 |   | 1,117,000                             |   | — |   | 1,024,000 |   |
| Weighted average shares for diluted |   | 12,171,000                             |   | 13,147,000                            |   | 12,143,000 |   | 12,766,000 |   |

    Stock options to purchase2,323,183 shares and 132,700 shares were not included in the computation ofdiluted earnings per share in 2001 and 2000, respectively.  These options are excluded from thecalculation because to include them would have been antidilutive.

** (e) RecentAccounting Pronouncements**

    In June of 1998, theFinancial Accounting Standards Board released Statement of Financial AccountingStandards (SFAS) No. 133, "Accounting for Derivative Instruments andHedging Activities."  SFAS No. 133, as amended by SFASNo. 137, establishes new standards of accounting and reporting forderivative instruments and hedging activities. The Company adoptedSFAS No. 133, as amended, on January 1, 2001, and determined itseffect on the condensed consolidated financial statements to be immaterial.

    In June of 2001, the FinancialAccounting Standards Board issued SFAS No. 141, “Business Combinations"and SFAS No. 142, "Goodwill and Other Intangible Assets.” SFAS No. 141requires that all business combinations initiated after June 30, 2001 beaccounted for under the purchase method and addresses the initial recognitionand measurement of goodwill and other intangible assets acquired in a businesscombination.  For business combinations with an acquisition date beforeJuly 1, 2001 and that were accounted for using the purchase accounting method,any reclassifications between intangible assets and goodwill resulting from theimplementation of SFAS No. 141 will take place as of the date that SFAS No. 142is initially applied in its entirety.  SFAS No. 142 addresses the initialrecognition and measurement of intangible assets acquired outside of a businesscombination and the accounting for goodwill and other intangible assetssubsequent to their acquisition. SFAS No. 142 provides that intangible assetswith finite useful lives be amortized and that goodwill and intangible assetswith indefinite lives will not be amortized, but will rather be tested at leastannually for impairment.  Any impairment loss incurred subsequent toinitial adoption of SFAS No. 142 is recorded as a charge to current periodearnings.  SFAS No.142 is effective for fiscal years beginning afterDecember 15, 2001, with early adoption permitted for companies with fiscalyears beginning after March 15, 2001 if their first quarter financialstatements have not previously been issued.  The Company is currentlyevaluating the provisions of SFAS No. 141 and SFAS No. 142 and has not yetdetermined the effect that adoption of these standards will have on itsconsolidated financial statements.

  In August of 2001, the Financial AccountingStandards Board issued SFAS No. 144, “Accounting for Impairment or Disposal ofLong-Lived Assets.”  SFAS No. 144supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assetsand for Long–Lived Assets to be Disposed of,” and the accounting and reportingprovisions of APB Opinion No. 30, “Reporting the Results of Operations – Reportingthe Effects of Disposal of a Segment of a Business, and Extraordinary, Unusualand Infrequently Occurring Events and Transactions,” for the disposal of asegment of a business.  SFAS No. 144 iseffective for fiscal years beginning after December 15, 2001.  The Company is currently evaluating theprovisions of SFAS No. 144 and has not yet determined the effect that adoptionof the standard will have on its consolidated financial statements.

**2.  DiscontinuedOperations**

    On February 8, 2001,the Company adopted formal plans to discontinue its Brooktrout Software andInterspeed segments. Accordingly, the results of these segments are presentedas discontinued operations in the accompanying condensed consolidated financialstatements. At the time the formal plans were adopted, the Company estimatedthe cost to discontinue these businesses and accounted for these costs in thefinancial statements for the year ended December 31, 2000 in accordance withAPB Opinion No. 30 and Emerging Issues Task Force No. 95-18.

    On April 16, 2001, theCompany sold Brooktrout Software to eYak, Inc. ("eYak") forapproximately $4,927 in cash and 3,374,054 shares of eYak preferred stock,which represents approximately 6 percent of eYak's aggregate outstandingshares. The 3,374,054 shares of eYak preferred stock, which are not marketablesecurities, have been independently valued at $5,364 ($1.59 per share) and areclassified as a cost basis, long-term investment as of September 30,2001.  eYak was subsequently renamed Sonexis, Inc.

    The saleof Brooktrout Software resulted in a net gain on disposal of discontinuedoperations during the nine months ended September 30, 2001of $6,073, net oftaxes.

    As ofSeptember 30, 2001, the balance of net liabilities related to discontinuedoperations consists of $574 for accruals of expenses related to the sale ofBrooktrout Software, and $340 of liabilities associated with the Interspeedbusiness. 
|                                                                |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|---------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                |   | **2001**                               |   | **2000**                              |   | **2001** |   | **2000** |   |
|                                                                |   |                                   |   |                                  |   |   |   |   |   |
| Loss from discontinued operations per common  share:           |   |                                   |   |                                  |   |   |   |   |   |
| Basic                                                               |   | $                                      | — |                                  | $      | (0.50 | ) | $ | — |   | $ | (1.05 | ) |
| Diluted                                                             |   | —                                 |   | (0.46                                 | )      | — |   | (0.97 | ) |
|                                                                |   |                                   |   |                                  |   |   |   |   |   |
| Gain on disposal of discontinued operations per  common share: |   |                                   |   |                                  |   |   |   |   |   |
| Basic                                                               |   | $                                      | — |                                  | $      | — |   | $ | 0.50 |   | $ | — |   |
| Diluted                                                             |   | —                                 |   | —                                |   | 0.50 |   | — |   |

**3.** ** Accountsreceivable**

     Accountsreceivable balances are net of allowance for doubtful accounts and allowancefor sales returns of the following:
|                            |   | **September 30,  2001** |   | **December 31,  2000** |   |
|---------------------------------|--------|-------------------------|--------|-----------------------------|--------|
| Allowance for doubtful accounts |   | $                       | 1,939  |                        | $      | 1,617 |   |
| Allowance for sales returns     |   | 982                     |   | 1,030                       |   |
| Total                           |   | $                       | 2,921  |                        | $      | 2,647 |   |

 

 

 

**4.** ** Inventory**

     Inventory is carriedat the lower of cost or market, on a first-in first-out basis, and consisted ofthe following: 
|            |   | **September 30, 2001** |   | **December 31,  2000** |   |
|-----------------|--------|------------------------|--------|-----------------------------|--------|
| Raw materials   |   | $                      | 3,351  |                        | $      | 3,008 |   |
| Work in process |   | 754                    |   | 1,576                       |   |
| Finished goods  |   | 11,592                 |   | 15,025                      |   |
| Total           |   | $                      | 15,697 |                        | $      | 19,609 |   |

**5.  IncomeTaxes**

     The Company's taxprovision in 2001 is based on the estimated effective tax rate for the fullyear. The Company's effective tax rate on continuing operations, excluding theeffect of non-deductible equity in loss of affiliates, was 39% for the ninemonths ended September 30, 2001.

**6.  Investments**

    Investments includeinvestments in Pelago Networks, Inc. ("Pelago", formerly knownas Beacon Networks, Inc.) and Telchemy, Inc. ("Telchemy"),which are accounted for under the equity method.  The Company's ownershipinterest in Pelago and Telchemy was approximately 28% and 25%, respectively, asof September 30, 2001.  Investments also includes two investments recordedunder the cost method with a carrying amount of $6,364 as of September 30,2001.

    During the first quarter of2000, the Company owned 100% of Pelago and accounted for its investment underthe consolidation method. As a result of the subsequent issuance of Pelagoshares in an equity financing on June 29, 2000, the Company's ownershippercentage in Pelago was reduced to 28%. Accordingly, the Company accounts forits investment under the equity method of accounting beginning in the secondquarter of 2000.

    In 2001, the Company’s Boardof Directors authorized an equity investment of up to $3,050 in one or moretranches, in Pelago. On August 6, 2001, the Company purchased 1,525,000preferred shares for $1,525.  A second tranche was committed to inSeptember 2001 and closed on October 2, 2001. The Company purchased anadditional 1,525,000 preferred shares for $1,525.  In applying the equity method for the quarter and nine monthsended September 30, 2001, the Company included in its investment account itscommitment to purchase the additional shares on October 2, 2001.  Accordingly, in that such investments fundedpast losses incurred by Pelago, Brooktrout recorded a charge of $2,818.  The Company’s percentage ownership did notchange as a result of these transactions. The carrying amount of the Company’s investment in Pelago as ofSeptember 30, 2001 is $232.

    TheCompany’s investment in Telchemy has been written down to zero as of September30, 2001 as the Company has absorbed its proportional share of losses of thisentity.  The Company has no furthercommitments relative to Telchemy and, accordingly, has ceased recording itsequity in Telchemy’s losses.

**7. SegmentReporting**

    The Company's continuingoperations represent one reportable operating segment, Brooktrout Technology,which provides enabling technologies that allow customers to deliver voice, faxand data solutions for the electronic communications market.  The rapidevolution of the world's telecommunication systems has created important marketopportunities for the Company. One opportunity consists of core technologiesand platforms primarily for business premise products such as fax, LanFax, andvoice mail—Today's Network.  Another opportunity—the New NetworkTM—is theresult of the global investments that are being made to expand the capabilitiesof today's communication networks. These new capabilities allow data, voice,and fax information to be distributed using packet-based data networks, such asthe Internet, for portions of the transmission and also allow such informationto be distributed using the traditional circuit switched telephone network.

*    ProductSales*—Brooktrout Technology groups its product sales based on theirapplications in the New NetworkTM and their applications in Today's Network. Forthe three months ended September 30, 2001, sales of products for use in the NewNetwork accounted for approximately 36% of total revenue as compared to 64% oftotal revenue for the same period in the prior year.  For the nine monthsended September 30, 2001, sales of products for use in the New Networkaccounted for approximately 42% of total revenue compared to 60% of totalrevenue for the same period in the prior year.

*    MajorCustomers—*One customer accounted for approximately 16% and 6%of revenue for the three months ended September 30, 2001 and September 30,2000, respectively.  A different customer accounted for 26% of revenue forthe quarter ended September 30, 2000; however, this customer representedapproximately 1% of revenue in the quarter ended September 30, 2001.  Thetwo above-mentioned customers accounted for approximately 12% and 9% of revenuerespectively for the nine months ended September 30, 2001, and 6% and 21% ofrevenue respectively, for the nine months ended September 30, 2000.

*    InternationalSales—*International sales, principally exports from the United States,accounted for approximately 23% and 15% of revenue for the three months endedSeptember 30, 2001 and September 30, 2000, respectively.  Internationalsales accounted for approximately 20% and 16% of revenue for the nine monthsended September 30, 2001 and September 30, 2000, respectively.

    Prior to the Company’sFebruary 8, 2001 decision to discontinue its Brooktrout Software andInterspeed segments, the Company was organized and reported the results of itsoperations in the following three business segments: Brooktrout Technology, BrooktroutSoftware and Interspeed (see note 2).

**8. Line ofCredit**

    The Company is currentlynegotiating a renewal of its working capital line of credit. Under the renewedline of credit, the Company will be able to borrow up to $5,000 on a securedbasis, all of which could be used for issuance of letters of credit, subject tocompliance with certain covenants. Any amounts borrowed under the line ofcredit will be subject to interest at the lender's prime rate.  TheCompany may issue letters of credit against the bank line from time to time inthe ordinary course.  As of September30, 2001, outstanding letters of credit issued against the Company’s existingline amount to $1,000 and relate to the collateralizing of certain leasecommitments.

**9. Contingencies**

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

**10. Purchaseof In-Process Research and Development**

    The Company recorded aone-time charge of $2,550 in 2000 for the purchased research and developmentrights in STS-1 technology, which has not yet reached technologicalfeasibility, has no alternative future use, and for which successfuldevelopment is uncertain.  During thequarter ended September 30, 2001, the Company ceased development of the productfor which this technology was originally intended.  The Company will seek to utilize certain elements of thein-process STS-1 technology in future research and development efforts where itis deemed feasible.

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

**Results ofOperations**

*SafeHarbor Statement Under the Private Securities Litigation Reform Act of 1995*

    This Quarterly Reportcontains certain statements that are "forward-looking statements" asthat term is defined under the Private Securities Litigation Reform Act of 1995and releases issued by the Securities and Exchange Commission. The words"believes," "expects," "anticipates,""intends," "estimates" and other expressions that arepredictions of or indications of future events and trends and that do notrelate to historical matters, identify forward-looking statements. You shouldnot rely on forward-looking statements because they involve known and unknownrisks, uncertainties and other factors, some of which are beyond the control ofBrooktrout, Inc. (the "Company" or "Brooktrout"),which may cause the actual results, performance or achievements of the Companyto differ materially from anticipated future results, performance orachievements expressed or implied by such forward-looking statements. Theseforward-looking statements were based on information, plans, and estimates atthe date of this document and the Company undertakes no obligation to updateany forward-looking statement, whether as a result of new information, futureevents or otherwise.

    The future operating resultsand performance trends of the Company may be affected by a number of factors,including, without limitation, risks related to the following: (i) thecurrent telecommunications market slowdown and its impact on our customers'business and financial strength; (ii) the uncertainties relating to recentglobal events; (iii) uncertainties regarding the future value of and thelack of liquidity of the Sonexis, Inc. (formerly known as eYak, Inc.)stock received in connection with the sale of Brooktrout Software;(iv) the Company's historical dependence on a small number of customers;(v) market growth, market acceptance of the Company's products and productdemand; (vi) rapid changes in technology and the ability to keep pace withthe evolution of the telecommunications hardware and software market;(vii) the impact of competition; and (viii) the impact of changes toregulations affecting the telecommunications and Internet industries. Inaddition to the foregoing, the Company's actual future results could differmaterially from those projected in the forward-looking statements as a resultof the risk factors set forth herein and in the Company's various filings withthe Securities and Exchange Commission and of changes in general economicconditions and changes in the assumptions used in making such forward-lookingstatements.

**Introduction**

    Brooktrout deliverscommunications hardware and software products that enable the development ofapplications ranging from Internet Protocol ("IP") telephony andembedded voicemail to wireless messaging for the new global telecommunicationsnetwork. The Company's strategy is to collaborate with its partners to helpthem increase existing business, expand into new markets and accelerate the deliveryof new applications and services. The Company sells its products to systemvendors, service providers, enterprise customers, original equipmentmanufacturers ("OEMs"), and value-added resellers ("VARs"),both domestically and internationally, through a direct sales force and atwo-tiered distribution system.

    The rapid evolution of theworld's telecommunications systems has created important market opportunitiesfor the Company. One opportunity involves core technologies and platforms thatare primarily used in business premise products such as fax, LanFax, and voicemail—Today's Network.   Another opportunity—the New NetworkTM—is theresult of the global investments that are being made to expand the capabilitiesof today's communications networks. These new capabilities allow data, voiceand fax information to be distributed using packet-based data networks, such asthe Internet, for portions of the transmission and also allow such informationto be distributed using the traditional circuit-switched telephone network.

    Prior to February 8,2001, the Company was organized and reported the results of its operations inthree operating segments, Brooktrout Technology, Inc. ("BrooktroutTechnology"), Brooktrout Software, Inc. ("BrooktroutSoftware"), and Interspeed, Inc. ("Interspeed"). OnFebruary 8, 2001, the Company's Board of Directors adopted formal plans todiscontinue its Brooktrout Software and Interspeed segments. Accordingly, theCompany has reclassified the accompanying condensed consolidated financialstatements to reflect the discontinuance of these two segments. (Seenote 1(c) and note 2 to the condensed consolidated financialstatements). The following discussion focuses on the Company's results fromcontinuing operations; the historical information presented has been revised toconform to the reclassified condensed consolidated financial statementpresentation.

**Three Months Ended September 30,2001 and 2000*****(inthousands except share and per share data)***

    Revenue during the threemonths ended September 30, 2001 decreased by approximately 56% to $17,213, downfrom $38,684 for the three months ended September 30, 2000. The decline inrevenue resulted primarily from the overall economic slowdown in the UnitedStates and international economies and the resulting softening in thetelecommunications market. The slowdown the Company is experiencing extendsacross most product lines and markets, though sales of products forapplications in the New Network, specifically those sold to OEM’s for use bylarge service providers, have declined most significantly.  Duringthe three months ended September 30, 2001, sales of products for applicationsin the New Network accounted for approximately 36% of total revenue, ascompared to 64% of total revenue for the same period in 2000.

    Revenue from one customeraccounted for approximately 16% of total revenue in the current quartercompared to 6% for this same customer in the prior year.  The Companyexpects that revenue from this customer will continue to be significant as apercentage of total revenue for the foreseeable future.  A differentcustomer, one typically considered a New Network customer, represented 26% ofsales during the three months ended September 30, 2000; however, revenue fromthis customer represented approximately 1% of total revenue for the threemonths ended September 30, 2001. For the foreseeable future, the Companyexpects that revenue from this customer will continue to be significantly lessthan that of prior comparative periods.

    Cost of product sold was$8,268, or 48% of revenue, for the three months ended September 30, 2001,compared to $14,394, or 37% of revenue, for the quarter ended September 30,2000. The lower gross margin during the three months ended September 30, 2001 wasprimarily due to decreased sales volumes across most product lines, especiallythose of New Network products that tend to have higher gross margins. Increases in other costs of product sold, principally reserves for inventoryobsolescence, also contributed to lower gross margins for the three monthsended September 30, 2001.

    Research and developmentexpense was $5,171 or 30% of revenue, compared with $6,045 or 16% of revenue,for the three months ended September 30, 2001 and 2000, respectively. The dollardecrease when compared to the same period in the prior year is primarilyattributable to decreased spending on temporary help, contract labor, and to alesser extent expendable materials and supplies. The Company's continuingdevelopment efforts are focused on its switching and access products that allowcustomers to create the infrastructure to support the New Network; messagingproducts that allow integration of voice, fax and e-mail into one location; andIP telephony products.  The Companyintends to continue to commit significant resources to product development.

    OnSeptember 29, 2000, the Company acquired rights to certain in-processtechnology that, upon completion, was intended to result in a single CompactPCIcircuit board that would provide an STS-1 interface that would be capable ofhandling 28 T1 links (672 voice channels) and echo cancellation.  The Company recorded a one-time charge of$2,550 for the purchased research and development rights in the STS-1 project,which has not yet reached technological feasibility, has no alternative futureuse, and for which successful development is uncertain.  During the quarter ended September 30, 2001,the Company ceased development of the product for which this technology wasoriginally intended.  The Company willseek to utilize certain elements of the in-process STS-1 technology in futureresearch and development efforts where it is deemed feasible.

    Selling, general andadministrative expense was $7,661 or 45% of revenue, compared with $9,358 or24% of revenue, for the three months ended September 30, 2001 and 2000,respectively.  The decline in dollar expense is primarily the result ofreduced spending for sales commissions and other incentive compensation,temporary help, discretionary travel, and expendable materials and supplies.

    Other income (expense) was$(2,769) compared to other income (expense) of $(127) for the three monthsended September 30, 2001 and September 30, 2000, respectively. During the threemonths ended September 30, 2001, the Company recognized equity in loss ofaffiliates of $3,081 related to its investment in Pelago Networks, Inc.(“Pelago”) and Telchemy, Inc. (“Telchemy”).  Equity in loss ofaffiliates recognized during the three months ended September 30, 2000 was $596and related exclusively to Pelago. The Company anticipates that equity inlosses of affiliates in the fourth quarter of 2001 will be limited to thecarrying amount of Pelago on the balance sheet as of September 30, 2001,amounting to $232.  In addition,interest income, net was $312 for the three months ended September 30, 2001 ascompared with $469 for the same period in 2000, reflecting lower short-terminterest rates.

    The Company's effective taxrate for continuing operations, excluding the effect of non-deductible equitylosses in affiliates, was 41% for the quarter ended September 30, 2001, basedon the estimated effective rate for the full year.

**Nine Months Ended September 30,2001 and 2000*****(inthousands except share and per share data)***

    Revenue during the ninemonths ended September 30, 2001 decreased by approximately 43% to $62,120, downfrom $109,177 for the nine months ended September 30, 2000. The decline inrevenue resulted primarily from the overall economic slowdown in the United Statesand international economies and the resulting softening in thetelecommunications market. The slowdown the Company is experiencing extendsacross most product lines and markets, though sales of products forapplications in the New Network, specifically those sold to OEM’s for use bylarge service providers, have declined most significantly.  Duringthe nine months ended September 30, 2001, the sales of products forapplications in the New Network accounted for approximately 42% of total revenue,as compared to 60% of total revenue for the same period in 2000.

    Revenue from one customeraccounted for approximately 12% of total revenue for the nine months endedSeptember 30, 2001, compared to 6% from this same customer for the same periodin the prior year.  The Company expects that revenue from this customerwill continue to be significant as a percent of total revenue for theforeseeable future.  A different customer, one typically considered a NewNetwork customer, represented 9% of sales during the nine months endedSeptember 30, 2001, and 21% of revenue for the same period in 2000. For theforeseeable future, the Company expects that revenue from this customer willcontinue to be significantly less than that of prior comparative periods.

    Cost of product sold was$27,912, or 45% of revenue, for the nine months ended September 30, 2001,compared to $40,279, or 37% of revenue, for the nine months ended September 30,2000. The lower gross margin in the nine months ended September 30, 2001 wasprimarily due to decreased sales volumes across most product lines, especiallythose of New Network products that tend to have higher gross margins. Increases in other costs of product sold, principally reserves for inventoryobsolescence, also contributed to lower gross margins for the nine months endedSeptember 30, 2001.

    Research and developmentexpense was $16,365 or 26% of revenue, compared with $17,442 or 16% of revenue,for the nine months ended September 30, 2001 and 2000, respectively. The dollardecrease when compared to the same period in the prior year is primarilyattributable to decreased spending for contract labor, temporary help, andexpendable materials and supplies.  The Company's continuingdevelopment efforts are focused on its switching and access products that allowcustomers to create the infrastructure to support the New Network; messagingproducts that allow integration of voice, fax and e-mail into one location; andIP telephony products. The Company intends to continue to commit significantresources to product development.

    OnSeptember 29, 2000, the Company acquired rights to certain in-processtechnology that, upon completion, was intended to result in a single CompactPCIcircuit board that would provide an STS-1 interface that would be capable ofhandling 28 T1 links (672 voice channels) and echo cancellation.  The Company recorded a one-time charge of$2,550 for the purchased research and development rights in the STS-1 project,which has not yet reached technological feasibility, has no alternative futureuse, and for which successful development is uncertain.  During the quarter ended September 30, 2001,the Company ceased development of the product for which this technology wasoriginally intended.  The Company willseek to utilize certain elements of the in-process STS-1 technology in futureresearch and development efforts where it is deemed feasible.

    Selling, general andadministrative expense was $25,135 or 40% of revenue, compared with $29,017 or27% of revenue, for the nine months ended September 30, 2001 and 2000,respectively.  The decline in dollar expense is primarily the result ofreduced spending for sales commissions and other incentive compensation,professional fees, advertising, temporary help, discretionary travel, andexpendable materials and supplies.

    Other income (expense) was$(3,550) compared to other income (expense) of $(398) for the nine months endedSeptember 30, 2001 and September 30, 2000, respectively. During the nine monthsended September 30, 2001, the Company recognized equity in loss of affiliatesof $4,478 related to its investments in Pelago and Telchemy.  Equity inlosses of affiliates recognized during the nine months ended September 30, 2000were $1,996 and related exclusively to Pelago.  In addition, interestincome, net was $928 for the nine months ended September 30, 2001 as comparedwith $1,598 for the same period in 2000, reflecting lower short-term interestrates.

    The Company's effective taxrate for continuing operations, excluding the effect of non-deductible equitylosses in affiliates, was 39% for the nine months ended September 30, 2001,based on the estimated effective rate for the full year.

**Liquidityand Capital Resources*****(inthousands, except share and per share data)***

    For the nine months endedSeptember 30, 2001, the Company funded its operations principally through cashreceived from customers. Working capital decreased to $51,498 at September 30,2001 from $52,344 at December 31, 2000, primarily due to lower accountsreceivable and inventory balances, partially offset by lower accounts payableand other current liabilities. Cash generated by operating activities for thenine months ended September 30, 2001 was approximately $6,967 and was primarilygenerated through the reduction of accounts receivable.

    The Company is currentlynegotiating a renewal of its working capital line of credit. Under the renewedline of credit, the Company will be able to borrow up to $5,000 on a securedbasis, all of which could be used for issuance of letters of credit, subject tocompliance with certain covenants. Any amounts borrowed under the line ofcredit will be subject to interest at the lender's prime rate.  TheCompany may issue letters of credit against the bank line from time to time inthe ordinary course.  As of September30, 2001, outstanding letters of credit issued against the Company’s existingline amount to $1,000 and relate to the collateralizing of certain leaseobligations.

    During the nine months endedSeptember 30, 2001, the Company purchased approximately $940 in equipment. TheCompany currently has no material commitments for additional capitalexpenditures.    The pricing of the Company's products and costs of itsgoods are generally determined by current market conditions. Market conditionscan be impacted by inflation; however, the Company believes that inflation hasnot had a significant effect on its operations to date.

    The Company has operatinglease commitments for its office and manufacturing facilities expiring through2006. Certain lease agreements require the Company to pay all of the building'staxes, insurance and maintenance costs.

    On April 16, 2001, theCompany sold Brooktrout Software to eYak, Inc. ("eYak"), a privatelyheld company, for approximately $4,927 in cash and 3,374,054 shares of eYakpreferred stock, which represent approximately 6 percent of eYak's aggregateoutstanding shares. The sale of Brooktrout Software resulted in a gain of$6,073, net of a provision for income taxes of $5,017, during the nine monthsended September 30, 2001.  eYak was subsequently renamed Sonexis.

    The Company’s Board of Directorsauthorized an equity investment of up $3,050, in one or more tranches, inPelago.   On August 6, 2001, the Company purchased 1,525,000preferred shares for $1,525.  A second tranche was committed to inSeptember 2001 and closed on October 2, 2001. The Company purchased anadditional 1,525,000 preferred shares for $1,525.  In applying the equity method for the quarter and nine monthsended September 30, 2001, the Company included in its investment account itscommitment to purchase the additional shares on October 2, 2001.  Accordingly, in that such investments fundedpast losses incurred by Pelago, Brooktrout recorded a charge of $2,818.  The Company has no further financingobligations with respect to Pelago or any other of its investments.

    The Company anticipates thatcurrent cash and marketable securities balances, together with revenues andfunds available under the Company's renewed line of credit, will be sufficientto meet the Company's working capital and capital equipment expenditurerequirements for the next twelve months.

**Risk Factors**

***The Company's operating results arelikely to fluctuate significantly and cause the Company's stock price to bevolatile, which could cause the value of your investment to decline.***

    The Company's operatingresults are likely to fluctuate in the future due to a variety of factors, manyof which 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 todevelop, manufacture, market and support its products and product enhancements;

• the timing and number oforders for the Company's products, which are generally weighted more heavilytoward the last month of each quarter;

• cancellation orrescheduling of orders for the Company's products;

• the Company's ability tohire, train and retain key management, sales and marketing and engineeringpersonnel;

• announcements ortechnological innovations by the Company's competitors or in competingtechnologies;

• the Company's ability toobtain sufficient supplies of sole or limited source components for theCompany's products;

• conditions in the domesticor global economy generally, and in the telecommunications industryspecifically;

• a decrease in the demandfor the Company's stock;

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

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

• the mix of products thatthe Company sells and the mix of distribution channels through which they aresold.

    Due to these and otherfactors, revenue, expenses and results of operations could vary significantlyin the future, and period-to-period comparisons should not be relied upon asindications of future performance.

***The Company is exposed to generaleconomic conditions, and the slowdown in some sectors of the telecommunicationsindustry in particular.***

    As a result of recentunfavorable economic conditions affecting most technology sectors and thetelecommunications sector in particular, many of our customers are aggressivelyincreasing efficiency in their supply chains and reducing inventory levels.Additionally, we expect the growth of data traffic and the use of the Internetwill continue to have a significant impact on traditional voice networks, whichis driving the convergence of data and telephony and giving rise to the demandfor New Network applications. We cannot be sure what the rate of such convergencewill be due to the slowdown in the communications industry and the resultingdecrease in spending by our customers. The current economic conditions haveadversely impacted the Company’s business and operating results.  If theeconomic conditions worsen or if a wider economic slowdown occurs, the Companymay experience a material adverse impact on its business, operating results,and financial condition.

***The Company has historically derivedthe majority of its revenue from a small number of customers.***

    The Company's failure togenerate as much revenue as expected from what has historically been arelatively small number of customers or the failure of these customers topurchase the Company's products could seriously harm the Company's business. Forthe quarter ended September 30, 2001, one customer accounted for approximately16% of the Company's revenue. A different customer accounted for 26% of revenuefor the quarter ended September 30, 2000; however, this customer representedless than 1% of revenue in the quarter ended September 30, 2001.  Thedecline in expected revenue from this customer, as well as the loss of any oneof the Company's other major customers or the delay of significant orders fromsuch customers, even if only temporary, has or could reduce or delay theCompany's revenue, could harm the Company's reputation in the industry andcould reduce the Company's ability to accurately predict cash flow, and, as aconsequence, could seriously harm the Company's business, financial conditionand results of operations.

    Present and future customersmay also terminate their purchasing arrangements with the Company,significantly reduce or delay their orders or seek to renegotiate theiragreements on terms less favorable to the Company. Furthermore, in any futurenegotiations, the Company may be subject to the perceived or actual leveragethe customers may have, given their relative size and importance to theCompany. Any termination, change, reduction or delay in orders could seriouslyharm the Company's business, financial condition and results of operations.Accordingly, unless and until the Company can diversify and expand its customerbase, the Company's future success will significantly depend upon the timingand size of future purchases by the Company's largest customers and thefinancial and operational success of these customers.

***The telecommunications markets arehighly competitive, and the Company may not be able to compete successfullyagainst new entrants and established companies with greater resources.***

    The market fortelecommunications equipment is highly competitive. If the Company is unable todifferentiate its products from existing and future offerings of itscompetitors, and thereby effectively compete in the market for telecommunicationsequipment, the Company's results of operations could be materially adverselyaffected. Many of the Company's current and potential competitors havesignificantly greater selling and marketing, technical, manufacturing,financial, and other resources. Moreover, the Company's competitors may havegreater access to components necessary to manufacture their products. Thestrength and capabilities of the Company's competitors may be increased as aresult of the trend toward consolidation in the telecommunications market.Capitalizing on and maintaining the Company's technological advantage willrequire a continued high level of investment in research and development,marketing and customer service and support. Due to the rapidly evolving marketsin which the Company competes, additional competitors with significant marketpresence and financial resources may enter those markets, thereby furtherintensifying competition. The Company may not have sufficient resources tocontinue to make the investments or achieve the technological advancesnecessary to 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'scustomers, including the large OEMs on which the Company focuses asignificant portion of its sales and marketing efforts, have the technical andfinancial ability to design and produce components replicating or improving onthe functionality of most of the Company's products. These customers oftenconsider in-house development of technologies and products as an alternative todoing business with the Company. The Company cannot assure you that itsexisting customers or potential customers will do business with the Company,rather than attempting to develop similar technology and products internally orobtaining them through acquisition. The Company cannot be certain that it willbe able to find customers to replace the revenue lost as a result of customersdeveloping technologies or products in-house. Any such occurrence could have amaterial adverse effect on the Company's business, financial condition orresults of operations.

***Unless the Company is able to keeppace with the evolution of the telecommunications hardware and software market,the Company's business may be adversely impacted.***

    The telecommunicationshardware and software market is characterized by:

• rapid technologicaladvances:

• evolving industrystandards;

• changes in customerrequirements;

• frequent new productintroductions;

• intense competition; and

• evolving offerings bytelecommunications service providers.

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

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

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

    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 the Company's products orproblems arising from the use of its products may seriously harm its businessand reputation.***

    Products as complex as theCompany's may contain known and undetected errors or performance problems.Defects are frequently found during the period immediately followingintroduction and initial implementation of new products or enhancements toexisting products. Although the Company attempts to resolve all errors that itbelieves would be considered serious by its customers before implementation,the Company's products may not be error-free. The Company also provideswarranties against defects in materials and workmanship on its hardwareproducts for five years. However, errors or performance problems could resultin lost revenue or customer relationships and could be detrimental to theCompany's business and reputation generally. Additionally, reduced marketacceptance of the Company's services due to errors or defects in its technologywould harm its business by reducing its revenue and damaging its reputation. Inaddition, the Company's customers generally use its products together withtheir own products and products from other vendors. As a result, when problemsoccur, it may be difficult to identify the source of the problem. Theseproblems may cause the Company to incur significant warranty and repair costs,divert the attention of its engineering personnel from the Company's productdevelopment efforts and cause significant customer relations problems. To date,defects in the Company's products or those of other vendors' products withwhich its products are used by its customers have not had a material adverseeffect on its business. However, the Company cannot be certain that defectswill not materially adversely affect the Company’s business in the future.

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

    Laws and regulationsgoverning telecommunications, electronic commerce and the Internet arebeginning to emerge, but remain largely unsettled, even in the areas wherethere has been some legislative action. Regulation may focus on, among otherthings, assessing access or settlement charges, or imposing tariffs orregulations based on the characteristics and quality of products and services,either of which could restrict the Company's business or increase its cost ofdoing business. Any changes to existing laws or the adoption of new regulationsby federal or state regulatory authorities or any legal challenges to existinglaws or regulations relating to the telecommunications industry couldmaterially adversely affect the market for the Company's products. Moreover,the Company's VARs or other customers may require, or the Company may otherwisedeem it necessary or advisable, that the Company alter its products to addressactual or anticipated changes in the regulatory environment. The Company'sinability to alter its products or address any regulatory changes could have amaterial adverse effect on its business, financial condition or results ofoperations.

***Provisions in the Company'scorporate charter may discourage takeover attempts and, thus, depress themarket price of the 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.                                                           |

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

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

    The Company's success andits ability 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 forunauthorized third parties to copy or reverse engineer aspects of the Company'sproducts, 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 againstthe Company 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. Although the Company believes that it does not face material liability relatedto infringement of the intellectual property of others, any claims assertingthat the Company's products infringe or may infringe proprietary rights ofthird parties, if determined adversely to the Company, could have a materialadverse effect on its business, financial condition or results of operations.Any claims, 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 affect 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 intellectualproperty rights of those parties claiming the infringement. In the event aclaim against the Company was successful, and it could not obtain a license onacceptable terms or license a substitute technology or redesign to avoidinfringement, the Company may be unable to market its affected products. Thiscould have a material adverse effect on the Company's business, financialcondition and results of operations.

***Certain of the Company's productsdepend upon the continued availability of licensed technology from thirdparties.***

    The Company currentlylicenses and will continue to license certain technology integral to certain ofits products 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.

    TheCompany may require new licenses in the future as its business grows andtechnology evolves. The Company cannot assure you that these licenses willcontinue to be available to it on commercially reasonable terms, if at all,which could have a material adverse effect on the Company's business, financialcondition and results of operations.

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

    The Company's successdepends in large part upon the continued contributions of its key management,sales and marketing, and engineering personnel, many of who perform importantfunctions and would be difficult to replace. The Company does not haveemployment contracts with its key personnel. There is intense competition inthe Company's industry for qualified personnel, and, at times, the Company hasexperienced difficulty in recruiting qualified personnel. The Company may notbe able to attract and retain the necessary personnel to accomplish itsbusiness objectives, and it may experience constraints that will adverselyaffect its ability to satisfy customer demand in a timely fashion or to supportits customers and operations. The Company's inability to hire qualifiedpersonnel on a timely basis, or to retain its key personnel, could materiallyadversely affect the Company's business, financial condition and results ofoperations.

***The Company's products typicallyhave long sales cycles, causing the Company to expend significant resourcesbefore recognizing 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 its customerscompete may cause prospective customers to delay their purchase decisions asthey evaluate new technologies and develop and implement new systems. Duringthe period in which the Company's customers are evaluating whether to place anorder with the Company, it often incurs substantial sales and marketingexpenses, without any assurance of future orders or their timing. Even after acustomer places an order with the Company and its product is expected to beutilized in a product or service offering being developed by our customer, thetiming of the development, introduction and implementation of those products iscontrolled by, and can vary significantly with the needs of, the Company'scustomers. In some circumstances, the customer will not require the product forseveral months. This complicates the Company's planning processes and reducesthe predictability of the Company's earnings.

***The Company derives a significantportion of its revenue from international sales; international businessoperations entail additional risks.***

    Risks arising from theCompany's international business include currency fluctuation, politicalinstability in other countries, the imposition of trade and tariff regulationsby foreign governments, and the difficulties in managing operations acrossdisparate geographic areas. In addition, most countries require technicalapprovals from their telecommunications regulatory agencies for products thatoperate in conjunction with the telephone system. Obtaining these approvals isgenerally a prerequisite for sales in a given jurisdiction. Obtaining requisiteapprovals may require from two months to a year or more depending on theproduct and the jurisdiction. These or other factors may limit the Company'sability to sell its products and services in other countries, which could havea material adverse effect on the Company's business, financial condition andresults of operations.

**ITEM 3.****  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

    On November 1, 2001, theCompany began invoicing its European customers in Euros, and therefore will beexposed to changes in foreign currency exchange rates that may adversely affectits results of operations and financial position. In order to minimize thepotential adverse impact, the Company anticipates the use of foreign currencyforward contracts to hedge this currency exchange rate risk. The Company doesnot utilize financial instruments for trading or other speculative purposes,nor does it utilize leveraged financial instruments.  Any gains or losses on the foreign currency contracts will belargely offset by the gains or losses on the underlying foreign currency assetsand liabilities and consequently a sudden or significant change in foreigncurrency exchange rates would not have a material impact on the Company’sfuture net income or cash flows.

    Certain of the Company’sinvestments are minority equity investments in privately held high-technologycompanies, many of which can still be considered in the start-up or developmentstages. These investments are inherently risky as the market for thetechnologies or products that they have under development are typically in theearly stages and may never materialize. Given the uncertainty of the success ofthese high-tech companies, in the future the Company could be required torecord impairment charges against these investments, though currently noinformation has come to the Company’s attention that would lead it to believeany such impairment exists.

    Readers are referred to theCompany’s Annual Report on Form 10-K, as amended, for the year ended December31, 2000 for additional information.

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

**Item 1.****  Legal Proceedings**

   In October 2000, severalshareholder class action complaints were filed in the United States DistrictCourt for the District of Massachusetts (the "Court") by certainshareholders of Interspeed and of the Company. Certain of the complaints named,among others, the Company and certain of its current directors and certain currentand former officers as defendants. The lawsuits were filed after Interspeed'sOctober 6, 2000 announcement that it would be restating its unauditedfinancial results for certain prior quarters of its fiscal year 2000. Thecomplaints included allegations that the Company or certain of its officers anddirectors participated in and approved the issuance of the financial statementsof Interspeed, that defendants are "controlling persons" ofInterspeed, and that the defendants made false or misleading statements regardingthe Company's own consolidated financial results. Following settlementdiscussions among the parties, (i) complaints filed by shareholders of theCompany were voluntarily dismissed in April 2001 and (ii) the Courtentered final approval of the settlement of the litigation brought byshareholders of Interspeed in July 2001. The dismissal and settlement of theseactions did not have a material adverse effect on the Company's financialposition or results of operations.

 

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

            (a) Exhibits

    None.

(b) Reports on Form 8-K

     None.

 

 **SIGNATURES**

    Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

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