10-Q/A 1 b37399a2e10-qa.txt BROOKTROUT, INC. 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------------------------------------------------------------- AMENDMENT NO. 2 ON FORM 10-Q/A (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2000 / / TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File No. 0-20698 BROOKTROUT, INC. . (Exact name of registrant as specified in its charter) Massachusetts 04-2814792 ------------------------------- ------------------------------- (State or other jurisdiction of (I.R.S. employer identification incorporation or organization) number) 250 First Avenue, Suite 300 02494-2814 Needham, Massachusetts ---------- ---------------------------------------- (Zip code) (Address of principal executive offices) 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 X No --- --- As of May 1, 2000, 12,212,941 shares of Common Stock, $.01 par value per share, were outstanding. EXPLANATORY NOTE The Company hereby amends Part 1 of its quarterly report on Form 10-Q for the period ended March 31, 2000 to reflect the restatement of its Unaudited Condensed Consolidated Financial Statements as of and for the three-month period ended March 31, 2000 (see Note 14 to the Unaudited Condensed Consolidated Financial Statements). Page 1 of 32 pages 2 BROOKTROUT, INC. AMENDMENT NO. 2 ON FORM 10-Q/A FOR THE QUARTER ENDED MARCH 31, 2000 TABLE OF CONTENTS
Page ---- PART I FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Unaudited Condensed Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999 3 Unaudited Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2000 and March 31, 1999 4 Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2000 and March 31, 1999 5 Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2000 and March 31, 1999 6 Notes to Unaudited Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Three Months Ended March 31, 2000 and 1999 15 Liquidity and Capital Resources 17 PART II OTHER INFORMATION Item 1. Legal Proceedings 29 Item 6. Exhibits 29 Signatures 30
2 3 Brooktrout, Inc. Unaudited Condensed Consolidated Balance Sheets (In thousands, except share data)
March 31, December 31, 2000 1999 ------------- ------------ (As Restated, see Note 14) ASSETS Current assets: Cash and equivalents ......................................................... $ 45,956 $ 48,541 Marketable securities ........................................................ 1,604 1,492 Accounts receivable (less allowance for doubtful accounts and sales returns of $2,487 in 2000 and $2,466 in 1999) ......................................... 22,878 22,232 Inventory .................................................................... 18,620 14,202 Deferred tax assets .......................................................... 5,051 5,121 Prepaid expenses ............................................................. 1,925 1,975 --------- --------- Total current assets ..................................................... 96,034 93,563 --------- --------- Equipment and furniture: Computer equipment .......................................................... 10,934 9,785 Furniture and office equipment .............................................. 9,535 8,628 --------- --------- Total .................................................................... 20,469 18,413 Less accumulated depreciation and amortization ........................... (10,762) (9,694) --------- --------- Equipment and furniture - net ............................................ 9,707 8,719 Acquired technology and other intangible assets ................................ 14,535 12,973 Investments and other assets ................................................... 347 180 --------- --------- Total Assets ...................................................................... $ 120,623 $ 115,435 ========= ========= LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities: Accounts payable and other accruals .......................................... $ 20,841 $ 18,158 Accrued compensation and commissions ......................................... 4,759 5,573 Customer deposits ............................................................ 745 661 Accrued warranty costs ....................................................... 1,513 1,304 Accrued taxes ................................................................ 1,201 2,736 --------- --------- Total current liabilities ................................................ 29,059 28,432 --------- --------- Deferred rent .................................................................. 478 469 Deferred tax liabilities ....................................................... 602 479 Minority interest .............................................................. 7,374 8,672 Contingencies .................................................................. -0- -0- Shareholders' equity: Common stock, $.01 par value; authorized, 25,000,000 shares; issued and outstanding 12,168,462 shares in 2000 and 11,004,019 in 1999 ............... 122 110 Additional paid-in capital .................................................. 60,233 42,991 Loans to officers ........................................................... (11,845) -- Accumulated other comprehensive income (loss) ............................... (134) (117) Retained earnings ........................................................... 38,196 37,846 Treasury stock, 248,026 shares in 2000 and 247,582 shares in 1999 ........... (3,462) (3,447) --------- --------- Total shareholders' equity .................................................. 83,110 77,383 --------- --------- Total liabilities and shareholders' equity ........................................ $ 120,623 $ 115,435 ========= =========
See notes to unaudited condensed consolidated financial statements. 3 4 Brooktrout, Inc. Unaudited Condensed Consolidated Statements of Income (In thousands, except per share data)
Three Months Ended March 31, ------------------------------ 2000 1999 ------------- -------- (As Restated, see Note 14) Revenue ........................................................... $ 37,101 $ 32,218 Cost and expenses: Cost of product sold ............................................ 15,215 12,957 Research and development ........................................ 8,542 6,536 Selling, general and administrative ............................. 13,098 10,342 Non-cash compensation and warrants .............................. 1,135 62 -------- -------- Total cost and expenses ..................................... 37,990 29,897 -------- -------- Income (loss) from operations ..................................... (889) 2,321 Interest income, net .............................................. 762 79 -------- -------- Income (loss) before income tax provision.......................... (127) 2,400 Income tax provision .............................................. 1,678 816 Minority interest in loss of subsidiary ........................... (2,155) -- -------- -------- Net income ........................................................ $ 350 $ 1,584 ======== ======== Basic income per common share ..................................... $ 0.03 $ 0.15 ======== ======== Shares for basic .................................................. 11,235 10,862 ======== ======== Diluted income per common share ................................... $ 0.03 $ 0.14 ======== ======== Shares for diluted ................................................ 12,380 11,404 ======== ========
See notes to unaudited condensed consolidated financial statements. 4 5 Brooktrout, Inc. Unaudited Condensed Consolidated Statements of Comprehensive Income (In thousands)
Three Months Ended March 31, ---------------------------- 2000 1999 ------------- -------- (As Restated, see Note 14) Net income ............................................... $ 350 $ 1,584 Unrealized gains (losses) on marketable securities..... (14) (1,235) Foreign currency translation adjustment ............... (8) (5) ------- ------- Comprehensive income before income tax (benefit) ......... 328 344 Income tax (benefit) related to items of comprehensive income ................................ (5) (482) ------- ------- Comprehensive income ..................................... $ 333 $ 826 ======= =======
See notes to unaudited condensed consolidated financial statements. 5 6 Brooktrout, Inc. Unaudited Condensed Consolidated Statements of Cash Flows (In thousands)
Three Months Ended March 31, ------------------------------ 2000 1999 ------------- -------- (As Restated, Cash flows from operating activities: see Note 14) Net income ................................................................ $ 350 $ 1,584 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation and amortization ........................................ 1,517 1,414 Non-cash compensation and warrants ................................... 1,415 -- Tax benefit of stock options ......................................... 1,562 -- Minority interest .................................................... (2,155) -- Deferred income taxes and other ...................................... 198 (39) Increase (decrease) in cash from: Accounts receivable ........................................... (646) (1,596) Inventory ..................................................... (4,418) (1,893) Other prepaid expenses ........................................ 50 (411) Accounts payable and other accruals ........................... 593 3,235 -------- -------- Cash provided by (used in) operating activities ........ (1,534) 2,294 -------- -------- Cash flows from investing activities: Expenditures for equipment and furniture .................................. (2,056) (541) Expenditures for acquired software ........................................ (1,982) -- Purchases of marketable securities ........................................ (126) -- Investment and other assets ............................................... (205) -- -------- -------- Cash used for investing activities ..................... (4,369) (541) -------- -------- Cash flows from financing activities: Proceeds from the sale of common stock .................................... 3,063 223 Proceeds from exercise of Interspeed options and warrants ................. 270 -- Purchase of treasury stock ................................................ (15) -- -------- -------- Cash provided by financing activities .................. 3,318 223 -------- -------- Increase (decrease) in cash and equivalents ..................................... (2,585) 1,976 Cash and equivalents, beginning of period ....................................... 48,541 8,518 -------- -------- Cash and equivalents, end of period ............................................. $ 45,956 $ 10,494 ======== ========
See notes to unaudited condensed consolidated financial statements. 6 7 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 1. Basis of Presentation Brooktrout, Inc. (the "Company") supplies electronic communications products to system vendors, service providers, and value added resellers, or VARs, developing applications for the new global communications network. During 1999, the Company reorganized its lines of business and changed its name from Brooktrout Technology, Inc. to Brooktrout, Inc. The Company is organized and reports the results of its operations in the following three business segments: Brooktrout Technology, Brooktrout Software, Inc. ("Brooktrout Software"), and Interspeed, Inc. ("Interspeed"). These segments are differentiated based upon the products and services provided to the marketplace, the customers served, and the distribution channels. The rapid evolution of the world's telecommunication systems has created important market opportunities for the Company. One opportunity consists of core technologies and platforms primarily for business premise products such as fax, LanFax, 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 communication 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 be distributed using the traditional circuit switched telephone network. 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. They should be read in conjunction with the audited consolidated financial statements included in the Company's 1999 Annual Report on Form 10-K. In the opinion of management, 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 operating results for the interim periods presented are not necessarily indicative of the results which could be expected for the full year. 7 8 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 2. Recent Accounting Pronouncements In June of 1998, the Financial Accounting Standards Board released Statement of Financial Accounting Standards (SFAS) No. 133,"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, establishes new standards of accounting and reporting for derivative instruments and hedging activities and will be effective for the Company in 2001. Management is currently evaluating the effect of adopting SFAS No. 133 on the condensed financial statements. In December 1999, the Securities and Exchange Commission (the "SEC") released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements and will be effective for the Company in the fourth quarter of 2000. Management is currently evaluating the effect of adopting SAB No. 101 on the condensed financial statements. 3. Income Per Share Basic income per share is computed using the weighted average number of common shares outstanding during each year. Diluted income per share reflects the effect of the Company's outstanding options (using the treasury stock method), except where such options would be antidilutive. A reconciliation of weighted average shares used for the basic and diluted computations is as follows:
Three Months Ended March 31, March 31, 2000 1999 --------- --------- Shares for basic ........................... 11,235,000 10,862,000 Dilutive effect of stock options............ 1,145,000 542,000 ---------- ---------- Shares for diluted ......................... 12,380,000 11,404,000 ========== ==========
8 9 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 4. Inventory Inventory is carried at the lower of cost (first-in, first-out basis) or market and consisted of the following:
March 31, December 31, 2000 1999 --------- ------------ Raw materials .............................. $ 8,123,000 $ 7,254,000 Work in process............................. 1,210,000 1,658,000 Finished goods ............................. 9,287,000 5,290,000 ----------- ----------- Total ................................... $18,620,000 $14,202,000 =========== ===========
Finished goods inventory includes approximately $956,000 of Interspeed product inventory being held under consignment type arrangements. 5. Cash Flow Information Cash equivalents include highly liquid securities with remaining maturities of three months or less at the time of purchase. Supplemental disclosure of cash flow information:
March 31, March 31, 2000 1999 --------- --------- Cash paid for interest............................. -- -- Cash paid for income taxes......................... $ 1,340,000 $ 156,000
6. Major Customers One customer accounted for approximately 11% and 15% of net revenue for the three months ended March 31, 2000 and 1999, respectively. 9 10 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 7. Marketable Securities Marketable securities are classified as available-for-sale and are carried at fair market value using current market quotes. Unrealized gains or losses are included in comprehensive income (loss). Marketable securities consist of U.S. government notes and bonds, commercial paper, and certificates of deposit. 8. Income Taxes The Company's tax provision in 2000 was based on the estimated effective tax rate for the full year. The effective tax rate is greater than the statutory tax rates due to the non-deductible Interspeed operating loss of $5,078,000. Excluding the impact of the Interspeed operating loss, the Company's effective tax rate would have been 35% in 2000. 9. International Sales International sales, principally exported from the United States, accounted for approximately 18% and 25% of revenue for the three months ended March 31, 2000 and 1999, respectively. 10. Warrants In consideration for entering into certain long-term reseller agreements, Interspeed granted to certain customers vested warrants to purchase an aggregate of 55,000 shares of Interspeed's common stock at the market price of Interspeed's common stock on the dates the warrants were granted. The 10. Warrants (Continued) value of the warrants was calculated by applying the Black-Scholes option pricing model using the fair market value of Interspeed's common stock on the date the agreements were executed. The value of the warrants has been charged to expense as a component of non-cash compensation and warrants in the condensed consolidated statements of income (loss). Interspeed also granted to certain customers warrants to purchase up to an aggregate of 150,000 shares of the Interspeed's common stock that vest in installments as the customers attain certain revenue milestones over the terms of the agreements. The exercise price of the warrants is the fair market value of Interspeed's common stock on the date that the warrants vest. Interspeed is accounting for these warrants as a sales discount. As revenue is recognized on sales to these customers, Interspeed is recording a sales discount based on the relationship of sales to date to the customer to the specified revenue milestone. The amount of the discount is being estimated by valuing the warrants using the Black-Scholes option-pricing model. The value of the warrants is being adjusted at the end of each quarter until the revenue levels are attained and the warrants vest. The amount of discounts recorded during the quarter ended March 31, 2000 is $280,000. 11. Loans to Officers The Board of Directors on March 3, 2000 approved and the Company instituted a loan program. Pursuant to this loan program, the Company may lend amounts to or on behalf of certain of the Company's executive officers (a "Loan") to finance an executive officer's payment of the exercise price of one or more stock options to purchase shares of common stock granted to such officer under the Stock Incentive Plan. 10 11 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 11. Loans to Officers (Continued) In connection with the loans, the executive officers must execute a Nonrecourse Promissory Note and Security Agreement (the "Promissory Note") related to each Loan made by the Company. The Promissory Note does not bear interest and becomes due and payable in full no later than the remaining term of the option. The Promissory Note provides for automatic repayment upon the sale of the common stock which is the subject of a Loan or within 90 days following the termination of the executive officer's employment with the Company. Pursuant to the Promissory Note, the shares of the common stock which are the subject of a Loan serve as collateral (the "Collateral Stock") for the Promissory Note until such time as the Promissory Note has been paid in full. Loans made by the Company are non-recourse against the officer, and consequently for satisfaction of the Loans the Company's recourse is to the Collateral Stock. As a result of this program, there are loans to officers totaling $11,845,000 that are reflected in the shareholders' equity section of the balance sheet. 12. Segment Reporting The Company is organized and reports the results of its operations in the following three business segments: Brooktrout Technology, Brooktrout Software and Interspeed. These segments are differentiated based upon the products and services provided to the marketplace, the customers served, and the distribution channels. Brooktrout Technology provides enabling technologies for customers to deliver voice, fax and data solutions for the electronic communications market. Brooktrout Software provides specialized e-Business software and services that enable companies to connect traditional telephone commerce systems with web-based commerce systems. Interspeed develops single system, high-speed Internet access solutions for telephone companies and Internet Service Providers. The Company evaluates performance and allocates resources based on revenue, gross margin and income or loss from operations. 11 12 12. Segment Reporting (Continued)
Three Months Ended March 31, ------------------------------------ 2000 1999 ------------- ------------ (As restated, see Note 14) Revenue: Brooktrout Technology $ 33,469,000 $ 30,009,000 Brooktrout Software 2,085,000 1,882,000 Interspeed 1,547,000 327,000 ------------ ------------ Consolidated revenue $ 37,101,000 $ 32,218,000 ============ ============ Gross margin: Brooktrout Technology $ 20,521,000 $ 18,298,000 Brooktrout Software 1,063,000 912,000 Interspeed 302,000 51,000 ------------ ------------ Consolidated gross margin $ 21,886,000 $ 19,261,000 ============ ============ Income (loss) from operations:(1) Brooktrout Technology $ 5,405,000 $ 5,169,000 Brooktrout Software (1,216,000) (1,122,000) Interspeed(2) (5,078,000) (1,726,000) ------------ ------------ Consolidated income (loss) from operations (889,000) 2,321,000 Other income (expense) 762,000 79,000 ---------- ---------- Consolidated income (loss) before income tax provision $ (127,000) $2,400,000 ========== ==========
(1) Amounts previously reported in 1999 have been revised to reflect an allocation of certain marketing and administrative expenses to the segments. Prior segment disclosure reflected the expenses in Brooktrout Technology. (2) Included in the Interspeed loss from operations for the three months ended March 31, 2000 and 1999 is a charge of $1,135,000 and $62,000, respectively, reflecting non-cash compensation expenses as a result of stock option and warrant grants. 13 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements
Three Months Ended March 31, -------------------------------- 2000 1999 ------------- ---------- Depreciation and amortization expense: Brooktrout Technology $1,235,000 $1,217,000 Brooktrout Software 111,000 128,000 Interspeed 171,000 69,000 ---------- ---------- Consolidated depreciation and amortization expense $1,517,000 $1,414,000 ========== ==========
13. Subsequent Events On October 9, 2000, the Company announced it would put in place a $2,500,000 revolving line of credit for Interspeed, a majority owned subsidiary. Borrowing on this line of credit will bear interest at the Silicon Valley Bank prime rate per annum. The revolving line of credit will be for a six month period from the date of closing and will be subject to a first security interest in all tangible and intangible assets of Interspeed. As of November 13, 2000, $578,000 has been advanced to Interspeed pursuant to promissory notes, which will be incorporated into the revolving credit facility, and is outstanding. In October 2000, several shareholder class action complaints were filed in the United States District Court for the District of Massachusetts by certain shareholders of Interspeed and of the Company. The complaints name, among others, the Company and certain of its current and former officers and directors as defendants. The lawsuits were filed after Interspeed's October 6, 2000 announcement that it would be restating its unaudited financial results for certain prior quarters of its fiscal year 2000. The complaints include allegations that the Company or certain of its officers and directors participated in and approved the issuance of the financial statements of Interspeed, that defendants are "controlling persons" of Interspeed, and that the defendants made false or misleading statements regarding the Company's own consolidated financial results. The plaintiffs are seeking unspecified damages. The Company is defending these actions vigorously. 13 14 Brooktrout, Inc. Notes to Condensed Consolidated Financial Statements 14. Restatement Subsequent to the issuance of the Company's Unaudited Condensed Consolidated Financial Statements as of and for the three months ended March 31, 2000, the Company's management was informed by Interspeed that revenue from transactions with certain resellers had been incorrectly recognized. Interspeed has restated its financial statements to reflect the transactions as the consignment of inventory rather than as sales and accordingly, the accompanying financial statements of the Company have been restated. A summary of the significant effects of the restatement is as follows:
AS PREVIOUSLY REPORTED AS RESTATED ------------- ----------- AS OF MARCH 31, 2000: Accounts receivable-net $ 25,063,000 $ 22,878,000 Inventory 17,664,000 18,620,000 Minority interest 7,912,000 7,374,000 Additional paid-in capital 60,319,000 60,233,000 Retained earnings 38,801,000 38,196,000 FOR THE THREE MONTHS ENDED MARCH 31, 2000: Revenue $ 39,119,000 $ 37,101,000 Cost of product sold 16,163,000 15,215,000 Minority interest in loss of subsidiary (1,690,000) (2,155,000) Net income 955,000 350,000 Basic income per common share $ 0.09 $ 0.03 Diluted income per common share $ 0.08 $ 0.03
14 15 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 document 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 "believe," "expect," "anticipate," "intend," "estimate," and other expressions, which are predictions of or indicate future events and trends and which 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"), 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. The future operating results and performance trends of the Company may be affected by a number of factors, including, without limitation, the following: (i) the Company's ability to respond to rapidly developing changes in its marketplace; (ii) the Company's ability to develop and market quality, innovative products; (iii) the Company's ability to protect its proprietary intellectual property; and (iv) the Company's ability to retain relationships with its major customers, including Lucent Technologies Inc. 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 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. As discussed in Note 14 to the unaudited condensed consolidated financial statements the unaudited condensed consolidated financial statements as of and for the three months ended March 31, 2000 have been restated. The accompanying discussion and analysis gives effect to the restatement. 15 16 Three Months Ended March 31, 2000 and 1999 Revenue during the three months ended March 31, 2000 increased by approximately 15% to $37,101,000, up from $32,218,000 during the three months ended March 31, 1999. The majority of this growth was from the Company's Brooktrout Technology segment driven by the New Network applications. There was an increase in switching and access products sold combined with an increase in messaging products sold. These increases in revenue were partially offset by a decline in voice mail systems sold for Today's Network applications. During the three months ended March 31, 2000, Interspeed recognized $280,000 of sales discounts related to warrants granted to certain customers. Since these equipment purchase contracts were executed during the three months ended March 31, 2000, no such sales discounts were recorded in any prior fiscal periods. Cost of product sold was $15,215,000, or 41% of revenue, during the three months ended March 31, 2000, compared to $12,957,000, or 40% of revenue, for the same period in 1999. Gross profit percentage was approximately 59% and 60% for the three months ended March 31, 2000 and 1999, respectively. The slight decrease in gross profit percentage was due to a greater amount of lower margin Interspeed products sold during the three months ended March 31, 2000, compared to the same period in 1999. Research and development expense was $8,542,000, or 23% of revenue, compared with $6,536,000, or 20% of revenue, for the three months ended March 31, 2000 and 1999, respectively. The increase primarily is attributable to the development of the digital subscriber line ("DSL") products of Interspeed combined with increased product development at Brooktrout Technology. The Company's continuing development efforts are focused on its switching and access products that allow customers to create the infrastructure to support the New Network, messaging products that allow integration of voice, fax and e-mail into one location and IP Telephony and e-Commerce products. Selling, general and administrative expense was $13,098,000, or 35% of revenue, compared with $10,342,000, or 32% of revenue, for the three months ended March 31, 2000 and 1999, respectively. The majority of this increase was generated by Interspeed due to increased staffing and marketing initiatives. In addition, there was an increase at Brooktrout Technology and Brooktrout Software as a result of increased staffing and related expenses in the sales and marketing areas. For the three months ended March 31, 2000 and 1999, the Company recorded a charge of $1,135,000 and $62,000, respectively, representing non-cash expenses of Interspeed as a result of stock option grants to employees and warrant grants to customers. For the three months ended March 31, 2000, interest and other income was $762,000, compared with $79,000 for the same period in 1999, reflecting higher investable cash balances after the sale of Interspeed common shares in 1999. The Company's tax provision in 2000 was based on the estimated effective tax rate for the full year. The effective tax rate is greater than the statutory tax rates due to the non-deductible Interspeed operating loss of $5,078,000. Excluding the impact of the Interspeed operating loss, the Company's effective tax rate would have been 35% in 2000. The Company's effective tax rate was 34% in 1999. Minority interest in loss of subsidiary was $2,155,000 for the three months ended March 31, 2000, which represents the minority shareholders' portion of the losses of Interspeed. 16 17 Liquidity and Capital Resources For the three months ended March 31, 2000, the Company funded its Brooktrout Technology and Brooktrout Software operations principally through operating revenue and it's Interspeed operations through Initial Public Offering ("IPO") proceeds. The Company's working capital increased to $67,000,000 at March 31, 2000 from $65,100,000 at December 31, 1999. This increase was a result of increases in accounts receivable and inventory balances offset by an increase in accounts payable and other accrual balances. Interspeed's cash balance at March 31, 2000 was $10,000,000 and is solely available for use by Interspeed. On October 1, 1999, the Company's Board of Directors approved the purchase of up to one million shares of the Company's common stock during the twelve month period ending September 30, 2000. Through March 31, 2000, the Company had repurchased a total of 248,026 shares for a total cash purchase of $3,500,000. In August 1999, the Company renewed its working capital line of credit. Under the renewed line of credit, the Company may borrow up to $10,000,000 on an unsecured basis, all of which may be used for issuance of letters of credit, subject to compliance with certain covenants. The line of credit will expire in July 2000 and at that time any outstanding balances would be payable in full. Any amounts borrowed under the line would be subject to interest at the lender's prime rate. At March 31, 2000 there were no commitments outstanding on letters of credit; no borrowings have been made during any period presented. During the first three months of 2000, the Company invested approximately $2,000,000 in capital equipment. A substantial portion of this was related to the expansion of the Company's facilities. In addition, the Company invested approximately $2,000,000 on purchased software to support New Network applications. The Company currently has no material commitments for additional capital expenditures. The Company generated approximately $3,000,000 from the sale of common stock. There was a large volume of employee option exercises due to the stock price increase during the quarter. The Company anticipates that cash flows from operations from Brooktrout Technology together with current cash and marketable securities balances and funds available under the Company's line of credit, will be sufficient to meet the Company's working capital and capital equipment expenditure requirements for the foreseeable future. The Company believes that the remaining Interspeed IPO proceeds will be sufficient to meet anticipated Interspeed cash needs for working capital and capital expenditures at least until September 30, 2000. Thereafter, if cash generated from operations is insufficient to satisfy Interspeed's liquidity requirements, Interspeed may need to raise additional funds through public or private financing, strategic relationships or other arrangements. Recent Accounting Pronouncements In June of 1998, the Financial Accounting Standards Board released Statement of Financial Accounting Standards (SFAS) No. 133,"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133, as amended, establishes new standards of accounting and reporting for derivative instruments and hedging activities and will be effective for the Company in 2001. Management is currently evaluating the effect of adopting SFAS No. 133 on the condensed consolidated financial statements. In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." SAB No. 101 summarizes certain of the 17 18 Securities and Exchange Commission's views in applying generally accepted accounting principles to revenue recognition in financial statements and will be effective for the Company in the fourth quarter of 2000. Management does not believe that SAB No. 101 will have a material impact on the condensed consolidated financial statements. 18 19 RISK FACTORS You should carefully consider the following risk factors before you decide to buy the Company's common stock. The Company's business, financial condition or results of operations could be harmed by any of the following risks. 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: - the Company's ability to develop, manufacture, market and support its products and product enhancements; - the timing and amount of, or cancellation or rescheduling of, orders for the Company's products; - the Company's ability to hire, train and retain key management, sales and marketing and engineering personnel; - announcements or technological innovations by the Company's competitors or in competing technologies; - the Company's ability to obtain sufficient supplies of sole or limited source components for the Company's products; - a decrease in the demand for the Company's stock; - a decrease in the average selling prices of the Company's products; - changes in costs of components which the Company includes in its products; and - the mix of products that the Company sells and the mix of distribution channels through which they are sold. Due to these and other factors, revenues, 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. IF THE COMPANY IS UNABLE TO ATTRACT OR RETAIN KEY PERSONNEL, IT MAY BE UNABLE TO SUCCESSFULLY OPERATE ITS BUSINESS. 19 20 The Company's success depends on a large part upon the continued contributions of its key management, sales and marketing and engineering personnel, many of whom perform important-functions and would be difficult to replace. The Company does not have employment contracts with its key personnel. In addition, in order to grow its business, the Company must increase the number of engineering, sales, customer support and administrative personnel. There is 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 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, marketing, 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 have sufficient resources to continue to make the investments or 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 OEM's 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 its products. These customers often consider in-house development of technologies and products as an alternative to doing business with the Company. For example, during 1999, Lucent designed a product that will replace the Merlin Legend Mail and Partner Mail products manufactured by the Company. As a result, future sales of these products will be limited to field replacement units and repairs. The Company cannot assure 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 revenues 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. 20 21 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: - rapid technological advances: - evolving industry standards; - changes in customer requirements; - frequent new product introductions; - emerging competition; and - evolving offerings by telecommunications service providers. 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. The introduction of new or enhanced products also requires that the Company manage the transition from older products 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 which 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 time 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. 21 22 In addition, the Company currently uses a number of independent manufacturers to manufacture printed circuit boards, chassis and subassemblies to its design. The Company's reliance on independent manufacturers involves a number of risks, including the potential for inadequate capacity, 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 and qualities, the Company will have to transfer manufacturing to acceptable alternative manufacturers whom 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 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. THE COMPANY'S REVENUE GROWTH DEPENDS SIGNIFICANTLY ON THE TIMELY DEVELOPMENT AND LAUNCH OF NEW PRODUCTS AND PRODUCT ENHANCEMENTS, AND THE COMPANY CANNOT BE SURE THAT ITS NEW PRODUCTS WILL GAIN WIDE MARKET ACCEPTANCE. The telecommunications equipment and services market is characterized by rapid technological change, which requires continual development and introduction of new products and product enhancements that respond to evolving customer needs and industry standards on a timely and cost-effective basis. Successfully developing new products requires the Company to accurately anticipate technological evolution in the telecommunications industry as well as the technical and design needs of its customers. In addition, new product development and launch require significant commitments of capital and personnel. Failure to successfully update and enhance current products and to develop and launch new products would harm the Company's business. In addition, failure of the market to accept the Company's new products could negatively impact the Company's business, results of operations and financial condition. 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 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 errors that it believes would be considered serious by its customers before implementation, the Company's products may not be error-free. The Company also provides warranties against defects in materials and workmanship on its products that range, depending on the product, generally from twelve months to five years. However, errors or performance problems could result in lost revenues or customer relationships and could be detrimental to the Company's business and reputation generally. Additionally, reduced market acceptance of the Company's services due to errors or defects in its technology would harm its business by reducing its revenues and damaging its reputation. 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 22 23 which its products are used by its customers have not had a material negative effect on its business. However, the Company cannot be certain that a material negative effect will not occur 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. 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 have a material adverse effect upon 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 it 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. The Company is unable to predict the impact, if any, that future legislation, legal decisions or regulations relating to telecommunications or the internet may have on its business, financial condition and results of operations. 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 and services, either of which could restrict the Company's business or increase its cost of doing business. PROVISIONS IN THE COMPANY'S CHARTER AND BY-LAWS 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: - right of the Board of Directors, without stockholder approval, to issue shares of preferred stock and to establish the voting rights, preferences, and other terms thereof; - the right of the Board of Directors to elect a director to fill a vacancy created by the expansion of the Board of Directors; - the ability of the Board of Directors to alter the Company's by-laws without prior stockholder approval; - the election of three classes of directors to each serve three year staggered terms; - the elimination of stockholder voting by consent; - the removal of directors only for cause; - the vesting of exclusive authority in the Board of Directors (except as otherwise required by law) to call special meetings of stockholders; and 23 24 - certain advance notice requirements for stockholder proposals and nominations for election to the Board of Directors. 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. 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 revenues. The Company relies upon a combination of 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 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 it 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. The Company has recently entered into an agreement in principal to settle such litigation. Although the Company believes that its proprietary rights do not infringe on 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 affect upon the Company's operating results. If any legal action claiming patent infringement is commenced against it, the Company cannot 24 25 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. 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 its products and services from third parties. For example, the Company has obtained licenses from third parties of software for 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. 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. If sales forecasted from a specific customer for a particular quarter are not realized in that quarter, the Company may fail to achieve its revenue goals. THE AVERAGE SELLING PRICES OF THE COMPANY'S PRODUCTS MAY DECREASE, WHICH COULD ADVERSELY AFFECT GROSS MARGINS AND REVENUES. Competitive pressures and rapid technological change may cause decreases of the average selling prices of the Company's products and services. In addition, as many of the Company's target customers are large OEM's with significant market power, the Company may face pressure from them for steep discounts in its pricing. Any significant erosion in the Company's average selling prices could impact its 25 26 gross margins and have a material adverse effect on the Company's business, financial condition and results of operations. THE COMPANY'S REVENUE GROWTH DEPENDS SIGNIFICANTLY ON THE TIMELY DEVELOPMENT AND LAUNCH OF NEW PRODUCTS AND PRODUCT ENHANCEMENTS, AND THE COMPANY CANNOT BE SURE THAT ITS NEW PRODUCTS WILL GAIN WIDE MARKET ACCEPTANCE. The telecommunications equipment and services market is characterized by rapid technological change, which requires continual development and introduction of new products and product enhancements that respond to evolving customer needs and industry standards on a timely and cost-effective basis. Successfully developing new products requires the Company to accurately anticipate technological evolution in the telecommunications industry as well as the technical and design needs of its customers. In addition, new product development and launch require significant commitments of capital and personnel. Failure to successfully update and enhance current products and to develop and launch new products would harm the Company's business. In addition, failure of the market to accept the Company's new products could negatively impact the Company's business, results of operations and financial condition. THE COMPANY DERIVES A SIGNIFICANT PORTION OF ITS REVENUES FROM INTERNATIONAL SALES. The Company believes a material portion of its domestic sales results in the use of its products outside North America. 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 which 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. The Company cannot assure a shareholder that it will not encounter delays in obtaining approval in a foreign jurisdiction. These or other factors may limit the Company's ability to sell its products and services in other countries, which could 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 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 errors that it believes would be considered serious by its customers before implementation, the Company's products may not be error-free. The Company also provides warranties against defects in materials and workmanship on its products that range, depending on the product, generally from twelve months to five years. However, errors or performance problems could result in lost revenues or customer relationships and could be detrimental to the Company's business and reputation generally. Additionally, reduced market acceptance of the Company's services due to errors or defects in its technology would harm its business by reducing its revenues and damaging its reputation. 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 26 27 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 negative effect on its business. However, the Company cannot be certain that a material negative effect will not occur in the future. 28 28 PART II. OTHER INFORMATION Item 1. Legal Proceedings On September 22, 1998, Syntellect Technology Corp. ("Syntellect") served the Company with notice that it intended to pursue arbitration of a claim based on an alleged infringement and breach of a patent license agreement. On October 22, 1998, Syntellect filed a demand for arbitration, with the American Arbitration Association in which Syntellect asserted that the Company failed to pay certain royalties under the patent license agreement. On June 15, 1999, Aspect Telecommunications Corporation joined the arbitration as a claimant. On January 31, 2000, Syntellect and the Company reached an understanding on terms under which the matter would be settled. The arbitration proceedings have been stayed pending final resolution of this settlement. On April 3, 2000, Syntellect and the Company finalized a settlement agreement to resolve the matter, and the arbitration proceeding has been dismissed with prejudice. The settlement will not have a material impact on the Company's consolidated financial position or results of operations. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits (a) Exhibits 27. Financial Data Schedule (as restated) (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarterly period ended March 31, 2000. 29 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Amendment No.2 on Form 10-Q/A to be signed on its behalf by the undersigned thereunto duly authorized. BROOKTROUT, INC. Date: November 16, 2000 By: /s/ Eric R. Giler ----------------------------- Eric R. Giler President (Principal Executive Officer) Date: November 16, 2000 By: /s/ Robert C. Leahy ----------------------------- Robert C. Leahy Vice President of Finance and Operations and Treasurer (Principal Financial and Accounting Officer) 30