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 June 30, 2002

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		02494-2814
Needham, Massachusetts
(Address of principal executive offices)		(Zip code)

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

    Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No o

    As of July 26, 2002, 12,243,826 shares of common stock, $.01 par value per share, were outstanding.

 

 

 

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

TABLE OF CONTENTS

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

 

 

2

Brooktrout, Inc.
Unaudited Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)

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

See notes to unaudited condensed consolidated financial statements.

 

3

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

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

See notes to unaudited condensed consolidated financial statements.

4

Brooktrout, Inc.
Unaudited Condensed Consolidated Statements of Comprehensive Income
(in thousands)

 

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

 

See notes to unaudited condensed consolidated financial statements.

 

5

Brooktrout, Inc.
Unaudited Condensed Consolidated Statements of Cash Flows
(in thousands)

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

See notes to unaudited condensed consolidated financial statements.

 

6

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

1. Description of Business and Summary of Significant Accounting Policies and Practices

(a) Description of Business

                Brooktrout, Inc. (the “Company” or “Brooktrout”) develops, manufactures and sells communications hardware and software products that enable the development of communications applications and systems in five targeted markets, including enhanced services platforms, wireless infrastructure, voice over packet gateways and switches, unified communications, and contact centers. The Company sells its products to system vendors, service providers, enterprise customers, original equipment manufacturers (“OEMs”), and value-added resellers (“VARs”), both domestically and internationally, through a direct sales force and a two-tiered distribution system. Prior to February 8, 2001, the Company was organized and reported the results of its operations in the following three business segments: Brooktrout Technology, Inc. (“Brooktrout Technology”), Brooktrout Software, Inc. (“Brooktrout Software”), and Interspeed, Inc. (“Interspeed”). These segments were differentiated based upon the products provided to the marketplace, the customers served, and the distribution channels utilized. Two of these segments have been discontinued and are classified as discontinued operations for the periods presented in these condensed consolidated financial statements. (See Note 2). Following the discontinuance of the Brooktrout Software and Interspeed segments, the Company’s operations consist of one reportable segment, Brooktrout Technology.

(b) Use of Estimates

                Accounting policies, methods and estimates are an integral part of the condensed consolidated financial statements and are based upon management’s current judgments. These policies, methods, and estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. The judgments made by management are based on knowledge and experience with regard to past and current events and assumptions about future events that are believed to be reasonable under the circumstances. On an on-going basis, the Company’s management evaluates its estimates and assumptions and adjusts them if expectations concerning events, including future events, affecting them differ markedly from management’s current judgments.

(c) Principles of Consolidation

                The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

                The accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the interim periods presented. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The operating results for the interim periods presented are not necessarily indicative of the results that could be expected for the full year.

(d) Revenue Recognition

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

 

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 (e) Concentration of Credit Risk

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

(f) Inventory

                Inventory is carried at the lower of cost or market. Cost is determined using the first-in, first-out method for all inventories. The Company reduces the value of its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

(g) Intangible Assets

                Intangible assets include acquired technology, customer base, and trademarks associated with purchased business combinations.  Acquired technology is being amortized on a straight-line basis over five to ten years, while all other intangibles are being amortized over periods of three to five years.  Accumulated amortization at June 30, 2002 and December 31, 2001 was $6,648 and $5,882, respectively.  Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

(h) Income Taxes

                Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carry forwards. These assets and liabilities are measured using the enacted rates and laws that are expected to be in effect when the differences reverse.  The Company believes that it is more likely than not that future operations will generate sufficient taxable income to realize the deferred tax assets.

(i) Earnings Per Share

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

                Potential common shares are antidilutive for the three and six months ended June 30, 2002 and 2001 and are excluded from the calculation.  Stock options to purchase 3,539,221 and 2,681,637 shares were not included in the computation of diluted earnings per share in 2002 and 2001, respectively.

 (j) Reclassifications

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

(k) Recent Accounting Pronouncements

                The Company has adopted SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” These pronouncements provide guidance on how to account for the acquisition of businesses and intangible assets, including goodwill, which arise from such activities. SFAS No. 141 affirms that only one method of accounting may be applied to a business combination, the purchase method. SFAS No. 141 also provides guidance on the allocation of purchase price to the assets acquired. SFAS No. 142 provides that goodwill resulting from business combinations can no longer be amortized to expense, but rather requires an annual assessment of impairment and, if necessary, adjustments to the carrying value of goodwill.  The adoption of SFAS Nos. 141 and 142 did not have a material effect on the Company's consolidated financial statements.  As of January 1, 2002, the Company had no intangible assets with indefinite useful lives.

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

 

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adoption of SFAS No. 144 did not have a material effect on the Company’s consolidated financial statements and had no effect on the accounting applied to the discontinued businesses described in Note 2.

2.  Discontinued Operations

                On February 8, 2001, the Company’s Board of Directors adopted formal plans to discontinue its Brooktrout Software and Interspeed segments.

                Brooktrout Software, Inc.— On March 12, 2002, the Company and Sonexis, Inc. (“Sonexis”) reached an agreement resolving various post-closing adjustments and indemnification claims of both parties that had been asserted in connection with the sale of Brooktrout Software. As part of this agreement, the Company agreed to exchange the Sonexis shares, received by the Company as partial consideration for the sale of Brooktrout Software, for an immediate and final resolution and release of substantially all claims related to the sale of Brooktrout Software.  The Sonexis shares had been classified in the Company’s financial statements as a cost basis investment at December 31, 2001.  The effect of this settlement was a pre-tax non-cash charge to discontinued operations in the first quarter of 2002 of $943.  This pre-tax non-cash charge was substantially offset by an income tax benefit of $915.  The income tax benefit related primarily to net deferred tax liabilities, which are no longer required due to the final settlement of the transaction.  As a result, the Company recognized a net loss from discontinued operations for the six months ended June 30, 2002 of $28.  As of June 30, 2002, “Net liabilities related to discontinued operations” consists of $86 for accruals of anticipated final expenses related to Brooktrout Software.

 

                Interspeed, Inc.— In January 2001, the Board of Directors of Interspeed announced that it was curtailing operations and liquidating the remaining assets for the benefit of creditors.  The Company is a creditor of Interspeed.  In the three months ended March 31, 2002, the Company received net proceeds from the Interspeed creditors’ trust of $238.  These proceeds, net of income tax expense of $130, resulted in a net gain from discontinued operations for the six months ended June 30, 2002, of $108.  As of June 30, 2002, “Net liabilities related to discontinued operations” consists of $192 of anticipated final expenses associated with the Interspeed business.

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

 

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

 

3.  Inventory

                Inventory consisted of the following at:

		June 30, 2002				December 31, 2001
Raw materials		$	961			$		3,763
Work in process		1,292				621
Finished goods		5,763				7,570
Total		$		8,016		$	11,954

 

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4.  Equipment and Furniture

                Equipment and furniture consisted of the following at:

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

 

5.  Bank Line of Credit

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

6.  Income Taxes

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

7.  Investments

                The Company has an investment in Pelago Networks, Inc. (“Pelago”), which it has previously accounted for under the equity method of accounting.  The Company’s investment in Pelago had been written down to zero as of December 31, 2001 as the Company recognized its share of Pelago’s losses.  The Company has no further funding commitment and has ceased recording its share of Pelago’s losses.  In the three months ended March 31, 2002, Pelago closed on an additional round of equity financing of its Series B preferred shares in which the Company did not participate.  As a result of this financing, the Company’s ownership percentage was reduced below 20% and the Company now accounts for this investment on the cost method basis.

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

8.  Segment Reporting

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

                Product Sales—Brooktrout Technology’s products are sold for applications in the New Network™ and for applications in Today’s Network. Today’s Network involves core technologies and platforms that are primarily used in business premise products such as fax, LAN fax, and voice mail. The New Network applications expand the capabilities of communications networks to allow data, voice and fax information to be distributed using packet-based data networks, such as the Internet, for portions of the transmission and also allow information to be distributed using the traditional circuit-switched telephone network. For the three months ended June 30, 2002, sales of products for use in the New Network accounted for approximately 36% of total revenue as compared to 33% of total revenue in the three months ended June 30, 2001.  For the six months ended June 30, 2002, sales of products

 

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for use in the New Network accounted for approximately 35% of total revenue as compared to 44% of total revenue for the six months ended June 30, 2001.

                Major Customers—One customer accounted for approximately 15% and 16% of revenue for the three months ended June 30, 2002 and 2001, respectively. The same customer accounted for approximately 14% and 10% of revenue for the six months ended June 30, 2002 and 2001, respectively.  A different customer represented 12% of sales for the six months ended June 30, 2001; however, revenue from this customer represented less than 1% of total revenue for the six months ended June 30, 2002.

                International Sales—International sales, principally exports from the United States, accounted for approximately 19% and 24% of revenue for the three months ended June 30, 2002 and 2001, respectively, and approximately 20% of revenue for the six months ended June 30, 2002 and 2001.

9.  Contingencies

                Litigation—The Company is a party to a number of legal actions that have arisen in the normal course of business.  The Company, taking into account advice of counsel, does not believe the eventual outcome of these matters will have a material effect on the Company's consolidated financial condition or results of operations.

 

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

Results of Operations

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

                This quarterly report on Form 10-Q contains certain statements that are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995 and releases issued by the Securities and Exchange Commission. The words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “assumes,” “will,” “should” and other expressions that are predictions of or indications of future events and trends and that do not relate to historical matters, identify forward-looking statements.  You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of Brooktrout, Inc. (the “Company” or “Brooktrout”), which may cause the actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on information, plans, and estimates at the date of this document and the Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.  In particular, (i) our revenue would be materially adversely affected if our largest customer does not continue to provide more than 10% of our overall revenue; (ii) the Company could be adversely affected if gross margins for the next several quarters do not remain similar to the gross margin for the quarter ended June 30, 2002, as expected; (iii) the Company’s financial condition and results of operations could be adversely affected if actual expenses for research and development and selling, general and administrative expenses are higher or lower than expected; (iv) the Company could be adversely affected if not successful in renewing its line of credit or if the line of credit is not renewed on as favorable terms as the existing line of credit; and (v) the Company could be adversely affected in the event that future operations do not generate sufficient taxable income to realize the deferred tax assets.

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

Introduction

                Brooktrout develops, manufactures and sells communications hardware and software products that enable the development of communications applications and systems in five targeted markets, including enhanced services platforms, wireless infrastructure, voice over packet gateways and switches, unified communications, and contact centers. The Company’s strategy is to collaborate with its partners on new ideas and to invest in the success of their businesses in order to help them expand into new markets, accelerate the delivery of their applications and services, and deliver quality products and services. The Company sells its products to system vendors, service providers, enterprise customers, original equipment manufacturers (“OEMs”), and value-added resellers (“VARs”), both domestically and internationally, through a direct sales force and a two-tiered distribution system.

                The evolution of the world’s telecommunications systems has created important market opportunities for the Company. One opportunity involves core technologies and platforms that are primarily used in business premise products such as fax, LAN fax, and voice mail—Today’s Network. Another opportunity—the New Network™—is the result of the global investments that are being made to expand the capabilities of today’s communications networks. These new capabilities allow data, voice and fax information to be distributed using packet-based data networks, such as the Internet, for portions of the transmission and also allow such information to 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 in three operating segments, Brooktrout Technology, Inc. (“Brooktrout Technology”), Brooktrout Software, Inc. (“Brooktrout Software”), and Interspeed, Inc. (“Interspeed”). On February 8, 2001, the Company’s Board of Directors adopted formal plans to discontinue its Brooktrout Software and Interspeed segments. Accordingly, the Company has accounted for these businesses as discontinued operations. (See Note 2 to condensed consolidated financial statements).  The following discussion relates to the Company’s results from continuing operations.

 

 

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Critical Accounting Policies

 

                Accounting policies, methods and estimates are an integral part of the consolidated financial statements and are based upon management’s current judgments. These judgments are based on knowledge and experience with regard to past and current events and assumptions about future events that are believed to be reasonable under the circumstances. On an on-going basis, the Company’s management evaluates its estimates and assumptions and adjusts them if expectations concerning events, including future events, affecting them differ markedly from management’s current judgments. Management believes that the following are certain critical accounting policies that particularly affect its more significant judgments and estimates used in the preparation of its condensed consolidated financial statements.

                The Company’s revenue recognition policy requires that revenue generally be recognized at the time of shipment to customers if there is persuasive evidence that an arrangement exists, the price is fixed or determinable, delivery has occurred, and collection is considered probable. The Company recognizes revenue from sales to two-tiered distributors of the Company’s products when the distributor has sold the products to their customers. The Company records a provision for estimated sales returns and allowances on product sales in the same period as the related revenue is recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. Actual results could differ from these estimates.

                As the Company adheres to its concentration of credit risk policy, management makes estimates concerning the realizable value of accounts receivable assets. The current and future economic environment affects these estimates. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of Brooktrout’s customers were to deteriorate, additional allowances would likely be required.

                As the Company adheres to its inventory valuation policy, management makes estimates concerning the realizable value of inventory. The current and future economic environment affects these estimates. The Company reduces the value of its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

                The Company reviews its intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Any evaluation of intangible assets would include assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, the Company could be required to record impairment charges for these assets.

                The carrying value of the Company’s deferred tax assets assumes that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions, based on estimates and assumptions. If these estimates and related assumptions change in the future, the Company may be required to record valuation allowances against its deferred tax assets, resulting in additional income tax expense in the Company’s consolidated statement of operations. Management evaluates the realizability of the deferred tax assets and assesses the need for valuation allowances quarterly.

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

Three Months Ended June 30, 2002 and 2001
(in thousands)

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

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

 

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                Cost of product sold was $8,732, or 46% of revenue, for the three months ended June 30, 2002, compared to $8,449, or 47% of revenue, for the three months ended June 30, 2001. Gross margin percent for the three months ended June 30, 2002 was 54% compared with 53% for the three months ended June 30, 2001. The higher gross margin percent in 2002 was primarily due to an increase in higher margin products sold together with a reduction in the manufacturing costs for certain products through identification of alternative manufacturing sources.  The Company expects that the gross margin for the next several quarters will be similar to the gross margin for the three months ended June 30, 2002.

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

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

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

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

                The effective tax benefit rate was 42% for the three months ended June 30, 2002. For the three months ended June 30, 2001, the effective tax expense rate was 34%. This tax rate for the second quarter of 2001 was the result of treating equity in loss of affiliates expense as a non-deductible item in the income tax provision calculation. Excluding the impact of equity in loss of affiliates, the effective tax expense rate would have been 37% for the three months ended June 30, 2001.

Six Months Ended June 30, 2002 and 2001
(in thousands)

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

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

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

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Company’s manufacturing expenses, which are primarily fixed, represented a larger percentage of cost of product sold in 2002 in comparison to 2001.

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

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

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

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

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

 

Liquidity and Capital Resources
(in thousands)

 

                For the six months ended June 30, 2002, the Company funded its operations principally through cash provided by operating activities. Cash provided by operating activities for the six months ended June 30, 2002 was $4,682 and was generated primarily from tax refunds received of $4,393.  Cash used in investing activities for the six months ended June 30, 2002 was $780 and consisted of purchases of marketable securities and capital equipment.  Working capital increased to $55,856 at June 30, 2002 from $54,701 at December 31, 2001.

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

                The Company believes that the current economic conditions will continue during this year and as a result, expects to have a loss from continuing operations for the year ending December 31, 2002. During the twelve months ended December 31, 2001, the Company had an operating loss of $9,460, but during the same period increased its cash and marketable securities balances by $12,138, of which $4,927 was from the sale of Brooktrout Software. The Company believes available cash resources will support its operations and capital needs for at least the next twelve months, and if the current economic climate worsens beyond the next twelve months, the Company may need to utilize funds available under the renewed line of credit or seek other sources of financing.  In the event that the line of credit is not renewed, the Company may also be required to seek other sources of financing. The terms of any future equity financings may be dilutive to the Company’s stockholders and the terms of any future debt financings may contain restrictive covenants, which could limit the Company’s ability to pursue certain courses of action.  It is possible that, should the need arise, the Company will not be able to obtain additional financing, or that the financing made available to the Company will not be on acceptable terms.

                For the six months ended June 30, 2002, the Company purchased approximately $292 in equipment. The Company currently has no material commitments for additional capital expenditures.

 

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            The pricing of the Company’s products and costs of its goods are generally determined by current market conditions, as well as value to the customer. Market conditions can be impacted by inflation; however, the Company believes that inflation has not had a significant effect on its operations to date.

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

Risk Factors

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

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

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

                The Company’s operating results are likely to fluctuate in the future due to a variety of factors, many of which are outside of its control. If the Company’s operating results do not meet the expectations of securities analysts, the trading price of the Company’s common stock could significantly decline. This may cause the value of your investment in the Company to decline. In addition, the value of your investment could be impacted by investor perception of the Company’s industry or its prospects generally, independent of the operating performance of the Company. Some of the factors that could affect the Company’s operating results or impact the market price of the common stock include:

 

 

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

The Company has historically derived a significant portion of its revenue from a small number of customers.

                The Company’s failure to generate as much revenue as expected from what has historically been a relatively small number of customers or the failure of these customers to purchase the Company’s products could seriously harm the Company’s business. One customer accounted for approximately 15% of the Company’s revenue for the three months ended June 30, 2002, compared to 16% for the three months ended June 30, 2001. The loss of any one of the Company’s major customers or the delay of significant orders from such customers, even if only temporary, has or could reduce or delay the Company’s revenue, could harm the Company’s reputation in the industry and could reduce the Company’s ability to accurately predict cash flow, and, as a consequence, could seriously harm the Company’s business, financial condition and results of operations.

The telecommunications markets are highly competitive, and the Company may not be able to compete successfully against new entrants and established companies with greater resources.

                The market for telecommunications equipment is highly competitive. If the Company is unable to differentiate its products from existing and future offerings of its competitors, and thereby effectively compete in the market for telecommunications equipment, the Company’s results of operations could be materially adversely affected. Many of the Company’s current and potential competitors have significantly greater selling and marketing, technical, manufacturing, financial, and other resources. Moreover, the Company’s competitors may have greater access to components necessary to manufacture their products. The strength and capabilities of the Company’s competitors may be increased as a result of the trend toward consolidation in the telecommunications market. Capitalizing on and maintaining the Company’s technological advantage will require a continued high level of investment in research and development, marketing and customer service and support. Due to the rapidly evolving markets in which the Company competes, additional competitors with significant market presence and financial resources may enter those markets, thereby further intensifying competition. The Company may not allocate sufficient resources to achieve the technological advances necessary to compete successfully with existing competitors or new entrants.

Internal development efforts by the Company’s customers may adversely affect demand for its products.

                Many of the Company’s customers, including the large OEMs on which the Company focuses a significant portion of its sales and marketing efforts, have the technical and financial ability to design and produce components replicating or improving on the functionality of most of the Company’s products. These customers often consider in-house development of technologies and products as an alternative to doing business with the Company. The Company cannot assure you that its existing customers or potential customers will do business with the Company, rather than attempting to develop similar technology and products internally or obtaining them through acquisition. The Company cannot be certain that it will be able to find customers to replace the revenue lost as a result of customers developing technologies or products in-house. Any such occurrence could have a material adverse effect on the Company’s business, financial condition or results of operations.

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

                The telecommunications hardware and software market is characterized by:

                The Company believes that its future success will depend, in part, on its ability to offer products that address the sophisticated and varied needs of its current and prospective customers and to respond to technological advances and evolving industry standards on a timely and cost-effective basis. The Company intends to continue to invest significantly in product and technology development. The development of new or enhanced products is a complex and uncertain process. The Company may experience design, manufacturing, marketing and other difficulties that could delay or prevent its development, introduction or marketing of new products and enhancements. The Company may also not be able to incorporate new technologies on a cost-effective or timely basis. This may result in unexpected expenses. Additionally, the Company may need to reduce its prices to remain competitive, which could affect its profitability. The introduction of new or enhanced products also requires that the Company

 

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manage the transition from older products so as to minimize the disruption to customers and ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. The Company’s inability to develop on a timely basis new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company’s dependence on sole and single source suppliers and independent manufacturers exposes it to supply interruptions that could result in product delivery delays.

                Although the Company generally uses standard parts and components for its products, some key components are purchased from sole or single source vendors for which alternative sources are not currently available or are difficult to obtain. The Company’s inability to obtain sufficient quantities of these components may result in future delays or reductions in product shipments that could materially adversely affect its business, financial condition and results of operations. The Company currently purchases proprietary components from a number of suppliers for which there are no direct substitutes. These components could be replaced with alternatives from other suppliers, but that could involve redesign of the Company’s products. If such redesign was required, the Company would incur considerable delay and expenses. The Company currently enters into purchase orders with its suppliers for materials based on forecasts of need, but has no guaranteed supply arrangements with these suppliers.

                In addition, the Company currently uses a number of independent manufacturers to manufacture printed circuit boards, chassis and subassemblies in accordance with the Company’s design and specification. The Company’s reliance on independent manufacturers involves a number of risks, including the potential for inadequate capacity of, unavailability of, or interruptions in access to, process technologies, and reduced control over delivery schedules, manufacturing yields and costs. If the Company’s manufacturers are unable or unwilling to continue manufacturing its components in required quantities or to the Company’s quality expectations, the Company will have to transfer manufacturing to acceptable alternative manufacturers that it has identified, which could result in significant delays in shipment of products to customers. Moreover, the manufacture of these components is extremely complex, and the Company’s reliance on the suppliers of these components exposes it to potential production difficulties and quality variations, which could negatively impact the cost and timely delivery of its products. The Company currently enters into purchase orders with independent manufacturers of materials based on forecasts of need, but has no guaranteed arrangements with these manufacturers. Any significant interruption in the supply, or degradation in the quality, of any component would have a material adverse effect on the Company’s business, financial condition and results of operations.

Defects in the Company’s products or problems arising from the use of its products may seriously harm its business and reputation.

                Products as complex as the Company’s may contain known and undetected errors, bugs or performance problems. Defects are frequently found during the period immediately following introduction and initial implementation of new products or enhancements to existing products. Although the Company attempts to resolve all bugs that it believes would be considered serious by its customers before implementation, the Company’s products may not be bug-free. The Company also provides warranties against defects in materials and workmanship on its hardware products for five years. However, errors, bugs or performance problems could result in lost revenue or customer relationships and could be detrimental to the Company’s business and reputation generally. In addition, the Company’s customers generally use its products together with their own products and products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause the Company to incur significant warranty and repair costs, divert the attention of its engineering personnel from the Company’s product development efforts and cause significant customer relations problems. To date, defects in the Company’s products or those of other vendors’ products with which its products are used by its customers have not had a material adverse effect on its business. However, the Company cannot be certain that product defects will not materially adversely affect the Company’s business in the future.

Changes to regulations affecting the telecommunications or Internet industries could reduce demand for the Company’s products or increase its costs.

                Laws and regulations governing telecommunications, electronic commerce and the Internet are beginning to emerge, but remain largely unsettled, even in the areas where there has been some legislative action. Regulation may focus on, among other things, assessing access or settlement charges, or imposing tariffs or regulations based on the characteristics and quality of products, either of which could restrict the Company’s business or increase its cost of doing business. Any changes to existing laws or the adoption of new regulations by federal or state regulatory authorities or any legal challenges to existing laws or regulations relating to the telecommunications industry could materially adversely affect the market for the Company’s products. Moreover, the Company’s VARs or other customers may require, or the Company may otherwise deem it necessary or advisable, that the Company alter its products to address actual or anticipated changes in the regulatory environment. The Company’s inability to alter its products or address any regulatory changes could have a material adverse effect on its business, financial condition or results of operations.

 

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Provisions in the Company’s corporate charter may discourage takeover attempts and, thus, depress the market price of the common stock.

                Provisions in the Company’s Charter may have the effect of delaying or preventing a change of control or changes in the Company’s management or Board of Directors. These provisions include:

 

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

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

                The Company’s success and its ability to compete are dependent, in part, upon its proprietary technology. Taken as a whole, the Company believes its intellectual property rights are significant and any failure to adequately protect the unauthorized use of its proprietary rights could result in the Company’s competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenue. The Company relies upon a combination of patents, trademark law, trade secret protections, copyright law and confidentiality agreements with consultants and third parties to protect its proprietary rights. Notwithstanding its efforts, third parties may infringe or misappropriate the Company’s proprietary rights. In addition, each employee of the Company has executed a proprietary information agreement designed to protect the trade secrets of the Company, inventions created in the course of employment with the Company and other proprietary information of the Company. Moreover, effective patent, trademark, copyright or trade secret protections may not be available in every country in which the Company operates or intends to operate to the same extent as the laws of the United States. Also, it may be possible for unauthorized third parties to copy or reverse engineer aspects of the Company’s products, develop similar technology independently or otherwise obtain and use information that the Company regards as proprietary. Furthermore, detecting unauthorized use of the Company’s proprietary rights is difficult. Litigation may be necessary in the future to enforce the Company’s proprietary rights. Such litigation could result in the expenditure of significant financial and managerial resources and could have a material adverse effect on the Company’s future operating results.

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

                In the telecommunications business, there is frequent litigation based on allegations of patent infringement. As the number of entrants in the Company’s market increases and the functionality of its products is enhanced and overlaps with the products of other companies, the Company may become subject to claims of infringement or misappropriation of the intellectual property rights of others. As a result, from time to time, third parties may claim exclusive patent or other intellectual property rights to technologies that the Company uses. Although the Company believes that it does not face material liability related to infringement of the intellectual property of others, any claims asserting that the Company’s products infringe or may infringe proprietary rights of third parties, if determined adversely to the Company, could have a material adverse effect on its business, financial condition or results of operations. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of the Company’s engineering and management personnel, cause delays in product shipments or require the Company to enter into royalty or licensing agreements, any of which could have a material adverse effect upon the Company’s operating results. If any legal action claiming patent infringement is commenced against it, the Company cannot assure you that it would prevail in such litigation given the complex technical issues and inherent uncertainties in patent litigation. In addition, the Company may be required to obtain a license or royalty agreement under the intellectual property rights of those parties claiming the infringement. In the event a claim against the Company was successful, and it could not obtain a license on acceptable terms or license a substitute technology or redesign to avoid infringement, the Company may be unable to market its affected products. This could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

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Certain of the Company’s products depend upon the continued availability of licensed technology from third parties.

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

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

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

                The Company’s success depends in large part upon the continued contributions of its key management, sales and marketing, and engineering personnel, many of who perform important functions and would be difficult to replace. The Company does not have employment contracts with its key personnel. There has been intense competition in the Company’s industry for qualified personnel, and, at times, the Company has experienced difficulty in recruiting qualified personnel. The Company may not be able to attract and retain the necessary personnel to accomplish its business objectives, and it may experience constraints that will adversely affect its ability to satisfy customer demand in a timely fashion or to support its customers and operations. The Company’s inability to hire qualified personnel on a timely basis, or to retain its key personnel, could materially adversely affect the Company’s business, financial condition and results of operations.

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

                The length of the Company’s sales cycle typically ranges from six to eighteen months and varies substantially from customer to customer. Prospective customers generally must commit significant resources to test and evaluate the Company’s products and integrate them into larger systems. This evaluation period is often prolonged due to delays associated with approval processes that typically accompany the design and testing of new communications equipment by the Company’s customers.

                In addition, the rapidly emerging and evolving nature of the markets in which the Company and its customers compete may cause prospective customers to delay their purchase decisions as they evaluate new technologies and develop and implement new systems. During the period in which the Company’s customers are evaluating whether to place an order with the Company, it often incurs substantial sales and marketing expenses, without any assurance of future orders or their timing. Even after a customer places an order with the Company and its product is expected to be utilized in a product or service offering being developed by our customer, the timing of the development, introduction and implementation of those products is controlled by, and can vary significantly with the needs of, the Company’s customers. In some circumstances, the customer will not require the product for several months. This complicates the Company’s planning processes and reduces the predictability of the Company’s earnings.

The Company derives a significant portion of its revenue from international sales; international business operations entail additional risks.

                Risks arising from the Company’s international business include currency fluctuation, political instability in other countries, the imposition of trade and tariff regulations by foreign governments, and the difficulties in managing operations across disparate geographic areas. In addition, most countries require technical approvals from their telecommunications regulatory agencies for products that operate in conjunction with the telephone system. Obtaining these approvals is generally a prerequisite for sales in a given jurisdiction. Obtaining requisite approvals may require from two months to a year or more depending on the product and the jurisdiction. These or other factors may limit the Company’s ability to sell its products in other countries, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

                The Company’s exposure to market risk from changes in interest rates and currency exchange rates has not changed materially from its exposure at year-end 2001. The Company’s market risk associated with investments in equity securities of privately held technology companies was reduced in 2002 since the investment in the preferred equity securities that constituted the Company’s investment in Sonexis was exchanged with Sonexis as part of the settlement discussed in Note 2 to the condensed consolidated financial statements.

 

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PART II.  OTHER INFORMATION

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

On May 9, 2002, the Company held its 2002 Annual Meeting of Stockholders (the “Annual Meeting”). At the Annual Meeting, stockholders of the Company were asked to consider proposals (the “Proposals”) (i) to elect two Class I directors, each to serve for a three-year term until the 2005 annual meeting of stockholders and until his successor is duly elected and qualified; (ii) to ratify the selection of Deloitte & Touche LLP as the Company’s independent auditors for the fiscal year ending December 31, 2002; and (iii) to consider and act upon any other matters that may properly be brought before the annual meeting and any adjournments or postponements thereof.

 

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

 

With respect to the Proposals, the stockholders of the Company voted at the Annual Meeting as hereinafter described.  By a vote of 10,549,165 votes of Common Stock in favor of David L. Chapman, a plurality of the eligible votes, and 1,095,031 votes withheld for Mr. Chapman, Mr. Chapman was elected as a Class I Director of the Company.  By a vote of 10,978,752 votes of Common Stock in favor of David W. Duehren, a plurality of the eligible votes, and 665,444 votes withheld for Mr. Duehren, Mr. Duehren was elected as a Class I Director of the Company.

 

The stockholders of the Company ratified and approved the selection of Deloitte & Touche LLP as the Company’s independent auditors for the current fiscal year by a vote of 11,523,898 votes in favor, in excess of a majority of eligible votes, with 107,896 votes against and 12,402 votes abstaining.

 

Item 6.  Exhibits and Reports on Form 8-K

                (a) Exhibits

 

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

 

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

 

(b) Reports on Form 8-K

      None.

 

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 SIGNATURES

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

 

	BROOKTROUT, INC.
Date: August 14, 2002	By:	/s/ ERIC R. GILER
		Eric R. Giler President (Principal Executive Officer)
Date: August 14, 2002	By:	/s/ ROBERT C. LEAHY
		Robert C. Leahy Vice President of Finance and Operations (Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

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

 

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

 

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