SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

	ý		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
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)

 

 

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

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o        No ý

 

As of April 30, 2003, 12,540,421 shares of common stock, $.01 par value per share, were outstanding.

 

 

BROOKTROUT, INC.

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2003

 

TABLE OF CONTENTS

 

PART I  FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements		1
		Unaudited Condensed Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002		1
		Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2003 and March 31, 2002		2
		Unaudited Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2003 and March 31, 2002		3
		Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2003 and March 31, 2002		4
		Notes to Unaudited Condensed Consolidated Financial Statements		5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		9
		Overview		9
		Application of Critical Accounting Policies		9
		Discontinued Operations		10
		Results of Operations		11
		Liquidity and Capital Resources		13
		Recent Accounting Pronouncements		14
		Factors That May Affect Future Results		15
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		19
Item 4.		Controls and Procedures		19
PART II  OTHER INFORMATION
Item 6.		Exhibits and Reports on Form 8-K	20
		Signatures	21
		Certifications	22
		Exhibit Index	24

 

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

 

ii

 

PART I  FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements

 

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

		March 31, 2003			December 31, 2002
Assets
Current assets:
Cash and cash equivalents		$	22,083		$	23,685
Marketable debt securities		23,851			18,103
Accounts receivable (less allowances for doubtful accounts and sales returns of $1,687 at March 31, 2003 and $1,679 at December 31, 2002)		7,740			8,853
Inventory		6,163			6,797
Income tax receivable		188			6,236
Deferred tax assets		4,661			3,856
Prepaid expenses		1,014			1,137
Total current assets		65,700			68,667
Equipment and furniture, less accumulated depreciation and amortization		2,975			3,404
Deferred tax assets		9,341			9,341
Intangible assets, less accumulated amortization		7,029			7,412
Other assets		1,346			1,511
Total assets		$	86,391		$	90,335
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	3,782		$	5,715
Accrued expenses		5,226			5,104
Accrued compensation and commissions		1,602			2,141
Accrued warranty costs		1,086			1,060
Customer deposits		892			883
Net liabilities related to discontinued operations		98			125
Total current liabilities		12,686			15,028
Deferred rent		196			209
Total liabilities		12,882			15,237
Commitments and contingencies (Note 9)
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 12,540,421 at March 31, 2003 and 12,532,810 at December 31, 2002		125			125
Additional paid-in capital		64,197			64,170
Accumulated other comprehensive loss		(17		)	(64		)
Notes receivable — officers		(11,760		)	(11,760		)
Retained earnings		24,724			26,387
Treasury stock, 255,384 shares, at cost		(3,760		)	(3,760		)
Total stockholders’ equity		73,509			75,098
Total liabilities and stockholders’ equity		$	86,391		$	90,335

 

See notes to condensed consolidated financial statements.

 

1

 

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

		Three Months Ended March 31,
		2003			2002
Revenue		$	15,534		$	18,422
Costs and expenses:
Cost of product sold		6,330			8,798
Research and development		4,586			5,619
Selling, general and administrative		7,269			7,481
Total costs and expenses		18,185			21,898
Operating loss		(2,651		)	(3,476		)
Other income, net		200			221
Loss before income taxes		(2,451		)	(3,255		)
Income tax (benefit)		(788		)	(1,367		)
Loss from continuing operations		(1,663		)	(1,888		)
Gain on disposal of discontinued operations, net of income tax benefit of $785 in 2002		—			80
Net loss		$	(1,663	)	$	(1,808	)
Loss per common share:
Loss from continuing operations, basic and diluted		$	(0.14	)	$	(0.15	)
Net loss, basic and diluted		$	(0.14	)	$	(0.15	)
Weighted average shares outstanding, basic and diluted		12,282			12,207

 

See notes to condensed consolidated financial statements.

 

2

 

BROOKTROUT, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)

		Three Months Ended March 31,
		2003			2002
Net loss		$	(1,663	)	$	(1,808	)
Unrealized gains (losses) on marketable debt securities, net of applicable taxes		47			(16		)
Comprehensive loss		$	(1,616	)	$	(1,824	)

 

See notes to condensed consolidated financial statements.

 

3

 

BROOKTROUT, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

		Three Months Ended March 31,
		2003			2002
Cash flows from operating activities:
Net loss		$	(1,663	)	$	(1,808	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Loss on disposal of discontinued operations		—			705
Depreciation and amortization		895			1,114
Amortization of acquired and licensed software		165			476
Deferred income taxes		—			326
Inventory obsolescence expense		362			825
Increase (decrease) in cash from changes in:
Accounts receivable		1,102			(950		)
Inventory		272			1,709
Prepaid expenses and other assets		5,375			989
Current liabilities		(2,370		)	137
Cash flows from operating activities		4,138			3,523
Cash flows from investing activities:
Expenditures for equipment and furniture		(83		)	(152		)
Sales and maturities of marketable debt securities		3,669			6,315
Purchases of marketable debt securities		(9,351		)	(2,842		)
Cash flows from investing activities		(5,765		)	3,321
Cash flows from financing activities:
Proceeds from the sale of common stock		25			7
Cash flows from financing activities		25			7
Increase (decrease) in cash and cash equivalents		(1,602		)	6,851
Cash and cash equivalents, beginning of period		23,685			22,425
Cash and cash equivalents, end of period		$	22,083		$	29,276

 

See notes to condensed consolidated financial statements.

 

4

 

BROOKTROUT, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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 hardware and software products that enable the development of communications systems and services. The Company sells its products to system vendors, service providers, enterprise customers, original equipment manufacturers, and value-added resellers, 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. For further discussion of discontinued operations, please see our Annual Report on Form 10-K for the year ended December 31, 2002.  Following the discontinuance of the Brooktrout Software and Interspeed segments, the Company’s operations consist of one reportable segment, Brooktrout Technology. Disclosures included herein pertain to the Company’s continuing operations unless noted otherwise.

 

(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. The Company’s management evaluates these estimates and assumptions and adjusts them if expectations concerning events, including future events, affecting them differ markedly from management’s current judgments.

 

(c) Basis of Presentation and 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, 2002.

 

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 recognized upon shipment to the customer (which constitutes delivery), provided that persuasive evidence of an arrangement exists, the fee is fixed or determinable, and collection is reasonably assured. To the extent that one or more of these conditions are not met, which has occurred from time to time, revenue is deferred until such time as all four criteria are met. Revenue from sales to certain distributors is recognized on a “sell-through” basis, that is, when the distributors report to the Company that resale of the product to the ultimate customer of the distributor in question has occurred. If the Company receives a payment from a customer prior to meeting all of the revenue recognition criteria, the payment is recorded as a customer deposit or deferred revenue. 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.

 

(e) Warranties

 

The Company provides warranties on its products for periods of up to five years. Provisions are made at the time revenue is recognized for the cost of fulfilling these commitments. Actual costs of fulfilling these warranty obligations have been within amounts estimated and provided.  At March 31, 2003 and December 31, 2002, the Company recorded a warranty obligation of $1.1 million.

 

(f) Concentration of Credit Risk

 

The Company sells its products to various customers in the high technology industry. The Company generally requires no collateral. To reduce credit risk, the Company performs credit evaluations of its customers. The Company maintains allowances for doubtful accounts for estimated losses resulting from its customers’ inability to make required payments. At March 31, 2003 and December 31, 2002, 13% and 23%, respectively, of the Company’s accounts receivable were from one customer, and 9% and 13%, respectively, were from a different customer.

 

5

 

(g) Inventory

 

Inventory is carried at the lower of cost or market. Cost is determined using the first-in, first-out method. 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 realizable value based upon assumptions about future demand and market conditions.

 

(h) Income Taxes

 

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the carrying value of existing assets and liabilities and their respective tax bases and for operating loss and credit carry forwards. These assets and liabilities are measured using the enacted tax rates and laws that are expected to be in effect at the time the differences are expected to reverse. The Company believes that it is more likely than not that future operations will generate sufficient taxable income to realize the majority of the deferred tax assets. Valuation allowances are provided to the extent that recoverability of tax assets is unlikely.

 

(i) Stock-Based Compensation

 

The Company uses the intrinsic value method to measure compensation expense associated with the grants of stock options or awards to employees. The Company accounts for stock options and awards to non-employees using the fair value method.

 

Under the intrinsic value method, compensation associated with stock awards to employees is determined as the difference, if any, between the current fair value of the underlying common stock on the date compensation is measured and the price an employee must pay to exercise the award. The measurement date for employee awards is generally the date of grant. Under the fair value method, compensation associated with stock awards to non-employees is determined based on the estimated fair value of the award itself, measured using either current market data or an established option pricing model. The measurement date for non-employee awards is generally the date that performance of certain services is complete.

 

Had the Company used the fair value method to measure compensation related to stock awards to employees, reported loss from continuing operations and loss per share would have been as follows:

		Three Months Ended March 31,
		2003			2002
		(in thousands, except per share data)
Loss from continuing operations, as reported		$	(1,663	)	$	(1,888	)
Stock based compensation recorded		—			—
Pro forma stock based compensation, net of tax		(934		)	(886		)
Loss from continuing operations, pro forma		$	(2,597	)	$	(2,774	)
Basic and diluted loss per common share		$	(0.21	)	$	(0.23	)

 

For purposes of determining the disclosure required by Statement of Financial Accounting Standards (“SFAS”) No. 123, the fair value of options on their grant date is measured using the Black/Scholes option-pricing model. Key assumptions used to apply this pricing model were as follows:

 

		Three Months Ended March 31,
		2003		2002
Risk-free interest rate		2.5	%	4.3	%
Expected life of option grants (years)		4.3		4.4
Expected volatility of underlying stock		43	%	52	%

 

The estimated weighted average fair value of option grants made during the three months ended March 31, 2003 and 2002 was $1.98 and $2.69, respectively, per option.

 

(j) 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 the net loss by the sum of the weighted average number of common shares outstanding and all additional common shares that would have been outstanding if potentially dilutive securities had been issued, using the treasury method.

 

Stock options to purchase 3,526,687 shares and 3,050,125 shares were excluded from the computation of diluted earnings per share in the three months ended March 31, 2003 and 2002, respectively.  These options were excluded from the calculation as to include them would have been antidilutive.

 

6

 

(k) Reclassifications

 

Certain amounts in the 2002 condensed consolidated financial statements have been reclassified to conform to the 2003 presentation.

 

(l) Recent Accounting Pronouncements

 

The Company has adopted SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  This pronouncement is effective for exit or disposal activities that are initiated after December 31, 2002, and requires these costs to be recognized when the liability is incurred and not at project initiation. The adoption of SFAS No. 146 has not had an impact on the Company’s operations or financial position since there has been no exit or disposal activities in the periods presented.

 

2. Marketable Debt Securities

 

The Company has classified all of its marketable debt securities as available-for-sale. There were no material realized or unrealized gains recognized during the three months ended March 31, 2003 and the year ended December 31, 2002.  As of both March 31, 2003 and December 31, 2002, the remaining maturities of debt securities range from one month to approximately two years.

 

Marketable debt securities consisted of the following:

 

		Amortized Cost			Market Value
		(in thousands)
March  31, 2003:
U.S. government notes and bonds		$	9,008		$	9,034
Corporate debt securities		14,757			14,817
Total		$	23,765		$	23,851
December 31, 2002:
U.S. government notes and bonds		$	7,520		$	7,532
Corporate debt securities		10,644			10,571
Total		$	18,164		$	18,103

 

3. Inventory

 

The components of inventory, net of reserves, consisted of the following:

 

		March 31, 2003			December 31, 2002
		(in thousands)
Raw materials		$	1,263		$	1,076
Work in process		674			740
Finished goods		4,226			4,981
Total		$	6,163		$	6,797

 

4. Intangible Assets

 

Intangible assets consisted of the following:

 

		March 31, 2003			December 31, 2002
		(in thousands)
Acquired technology		$	12,038		$	12,038
Customer base		1,264			1,264
In-place workforce		972			972
Trademarks		301			301
Total intangible assets		14,575			14,575
Less: accumulated amortization		(7,546		)	(7,163		)
Intangible assets, net		$	7,029		$	7,412

 

Intangible asset amortization expense was $0.4 million for both the three months ended March 31, 2003 and 2002.

 

7

 

5. Accrued Warranty Costs

 

The Company’s accrued warranty cost liability was $1.1 million and $0.8 million as of March 31, 2003 and 2002, respectively. The following is a rollforward of the accrued warranty costs:

 

		Three months ended March 31,
		2003			2002
		(in thousands)
Balance, beginning of the period		$	1,060		$	789
Provisions for claims		61			30
Costs incurred		(35		)	(19		)
Balance, end of period		$	1,086		$	800

 

6. Bank Line of Credit

 

As of March 31, 2003, the Company has a line of credit under which it can borrow up to $5.0 million, subject to compliance with certain covenants. Any amounts borrowed under the line of credit bear interest at the lender’s prime rate. The line of credit is secured by a pledge of substantially all of the assets of the Company. As of March 31, 2003, letters of credit issued against the Company’s existing line totaled $1.0 million, representing the collateral required for certain lease obligations. Other than the issuance of letters of credit and using the credit line to secure immaterial foreign currency forward contracts, there have been no borrowings under the line during the past three years. The line of credit expires on June 30, 2003. The Company anticipates that the line of credit will be renewed on substantially the same terms as the existing line of credit.

 

7. Income Taxes

 

The Company’s tax provision in 2003 is based on the estimated effective tax rate for the full year.  The Company’s effective tax benefit rate on continuing operations was 32% for the three months ended March 31, 2003 and 42% for the three months ended March 31, 2002.  The reduction in the income tax benefit rate for the three months ended March 31, 2003 was primarily due to a limitation of, and corresponding reduction in, the research and development tax credit that the Company can utilize in 2003. During the three months ended March 31, 2003, the Company received federal income tax refunds totaling $6.0 million related to the carryback of 2002 net operating losses and tax credits.

 

8. Segment Information

 

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.

 

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 March 31, 2003, sales of products for use in the New Network accounted for approximately 39% of total revenue as compared to 33% of total revenue for the three months ended March 31, 2002.

 

Major Customers—One customer accounted for approximately 14% of revenue for both the three months ended March 31, 2003 and 2002.

 

International Sales—International sales, principally exports from the United States, accounted for approximately 27% and 21% of revenue for the three months ended March 31, 2003 and 2002, respectively.

 

9. Commitments and Contingencies

 

Litigation—From time to time, the Company is a party to legal actions that arise in the normal course of business. The Company, taking into account advice of counsel, does not believe the eventual outcome of any such pending matters will have a material effect on the Company’s consolidated financial condition or results of operations.

 

8

 

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

 

The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes appearing elsewhere in this quarterly report and in our Annual Report on Form 10-K for the year ended December 31, 2002. The discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth below under “Factors That May Affect Future Results.”

 

Overview

 

We develop hardware and software platforms that original equipment manufacturers, or OEMs, developers and corporate information technology managers build into their communications systems. Customers incorporate our products into applications, systems and services that allow voice, fax and data to be distributed over both Internet protocol, or IP, packet-based networks, which we refer to as the New Network, and the traditional circuit-based telephone network. We supply products for media processing, network interface, call control and signal processing, including protocols that allow Internet and traditional telephony systems to communicate.

 

We measure our operating success using both financial and market metrics. The financial metrics include revenue, gross margin, operating expenses, income from continuing operations and cash provided by operating activities. Other key metrics include the total number of enterprise and service provider customers, customers whose purchases exceed $100,000, and the portion of our revenue that is generated by the sales of products for applications in the New Network. Our long-term business model stresses our commitment to establishing and maintaining close customer relationships and to continuing to develop innovative products.

 

The most significant trend that has impacted our business has been the unfavorable economic conditions affecting most technology sectors and the communications sector in particular. This has resulted in a decrease in our revenue in the first quarter of 2003 and for the fiscal years 2002 and 2001, compared to prior periods. Sales of products, particularly for applications in the New Network, to OEMs for use by large service providers have declined most significantly. In response to the revenue decreases, we implemented expense control programs to reduce operating expenses, while at the same time, we have continued to invest in developing products that we believe our customers will need when the economy improves.

 

Despite these difficult economic conditions, we have been able to increase our cash and marketable debt securities balances to $45.9 million at March 31, 2003 from $26.0 million at December 31, 2000. This was accomplished primarily through operating expense reductions, the sale of a business segment and income tax refunds. If current adverse economic conditions continue for an extended period of time or worsen, we may experience adverse effects on our business, operating results, and cash and marketable debt securities.

 

Application of Critical Accounting Policies

 

Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to interim financial information. We make estimates and assumptions in the preparation of the condensed consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses, and the related disclosures of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, actual results may differ from these estimates under different assumptions or conditions

 

The following critical accounting policies require the use of significant judgment and estimates in the preparation of the condensed consolidated financial statements. This listing is not a comprehensive list of all of our significant accounting policies. For further information regarding the application of these and other accounting policies, see Note 1 to the condensed consolidated financial statements in Item 1 of this report.

 

Revenue Recognition

 

Revenue from product sales is recognized upon shipment to the customer (which constitutes delivery), provided that persuasive evidence of an arrangement exists, the fee is fixed or determinable, and collection is reasonably assured. In determining when to recognize revenue we often are required to exercise judgment. To the extent that one or more of these criteria are not met, which has occurred from time to time, revenue is deferred until such time as all four conditions are satisfied. We record 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 and could therefore impact our results of operations and cash flows.

 

Allowances for Doubtful Accounts

 

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. The estimated allowance for doubtful amounts is based primarily on a specific analysis of accounts in the receivable portfolio and a general reserve based on the aging of receivables. While management believes the allowance to be adequate, if the financial condition of our customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required and could materially impact our financial position and results of operations.

 

9

 

Inventory Allowances

 

We evaluate our ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels by product and projections of future demand. In addition, we assess the impact of changing technology on our inventory-on-hand. We provide reserves for inventories that are considered excess or obsolete. If future demand or market conditions are less favorable than our projections, additional inventory reserves may be required and would be reflected in cost of sales in the period in which the revision is made. These actions could impact both our results of operations and our cash flows.

 

Intangible Assets

 

We review our intangible assets for impairment periodically and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The evaluation of the fair value of our intangible assets includes assumptions regarding estimated future undiscounted cash flows associated with these assets and other factors. If these estimates or assumptions change in the future, we may be required to record impairment charges for these assets. Such an impairment charge would impact the results of operations, but would not directly impact our cash flows.

 

Deferred Tax Assets

 

We assess the carrying value of our deferred tax assets to determine if it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions in order to realize these assets. When necessary, we have reduced the deferred tax asset to its estimated realizable value by recording a valuation allowance. This assessment requires us to make estimates and assumptions about our future profitability. In determining the carrying value of the deferred tax assets as of March 31, 2003, we are assuming profitability in the future and that it is more likely than not that we will be able to realize these assets. This assumption is based in part upon our history of profitability. If current economic conditions deteriorate or future results of operations are less than expected, future assessments may result in a determination that all or a portion of the remaining deferred tax assets are not realizable. As a result, we may need to establish additional valuation allowances for all or a portion of the deferred tax assets, which may have a material adverse effect on our results of operations.

 

Accrued Warranty Costs

 

We accrue for warranty costs based on historical trends in product return rates and the expected material and labor costs to provide warranty services. If we were to experience an increase in warranty claims compared with our historical experience, or if costs of servicing warranty claims were greater than the expectation on which the accrual had been based, our gross margins could be adversely affected.

 

Discontinued Operations

 

Prior to February 8, 2001, we were organized and reported the results of our operations in three operating segments, Brooktrout Technology, Brooktrout Software, and Interspeed. On February 8, 2001, our board of directors adopted formal plans to discontinue our Brooktrout Software and Interspeed segments. We have accounted for these businesses as discontinued operations.  These businesses were substantially disposed of prior to December 31, 2001, and adjustments recorded in 2002 primarily reflect additional proceeds and changes in estimates to the amounts recorded related to gains or losses on disposal.  There are no operating activities related to discontinued operations included in our condensed consolidated financial statements in either 2002 or 2003.

 

10

 

Results of Operations

 

The following discussion focuses on our results from continuing operations for the three months ended March 31, 2003 and 2002. The table below sets forth certain condensed consolidated statements of operations data as a percentage of total revenue for the periods presented.

 

		Three Months Ended March 31,
		2003		2002
Domestic revenue		73	%	79	%
International revenue		27		21
Total revenue		100		100
Cost of product sold		41		48
Gross margin		59		52
Operating expenses:
Research and development		29		30
Selling, general and administrative		47		41
Total operating expenses		76		71
Operating loss		(17	)	(19	)
Other income, net		1		1
Loss before income taxes		(16	)	(18	)
Income tax (benefit)		(5	)	(8	)
Loss from continuing operations		(11	)%	(10	)%

 

Revenue

 

The following table presents our domestic and international revenue:

 

		Three Months Ended March 31,
		2003					2002
		(dollars in thousands)
Domestic revenue		$	11,282		73	%	$	14,512		79	%
International revenue, principally export		4,252			27		3,910			21
Total revenue		$	15,534		100	%	$	18,422		100	%

 

Three Months Ended March 31, 2003 and 2002

 

Revenue for the three months ended March 31, 2003 decreased by $2.9 million compared to the three months ended March 31, 2002.  Sales to domestic original equipment manufacturers and enterprise customers decreased primarily due to recent world events and the continued unfavorable economic conditions in the communications marketplace.  International revenue increased by $0.3 million, primarily as a result of favorable foreign currency exchange rates.  For the three months ended March 31, 2003, international revenue represented 27% of total revenue compared to 21% of total revenue for the three months ended March 31, 2002.

 

Revenue from sales of products for applications in the New Network was similar for the three months ended March 31, 2003 and 2002.  However, due to the decrease in total revenue, New Network revenue was approximately 39% of total revenue for the three months ended March 31, 2003, as compared to 33% of total revenue in the three months ended March 31, 2002.

 

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Cost of Product Sold and Gross Margin

 

The following table presents cost of product sold and gross margin information:

 

		Three Months Ended March 31,
		2003			2002
		(dollars in thousands)
Cost of product sold		$	6,330		$	8,798
Gross profit		$	9,204		$	9,624
Gross margin		59		%	52		%

 

Three Months Ended March 31, 2003 and 2002

 

The decrease in cost of product sold from the three months ended March 31, 2002 to the corresponding period in 2003 was primarily the result of direct material cost reductions achieved from using new manufacturing subcontractors, combined with decreased product sales.  In addition, inventory obsolescence expense decreased by $0.4 million, primarily due to lower levels of excess service provider product inventory in the three months ended March 31, 2003. These factors contributed to a significant improvement in gross margin percentages, along with a $0.4 million decrease in gross profit dollars, in the first quarter of 2003 compared to the first quarter of 2002.

 

Operating Expenses

 

The following table presents our operating expenses:

 

		Three Months Ended March 31,
		2003			2002
		(in thousands)
Research and development		$	4,586		$	5,619
Selling, general and administrative		7,269			7,481
Total operating expenses		$	11,855		$	13,100

 

Research and development expense

 

Three Months Ended March 31, 2003 and 2002

 

Research and development expense represented 29% of total revenue in the three months ended March 31, 2003, compared with 30% of total revenue in the corresponding period in 2002. The $1.0 million decrease in 2003 was primarily the result of reduced consulting, contract labor, variable incentive compensation, and depreciation expenses, combined with decreased spending on new product prototypes.  Our continuing development efforts are focused on hardware and software for media processing products (voice, fax and data), network interface products, call control products and signal processing products.

 

Selling, general and administrative expense

 

Three Months Ended March 31, 2003 and 2002

 

The slight decrease in selling, general and administrative expense from the three months ended March 31, 2002 to the corresponding period of 2003 was primarily due to a decrease in bad debt expense as a result of improved collectability of accounts receivable, along with depreciation and reduced spending for variable incentive compensation. These expense decreases were partially offset by increases in employee health insurance premiums, as well as marketing expenses associated with the Partner Access Network Program.

 

Other income, net

 

Three Months Ended March 31, 2003 and 2002

 

The decrease in other income, net, from $221,000 in the three months ended March 31, 2002 to $200,000 in the corresponding period in 2003 was the result of a decline in short-term interest rates, which offset the favorable impact of increased cash and marketable debt securities balances.

 

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Income tax (benefit)

 

The following table presents our income tax (benefit) and effective tax rate:

 

		Three Months Ended March 31,
		2003			2002
		(dollars in thousands)
Income tax (benefit)		$	(788	)	$	(1,367	)
Effective tax rate		(32		)%	(42		)%

 

Three Months Ended March 31, 2003 and 2002

 

The reduction in the income tax benefit rate for the three months ended March 31, 2003 was primarily due to a limitation of, and corresponding reduction in, the research and development tax credit that we can utilize in 2003.

 

Liquidity and Capital Resources

 

Cash flows for the three months ended March 31, 2003 and 2002

 

Net cash from operating activities was $4.1 million in the three months ended March 31, 2003. This increase primarily resulted from tax refunds of $6.0 million and reductions in accounts receivable that were offset by changes in other components of working capital. Net cash from operating activities was $3.5 million in three months ended March 31, 2002. This primarily resulted from income tax refunds of $3.7 million and reductions in inventory, offset by a slight increase in accounts receivable.

 

Net cash used in investing activities was $5.8 million in the three months ended March 31, 2003. This primarily resulted from net purchases of marketable debt securities of $5.7 million. Net cash from investing activities was $3.3 million in the three months ended March 31, 2002. This primarily resulted from net sales of marketable debt securities of $3.5 million.

 

Net cash from financing activities was $25,000 and $7,000 in the three months ended March 31, 2003 and 2002, respectively, all attributable to proceeds from the sale of common stock.

 

Contractual Obligations and Capital Expenditures

 

The following table presents our future contractual obligations and commercial commitments as of March 31, 2003:

 

		Total			2003			2004			2005			2006			2007			Thereafter
		(in thousands)
Operating leases		$	8,017		$	1,937		$	2,802		$	1,933		$	697		$	202		$	446

 

We have operating lease commitments for our primary office and manufacturing facilities that expire between 2003 and 2006. In addition, we lease office space for sales and support functions that expire beyond 2006. Certain lease agreements require us to pay all of the building’s taxes, insurance and maintenance costs.

 

We purchased $83,000 of capital equipment in the three months ended March 31, 2003, and $152,000 of capital equipment in the three months ended March 31, 2002. We currently have no material commitments for additional capital expenditures, but we do have certain inventory purchase commitments that are part of our ordinary course of business. Our purchasing arrangements with vendors typically allow for cancellations without significant adverse financial implications.

 

We had no long-term debt as of March 31, 2003 or May 12, 2003.

 

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Cash and Cash Requirements

 

		March 31, 2003			December 31, 2002
		(dollars in thousands)
Cash and cash equivalents		$	22,083		$	23,685
Marketable debt securities		23,851			18,103
Total		$	45,934		$	41,788
Working capital		$	53,014		$	53,639
Quick ratio		4.23			3.37
Available line of credit		$	5,000		$	5,000

 

Cash, cash equivalents and marketable debt securities increased to $45.9 million as of March 31, 2003 from $41.8 million as of December 31, 2002, primarily due to a $6.0 million tax refund, offset by a net cash outflow from operations of $1.9 million in the first three months of 2003. Working capital decreased by $0.6 million from December 31, 2002 to March 31, 2003. This decrease was the result of decreases in accounts payable and accrued expenses due to reduced inventory purchases and lower operating expenses, offset by a decrease in income tax receivable. Our quick ratio improved from 3.37 at December 31, 2002 to 4.23 at March 31, 2003, due primarily to a reduction of current liabilities by 16%, from $15.0 million as of December 31, 2002 to $12.7 million as of March 31, 2003, while we increased cash and marketable debt securities balances.

 

We have a $5.0 million working capital line of credit available from a commercial bank. Availability of funds under this line of credit is subject to compliance with certain covenants, and borrowings bear interest at the lender’s prime rate. The line of credit is secured by a pledge of substantially all of our assets.  As of March 31, 2003, letters of credit issued against the existing line totaled $1.0 million, representing the collateral required for certain lease obligations. Other than the issuance of letters of credit and using the credit line to secure immaterial foreign currency forward contracts, there have been no borrowings under the line during the past three years. The line of credit expires on June 30, 2003. We anticipate that the line of credit will be renewed on substantially the same terms as the existing line of credit.

 

We believe that our cash, cash equivalents and marketable debt securities are likely to meet our needs for the foreseeable future.  Though we do not expect to make any major capital expenditures in 2003, we are always looking for opportunities to expand the business, which could include acquisitions or organic expansion into new markets.  If we find that our cash, marketable debt securities and funds available from our bank line of credit are not sufficient, we may choose to utilize or to seek other sources of financing. If we were to seek future equity financings, the terms may be dilutive to our stockholders and may contain restrictive covenants, which could limit our ability to pursue certain courses of action. It is possible that, should the need arise, we will not be able to obtain additional financing, or that the financing made available to us will not be on acceptable terms.

 

The pricing of our products and the costs of our goods can be significantly affected by current market conditions. Market conditions can be impacted by inflation; however, we believe that inflation has not had a significant effect on our operations to date.

 

Recent Accounting Pronouncements

 

We have adopted Statement of Financial Accounting Standards (“SFAS”) No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”  This pronouncement is effective for exit or disposal activities that are initiated after December 31, 2002, and requires these costs to be recognized when the liability is incurred and not at project initiation. The adoption of SFAS No. 146 has not had an impact on our operations or financial position since there have been no exit or disposal activities in the periods presented.

 

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Factors That May Affect Future Results

 

The trading price of our common stock could decline due to any of these factors, in which case you could lose all or part of your investment. You should also refer to the other information in this report, including the condensed consolidated financial statements and related notes. The risks and uncertainties described below are those that we currently believe may materially affect us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us.

Risks Related to Our Business

 

Downturns in the economy generally, and in sectors of the telecommunications industry in particular, make it difficult to anticipate or expand sales.

 

As a result of the unfavorable economic conditions affecting most technology sectors and the telecommunications sector in particular, many of our customers are seeking aggressively to increase efficiency in their supply chains and reduce their inventory levels. Additionally, the slowdown in the telecommunications industry and the resulting decrease in spending by companies in our target markets have reduced the rate of growth of data traffic and the use of the Internet, which are driving the convergence of data and telephony that we expect will give rise to demand for New Network applications. The economic downturn has adversely affected our business and operating results, including a reduction in revenue of $2.9 million for the three months ended March 31, 2003, or 16%, compared to the three months ended March 31, 2002, and $11.5 million, or 43%, compared to the three months ended March 31, 2001. If current economic conditions continue for an extended period of time or worsen, we may experience additional adverse effects on our revenue, net income and cash flow. For example, as the rate at which our customers order products decreases, it becomes more likely that our current inventories will be exposed to technological obsolescence, which would require us to reduce the value of those inventories on our balance sheet.

 

If we fail to compete successfully in the highly competitive telecommunications market, our revenue and profitability will suffer.

 

The market for telecommunications equipment is highly competitive. If we are unable to differentiate our products from existing and future offerings of our competitors, and thereby effectively compete in the market for telecommunications equipment, our operating results could be materially adversely affected. Many of our current and potential competitors have significantly greater selling and marketing, technical, manufacturing, financial, and other resources. We expect our current competitors to continue to improve the design and performance of their existing products and to introduce new products and enhancements with improved price and performance characteristics. Our product sales may be threatened by new technologies, products or market trends, and we may have to reduce the prices of our products to stay competitive. In addition, new competitors may emerge in the markets we serve. An acquisition of, or by, one of our competitors may result in a substantially strengthened competitor with greater financial, engineering, manufacturing, marketing, and customer service and support resources than we have. If our current or future competitors enter into strategic relationships with leading manufacturers covering products similar to those sold or being developed by us, our ability to sell products to those manufacturers may be adversely affected.

 

Capitalizing on our technology will require a continued high level of investment in research and development, marketing, and customer service and support. We may be unable, or otherwise fail, to allocate sufficient resources to achieve the technological advances necessary to compete successfully with existing competitors or new entrants.

 

Internal development efforts by our customers may adversely affect demand for our products.

 

Many of our customers, including the large original equipment manufacturers on which we focus a significant portion of our sales and marketing efforts, have the technical and financial ability to design and produce components replicating or improving on the functionality of most of our products. These customers often consider in-house development of technologies and products as an alternative to doing business with us. We cannot assure you that our existing or potential customers will do business with us, rather than attempting to develop similar technology and products internally or obtaining technology or products through acquisitions. We cannot be certain that we 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 our business, financial condition or operating results.

 

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

 

The telecommunications hardware and software market is characterized by:

 

•                  rapid technological advances;

 

•                  evolving industry standards;

 

•                  changes in customer requirements;

 

•                  frequent new product introductions;

 

•                  declining prices;

 

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•                  intense competition; and

 

•                  evolving offerings by telecommunications service providers.

 

Our future success depends in large part on our ability to offer products that address the sophisticated and varied needs of our current and prospective customers and to respond to technological advances and evolving industry standards on a timely and cost-effective basis.

 

The timely development of new or enhanced products is a complex and uncertain process. We intend to continue to invest significantly in product and technology development. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent our development, introduction or commercialization of any new and enhanced products. We may also not be able to incorporate new technologies on a cost-effective or timely basis, which may result in unexpected expenses. We may not anticipate technological or market trends accurately or manage long development cycles successfully. We may be required to collaborate with third parties to develop products and may not be able to do so on a timely and cost-effective basis, if at all.

 

The introduction of new or enhanced products also requires that we 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. If we are unable to develop new products or enhancements on a timely and cost-effective basis, or if the new products or enhancements that we introduce fail to achieve market acceptance, our ability to grow our business would be harmed and competitors could achieve greater market share.

 

Our revenue could decline significantly if we lose a major customer or if a major customer cancels, reduces or delays an order.

 

One customer accounted for 14% of our revenue in each of three months ended March 31, 2003 and 2002. The loss of this or any other major customer or the cancellation, reduction or delay of significant orders from such customers, even if only temporary, could significantly reduce our revenue and cash flow and could harm our reputation in the industry.

 

Our dependence on sole and single source suppliers and independent manufacturers could result in increased costs or delays in the manufacture and delivery of our products.

 

Although we generally use standard parts and components for our 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. Our inability to obtain sufficient quantities of these components may result in future delays or reductions in product shipments that could cause us to lose sales, incur additional costs and suffer harm to our reputation. We currently purchase 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 might require redesign of our products. If such a redesign were required, we would incur considerable delay and expenses. We currently enter into purchase orders with our suppliers for materials based on forecasts of need, but have no guaranteed supply arrangements with these suppliers.

 

In addition, we currently use a number of independent manufacturers to manufacture printed circuit boards, chassis and subassemblies in accordance with our design and specification. Our 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 our manufacturers are unable or unwilling to continue manufacturing our components in required quantities or to our quality expectations, we will have to transfer manufacturing to acceptable alternative manufacturers that we have identified, which could result in significant delays in shipment of products to customers. Moreover, the manufacture of these components is extremely complex, and our reliance on the suppliers of these components exposes us to potential production difficulties and quality variations, which could negatively affect the cost and timely delivery of our products. We currently enter into purchase orders with independent manufacturers of materials based on forecasts of need, but have no guaranteed arrangements with these manufacturers. Any significant interruption in the supply, or degradation in the quality, of any component could cause us to lose sales, incur additional costs and suffer harm to our reputation.

 

Defects in our products or problems arising from the use of our products may seriously harm our business and reputation.

 

Products as complex as ours may contain known and undetected errors, bugs, or other performance problems. Defects are frequently found during the period immediately following introduction and initial implementation of new products or enhancements to existing products. Although we attempt to resolve all bugs that we believe would be considered serious by our customers before implementation, our products may not be bug-free. We also provide warranties against defects in materials and workmanship on our hardware products for five years. Errors, bugs or performance problems, however, could result in lost revenue or customer relationships and could be detrimental to our business and reputation generally. In addition, our customers generally use our 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 us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.

 

Changes to regulations affecting the telecommunications or Internet industries could reduce demand for our products or increase our costs.

 

Laws and regulations governing telecommunications, electronic commerce and the Internet are emerging, 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 our business or increase our 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 our products. Moreover, our value-added resellers or other customers may require, or we may otherwise deem it necessary or advisable, for us to alter our products to address actual or anticipated changes in the regulatory environment. Our inability to alter our products or address any regulatory changes could have a material adverse effect on our business, financial condition or operating results.

 

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Limitations on our ability to adequately protect our proprietary rights may prevent us from retaining our competitive advantage and negatively affect our future operating results.

 

Our success and ability to compete are dependent, in part, upon our proprietary technology. Taken as a whole, we believe our intellectual property rights are significant and any failure to adequately protect the unauthorized use of our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenue. We rely upon a combination of patents, trademark law, trade secret protections, copyright law and confidentiality agreements with consultants and third parties to protect our proprietary rights. Notwithstanding our efforts, third parties may infringe or misappropriate our proprietary rights. In addition, we generally require each of our employees to execute a proprietary information agreement designed to protect our trade secrets, our inventions created in the course of employment with us and other proprietary information of our company. Moreover, effective patent, trademark, copyright or trade secret protections may not be available in every country in which we operate or intend 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 our products, develop similar technology independently or otherwise obtain and use information that we regard as proprietary. Furthermore, detecting unauthorized use of our proprietary rights is difficult. Litigation may be necessary in the future to enforce our proprietary rights. Such litigation could result in the expenditure of significant financial and managerial resources and could have a material adverse effect on our future operating results.

 

Intellectual property claims against us can be costly and negatively affect our business.

 

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

 

Certain of our products depend upon the continued availability of licensed technology from third parties.

 

We currently license and will continue to license certain technology integral to certain of our products from third parties. For example, we have obtained licenses from third parties for software for certain of our voice and fax products. While we believe 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 our products, could result in delays in product development or upgrades until equivalent technology can be identified, licensed and integrated.

 

We may require new licenses in the future as our business grows and technology evolves. We cannot assure you that these licenses will continue to be available to us on commercially reasonable terms, if at all, which could have a material adverse effect on our business, financial condition and operating results.

 

If we are unable to attract or retain key personnel, we may be unable to operate our business successfully.

 

Our success depends in large part upon the continued contributions of our key management, sales, marketing, and engineering personnel, many of whom perform important functions and would be difficult to replace. If we lose one or more members of our senior management team our business and operating results would be harmed. We do not have employment contracts with our key personnel. There has been significant competition in our industry for qualified personnel, and, at times, we have experienced difficulty in recruiting qualified personnel. We may not be able to attract and retain the necessary personnel to accomplish our business objectives, and we may experience constraints that will adversely affect our ability to satisfy customer demand in a timely fashion or to support our customers and operations. Our inability to hire qualified personnel on a timely basis, or to retain our key personnel, could materially adversely affect our business, financial condition and operating results.

 

Our products typically have long sales cycles, causing us to expend significant resources before recognizing revenue.

 

The length of our sales cycle typically ranges from six to eighteen months and varies substantially from customer to customer. Prospective customers generally must commit significant resources to test and evaluate our 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 our customers.

 

In addition, the rapidly emerging and evolving nature of the markets in which we and our 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 our customers are evaluating whether to place an order with us, we often incur substantial sales and marketing expenses, without any assurance of future orders or their timing. Even after a customer places an order, the timing of the development, introduction and implementation of the customer’s product or service using our product is controlled by, and can vary significantly with the needs of, the customer. In some circumstances, the customer will not require the product for several months. This continuing uncertainty can complicate our planning processes and reduce the predictability of our earnings and cash flows.

 

17

 

Our business and operating results could be adversely affected by downturns in economic conditions in countries outside the United States and other risks associated with international operations.

 

Sales of our products to customers outside the United States accounted for 27% of our revenue in the three months ended March 31, 2003. We anticipate that international sales will continue to account for a significant portion of our revenue. Because of our dependence upon international sales, we are subject to a number of risks, including volatility in currency exchange rates, political and economic instability in other countries, the imposition of trade and tariff regulations by foreign governments, difficulties in accounts receivable collections, extended payment terms beyond those customarily offered in the United States, potentially adverse tax consequences, 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 local telephone system. Obtaining these approvals is generally a prerequisite for sales in a given jurisdiction. Obtaining requisite approvals takes from two months to a year or more depending on the product and the jurisdiction. These or other factors may limit our ability to sell our products in other countries, which could have a material adverse effect on our business, financial condition and operating results.

 

We may seek to expand through acquisitions of complementary businesses, and we may not be able to successfully integrate acquired companies.

 

We may seek to acquire complementary companies in the future. In addition to the difficulties we may face in identifying and consummating acquisitions, we will also be required to integrate and consolidate any acquired businesses or assets with our existing operations. Managing an acquired business entails numerous operational and financial risks, including difficulties in integrating disparate administrative, accounting and finance, and information systems, difficulties in assimilating acquired operations and new personnel, diversion of management’s attention from other business concerns, and potential loss of key employees or customers of any acquired operations. Accordingly, we may be unable to successfully identify, consummate and integrate future acquisitions or operate acquired businesses profitably. Our success will depend, to a significant extent, on the ability of our executive officers and other members of senior management to respond to these challenges effectively. If we are unable to integrate successfully an acquired company, our future growth may suffer, and our results of operations could be harmed.

 

Risks Related to Our Financial Results

 

Our operating results are likely to fluctuate significantly and cause our stock price to be volatile, which could cause the value of your investment to decline.

 

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

 

•                  our ability to cope with difficult conditions in the economy in general, and the telecommunications market in particular;

 

•                  our ability to formulate and implement effective strategies to respond to changing market requirements and conditions;

 

•                  cancellation or rescheduling of orders for our products;

 

•                  our ability to collect accounts receivable from customers that have been adversely affected by the difficult economic conditions;

 

•                  our ability to develop, manufacture, market and support our products and product enhancements;

 

•                  the timing and number of orders for our products, which have historically been weighted more heavily toward the last month of each quarter and the second and fourth quarters of each year;

 

•                  we typically experience lower revenue in the third quarter, due to customer summer vacation schedules, particularly in Europe, and to a lesser extent, the first quarter of each year;

 

•                  our ability to hire, train and retain key management, sales, marketing and engineering personnel;

 

•                  announcements or technological innovations by our competitors or in competing technologies;

 

•                  our ability to obtain sufficient supplies of sole or limited source components for our products;

 

•                  a decrease in the average selling prices of our products;

 

•                  changes in costs of components that we include in our products;

 

•                  the mix of products that we sell and the mix of distribution channels through which they are sold; and

 

•                  a decrease in the demand for our common stock.

 

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

 

The market price of our common stock is volatile, which could lead to losses for individual investors.

 

Stock markets in general, and the market for technology stocks, including our common stock, in particular, have experienced extreme price and volume fluctuations that often have been unrelated, or disproportionate, to the operating performance of those companies. The market for our common stock has been and is likely to continue to be volatile. Many factors could cause the trading price of our common stock to fluctuate substantially, including the following:

 

•                  future announcements concerning our business, technology, acquisitions, strategic partnerships, management, customers or competitors;

 

•                  introduction of new products or changes in product pricing policies by us, our competitors or our customers;

 

•                  changes in earnings estimates by securities analysts or announcements of results of operations that are not aligned with the expectations of analysts and investors;

 

•                  changes in market valuations of similar companies;

 

•                  reduced spending for telecommunications hardware and software;

 

•                  the economic and competitive conditions in the telecommunications sectors in which our customers operate; and

 

•                  general economic conditions and stock market trends.

 

In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. Many technology companies have been subject to this type of litigation. This type of litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

Our corporate documents may prevent a change in control or management that stockholders consider desirable.

 

Our charter and by-laws contain provisions that might enable our management to resist a takeover of our company. In addition, our board of directors has adopted a shareholder rights plan. These provisions and our shareholder rights plan could have the effect of delaying, deferring, or preventing a change in control of Brooktrout or a change in our management that stockholders consider favorable or beneficial. They could discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. They also could limit the price that investors may be willing to pay in the future for shares of our common stock.

 

We may need additional financing in the future, and any additional financing may result in restrictions on our operations or substantial dilution to our stockholders.

 

We may need to raise additional funds in the future, for example, to develop new technologies, support our expansion, respond to competitive pressures, acquire complementary businesses or respond to unanticipated situations. We may try to raise additional funds through public or private financings, strategic relationships or other arrangements. Our ability to obtain debt or equity funding will depend on a number of factors, including market conditions, our operating performance and investor interest. Additional funding may not be available to us on acceptable terms or at all. If adequate funds are not available, we may be required to revise our business plan to reduce expenditures, including curtailing our growth strategies, foregoing acquisitions or reducing our product development efforts. If we succeed in raising additional funds through the issuance of equity or convertible securities, the issuance could result in substantial dilution to existing stockholders. If we raise additional funds through the issuance of debt securities or preferred stock, these new securities would have rights, preferences and privileges senior to those of the holders of our common stock. The terms of these securities, as well as any borrowings under our bank line of credit agreement, could impose restrictions on our operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Our exposure to market risk from changes in interest rates and currency exchange rates has not changed materially from our exposure at year-end 2002.

 

Item 4. Controls and Procedures

 

(a)     Evaluation of disclosure controls and procedures.

 

Based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this quarterly report, our chief executive officer and chief financial officer have

 

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concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and are operating in an effective manner.

 

(b)         Changes in internal controls.

 

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.

 

PART II OTHER INFORMATION

 

Item 6. Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

3.1		Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.1 to Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000-20698).
3.2		Articles of Amendment to the Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000-20698).
3.3		Articles of Amendment to the Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.3 to Amendment No. 2 to the quarterly report on Form 10-Q/A for the fiscal quarter ended June 30, 2000 filed with the SEC on November 17, 2000 (File No. 000-20698).
3.4		Amended and Restated By-laws of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.4 to Annual Report on Form 10-K for the fiscal year ended December 31, 2001 filed with the SEC on March 25, 2002 (File No. 000-20698).
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

 

On April 16, 2003, we filed a current report on Form 8-K, dated April 16, 2003, furnishing under Item 12 our press release announcing financial results for the quarter ended March 31, 2003.

 

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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: May 12, 2003	By:	/s/  ERIC R. GILER
		Eric R. Giler President (Principal Executive Officer)
Date: May 12, 2003	By:	/s/  ROBERT C. LEAHY
		Robert C. Leahy Vice President of Finance and Operations (Principal Financial and Accounting Officer)

 

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CERTIFICATIONS

 

I, Eric R. Giler, President of Brooktrout, Inc. (the “Company”), certify that:

 

1.	I have reviewed this quarterly report on Form 10-Q of the Company for the quarter ended March 31, 2003;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:
	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.	The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 12, 2003	By:	/s/  ERIC R. GILER
		Eric R. Giler President (Principal Executive Officer)

 

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I, Robert C. Leahy, Vice President of Finance and Operations of Brooktrout, Inc. (the “Company”), certify that:

 

1.	I have reviewed this quarterly report on Form 10-Q of the Company for the quarter ended March 31, 2003;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:
	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.	The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

 

Date: May 12, 2003	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

 

3.1		Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.1 to Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000-20698).
3.2		Articles of Amendment to the Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.2 to Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the SEC on March 30, 2000 (File No. 000-20698).
3.3		Articles of Amendment to the Restated Articles of Organization of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.3 to Amendment No. 2 to the quarterly report on Form 10-Q/A for the fiscal quarter ended June 30, 2000 filed with the SEC on November 17, 2000 (File No. 000-20698).
3.4		Amended and Restated By-laws of Brooktrout, Inc. are hereby incorporated by reference from Exhibit 3.4 to Annual Report on Form 10-K for the fiscal year ended December 31, 2001 filed with the SEC on March 25, 2002 (File No. 000-20698).
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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