-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RpdzCw+q9bJbReRNr6m5OtGSbQrA5RXR/szf941FZw1e2YvFxAP2YrM1VGHQrKvi nkRGPBkuq6TnL9OG5ncYVw== 0000950135-98-001985.txt : 19980331 0000950135-98-001985.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950135-98-001985 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: BROOKTROUT TECHNOLOGY INC CENTRAL INDEX KEY: 0000754516 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 042814792 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-20698 FILM NUMBER: 98577713 BUSINESS ADDRESS: STREET 1: 410 FIRST AVE CITY: NEEDHAM STATE: MA ZIP: 02194 BUSINESS PHONE: 6174494100 MAIL ADDRESS: STREET 1: 410 FIRST STREET 2: 410 FIRST CITY: NEEDHAM STATE: MA ZIP: 02194 10-K405 1 BROOKTROUT TECHNOLOGY, INC. 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from __ to__. Commission File No. 0-20698 BROOKTROUT TECHNOLOGY, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2184792 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 410 FIRST AVENUE, NEEDHAM, MASSACHUSETTS 02194 (Address of principal executive offices)(Zip Code) Registrant's telephone number, including area code: (781) 449-4100 Securities registered pursuant to Section 12(b) of the Act: None NAME OF EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED --------- ---------- Securities registered pursuant to Section 12(g) of the Act: Common Stock (Title of Class) 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 20, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $164 million, based on the closing price on such date of the Company's Common Stock on the Nasdaq National Market ("Nasdaq"). As of March 20, 1998, 10,753,834 shares of Common Stock, $.01 par value per share, were outstanding. 2 DOCUMENTS INCORPORATED BY REFERENCE Portions of (i) the Company's Annual Report for the fiscal year ended December 31, 1997 are incorporated into Part II of this Form 10-K and (ii) the Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders of the Company are incorporated into Part III of this Form 10-K. "TR114", "Universal Port", "QuadraFax", "Show N Tel", "BTStack323", "PowerBlock" and "IP/FaxRouter" are trademarks of Brooktrout Technology, Inc. "TR Series" and "TruFax" are registered trademarks of Brooktrout Technology, Inc. "MVIP" is a trademark of Natural MicroSystems, Inc. "Touch-Tone" is a registered trademark and "UNIX"is a trademark of AT&T. "Merlin" is a registered trademark and "Legend", "Merlin Legend", "Merlin Mail", "Merlin Multi-Lingual Version" and "Partner Mail" are trademarks of Lucent Technologies, Inc. ("Lucent".) "Microsoft" and "MS-DOS" are registered trademarks and "Microsoft Windows Sound System" and "Windows NT" are trademarks of Microsoft Corporation. "OS/2" is a registered trademark of International Business Machines Corp. "UnixWare" is a trademark of Univel. "QNX" is trademark of QNX, Inc. "Netaccess" and "Instant ISDN" are trademarks of Netaccess, Inc. "Instant RAS" is a registered trademark of Netaccess, Inc. 3 PART I BUSINESS Brooktrout Technology, Inc. ("Brooktrout" or the "Company") is a Massachusetts corporation founded in 1984 to design, manufacture and market computer hardware and software for use in electronic messaging applications in telecommunications and networking environments. Brooktrout is a supplier of advanced software and hardware products for system vendors and service providers in the electronic messaging market. The Company's products enable its customers to deliver a wide range of solutions for the integration and management of image (fax), voice and data communications in telecommunications and networking environments. The Company sells its products primarily to service providers, original equipment manufacturers ("OEMs") and value added resellers ("VARs") both domestically and internationally through a direct sales force. The Company has direct sales offices in California, Illinois, Maryland, New Hampshire and Massachusetts and has established sales and support offices in Belgium, England and Singapore. The Company's international sales efforts, principally exports from the United States, are initiated from corporate headquarters in the United States and internationally located sales and support offices. In addition to direct international sales, significant additional revenue is derived from international sales by Brooktrout's customers of systems which incorporate Brooktrout's products. On April 1, 1993, the Company acquired all of the assets of DAFcom Corporation ("DAFcom"), a producer of fax routing products for private data networks. DAFcom, based in Dallas, Texas, is now operating as a wholly owned subsidiary of the Company under the name "Brooktrout Networks Group, Inc." On May 29, l996, the Company acquired Technically Speaking, Inc. ("TSI"), a supplier of graphical, object-oriented software application development tools for the electronic messaging market. TSI is now operating as a division of the Company. On June 30, 1997, the Company acquired the assets and assumed certain liabilities of Netaccess, Inc. (Netaccess), a worldwide supplier of Primary Rate and Basic Rate ISDN network interface products and multiport modem products for standards-based, open remote access and computer telephony systems. Netaccess is now operating as a wholly-owned subsidiary of the Company. During 1997, the Company formed Interspeed, Inc., a new subsidiary that will focus exclusively on high-speed network access in the data communications segment. BROOKTROUT'S PRODUCTS 4 The Company's first products were voice processing boards and voice mail systems based on those boards. The Company became a significant supplier of personal computer-based voice mail systems to OEMs of small telephone systems. As it developed its voice processing business, the Company began to explore computer-based fax processing using digital signal processing ("DSP") technology. DSP is a technology which permits the complex signals transmitted through the telecommunications network, including voice and fax signals, to be interpreted and rapidly processed in much the same manner as basic numerical data. The Company introduced its first TR Series fax processing product in 1987 and followed this with more advanced fax products in subsequent years. In addition to hardware products, the Company has emphasized the development of firmware and software development tools that support rapid and flexible applications development by software developers. Initially the Company began making software drivers for its hardware products. In August 1991, the Company introduced a higher-level TR Series Fax & Voice Applications Programming Interface ("API"). The API provides a development environment which permits access to the functionality of Brooktrout's TR Series hardware products. Using the API, a developer of fax or voice software may readily program commands to direct a TR Series hardware product to carry out any of its signal processing functions by calling routines within the API that interpret the program's instructions in the form of detailed hardware commands. In May 1996, the Company added Show N Tel, a graphical object oriented software application development tool to the software product line through the acquisition of TSI. In 1993, the Company formed Brooktrout Networks Group, Inc., through the acquisition of all of the assets of DAFcom, to develop a new product which provides fax networking solutions. In June 1997, the Company added multi-channel Primary Rate ISDN, multi-channel Basic Rate ISDN, and multiport modem products by acquiring Netaccess, Inc. These products provide data communications and networking capabilities for remote access applications and for integration into computer telephony systems. In June 1997, the Company introduced the Brooktrout Open System Telephony architecture (BOSTON), a next generation Universal Port software architecture for electronic messaging applications. BOSTON will enable the Company to provide (i) a comprehensive universal port development environment for electronic messaging applications, (ii) development tools that have the potential to reduce the time and cost of maintaining application software, and (iii) cost-effective DSP resource boards for a wide variety of applications and system configurations. In September 1997, the Company announced that it would add to its TR Series product line new software and hardware products for real-time transmission of voice and fax over packet data networks using the Internet Protocol (IP). These products include DSP resource boards, firmware, communication protocol "stacks" and enhancements to the TR Series API, all of which will be integrated into the BOSTON architecture. 5 The Company has six major product lines, all of which serve the electronic messaging market: fax and voice processing boards, IP telephony boards, network interface boards, application development tools, fax systems, and OEM systems. The following table describes Brooktrout's principal products and the markets which they serve:
Products Description Target Customers -------- ----------- ---------------- Fax & Voice Processing Boards TR114 Series Universal Port Fax & Multichannel boards with Service providers, OEMs Voice boards advanced fax and voice and VARs implementing processing capabilities medium to high density available with 2, 4, 8,12 or 16 fax and voice systems channels/board TruFax Series Fax boards Two channel fax boards with OEMs and VARs general purpose features implementing low density, general purpose fax systems IP/Telephony Boards TR2000 Series boards Multichannel boards that Service providers and support real-time voice and fax OEMs implementing transmission over IP networks medium and high density "gateways" and other IP telephony systems Network Interface Boards PRI/BRI WAN Interface boards Multi-span ISDN/T1/E1/BRI OEMs and system boards for data, voice, video integrators implementing applications available in data networking and multiple bus types computer telephony applications Instant RAS Open Remote Access A family of remote access VARs and system Server products software and hardware for integrators providing industry standard platforms remote access solutions providing analog and digital for office and connectivity departmental applications Application Development Tools TR Series API C-language application Service providers, OEMs development software for the and VARs developing TR Series and TruFax boards high performance fax and voice applications with specific custom requirements
6 Show N Tel A graphical, object-oriented Service providers, OEMs development environment for and VARs developing enterprise-wide voice, fax and enterprise computer computer telephony telephony systems applications seeking an easy-to-use application development and prototyping tool Fax Systems IP/FaxRouter An embedded system platform OEMs and VARs for routing faxes over the providing solutions for Internet and other IP networks businesses with high fax transmission expenses that have access to the Internet or other IP network services OEM Systems Lucent Technologies, Inc.'s Voice messaging systems Provided to Lucent on a MerlinMail and designed for Lucent's Merlin private label basis for sale PartnerMail systems Partner and Merlin Legend to purchasers of Merlin telephone switches Partner and Merlin Legend telephone systems
Fax, Voice & Data Messaging TR114 Series. Introduced in 1992 and periodically enhanced since then, the TR114 Series Universal Port boards are designed for high performance fax and fax and voice messaging systems, such as those used by telecommunications service providers, messaging system vendors and network communication server vendors. The TR114 Series Universal Port boards offer full fax and voice processing on each channel of a single multi-channel board. Advanced fax and voice features, such as file conversions and file transfer protocols, are supported on the TR114 Series. Boards are available in a range of configurations; with two, four, eight, twelve or sixteen channels per board. The TR114 Series boards are designed to be approved by telecommunications regulatory agencies worldwide and have been approved for use in 32 countries including the United States, Japan, England, France and Germany. The range of the TR114 Series configurations allows developers flexibility in designing systems from small corporate systems to large telephone company service systems cost effectively. The TR114 Series two and four channel analog boards support loop start, DID, and Basic Rate ISDN telephone service. The TR114 Series boards are designed to be used in ISA and PCI-bus computers which may be used as platforms for smaller systems, and special purpose computers providing expansion slots for up to 20 boards to serve the needs of large service providers. TR114 Series four, eight, twelve and sixteen channel digital boards with interfaces for popular Pulse Code Modulation ("PCM") highways, such as MVIP, SC Bus and PCM Expansion Bus ("PEB"), offer developers options in designing systems for digital network services (such as T1, E1 and ISDN) or with other resources, such as voice recognition, from other vendors. 7 TruFax Series. Released in January 1995, the TruFax Series fax boards are fax processing boards designed for small to medium scale, general purpose fax servers and systems. TruFax Series products incorporate many of the functions that contribute to the high reliability of TR114 Series products but do not support many of their advanced fax features, or voice processing. TruFax Series products are lower-priced than TR Series products. The first TruFax Series product, the TruFax 200, is a two channel fax board. At the core of each channel is a fax modem controlled by a microprocessor. The TruFax 200 is available with loop start telephone system interfaces. IP/Telephony Boards TR2000 Series. Announced in September 1997, the TR2000 Series IP/Telephony boards are designed for systems that send voice and fax communications over packet data networks based in the Internet Protocol (IP). These systems are being developed for use by service providers as well as enterprises that will use IP networks, rather than the public switched telephone network, for voice and fax communications. TR2000 Series products offer up to 60 channels of real-time voice and fax processing on each channel of a multichannel board. The boards include integrated interfaces to selected digital telephone networks. In addition, the boards include interfaces to PCM buses to enable system developers to connect to digital network interface boards for connection to networks not supported by the on-board telephone interface. Network Interface Boards Netaccess PRI/BRI ISDN/TI/E1 Interfaces. Originally introduced in 1991 and periodically enhanced since then, the Netaccess ISDN interface boards give OEMs and systems integrators easy to implement digital wide area network interface solutions. When combined with Netaccess' Instant ISDN Software and application interface, customers can develop data networking and computer telephony solutions quickly with certifications in a large number of jurisdictions throughout the world. Boards are available in several bus formats including ISA, VME, and PCI with up to four interfaces per board and include computer telephony interfaces such as MVIP. Instant Remote Access Server Products. Introduced originally in 1995 as the Multiport Modem product, the Instant RAS product family provides remote access capability for industry standard platforms, such as Microsoft's Windows NT Server. These products are designed for end users requiring economical access to corporate networks through a variety of connection mechanisms, including analog modem and digital ISDN interfaces. Instant RAS products provide reliable, easy to install and maintain, and low price per port connections for small offices, branch offices, departments of larger corporations, and small Internet Service Providers. These products leverage Netaccess' expertise in developing network interface products for its OEM partners. Application Development Tools TR Series API. The TR Series API, originally introduced in 1991 and periodically enhanced since then, enables developers to quickly develop sophisticated fax and voice applications. It is being enhanced to incorporate support for Netaccess network interface products and real-time voice and fax on IP networks. The API is a complete C language library of fax, voice, tone signaling and call processing function calls. It also includes BTStack323 - an H.323 protocol stack, time-saving sample applications, utilities and debugging tools. The API is operating-system independent and will support most operating systems, including Windows NT, UNIX, UnixWare, AIX, Solaris, QNX, OS/2, Windows 95 and MS DOS. Applications developed with the API run on all of the Company's TR Series and TruFax Series products that support the features. 8 Show N Tel. Show N Tel is a graphical, object-oriented development and prototyping environment for enterprise-wide, client/server voice, fax, and computer telephony applications. It is designed to simplify and reduce the time to develop complex applications. Show N Tel provides a library of over 200 PowerBlocks; graphical icons that represent common operations in computer-telephony applications. Developers create applications by connecting these icons on a drag-and-drop template. In addition to the core voice, fax and computer telephony functions, optional components are available to support functions such as database access, speech recognition, speech synthesis (text-to-speech) and fax document creation. Show N Tel supports Microsoft's Windows NT. Fax Systems IP/FaxRouter. In June l996, Brooktrout introduced the IP/FaxRouter, an Ethernet peripheral which sends facsimile traffic via IP wide area networks including the Internet. The IP/FaxRouter was developed to address the escalating costs associated with facsimile transmission. By routing fax traffic over IP data networks like the Internet, it can reduce or eliminate fax transmission charges normally incurred from the telephone company. In organizations with significant international fax traffic, the IP/FaxRouter can significantly reduce telephone charges by routing faxes over an existing data network. Configuration Network Management System ("CNMS") software and Account Data Management System ("ADMS") software are also available with the IP/FaxRouter for centralized and remote system management as well as tracking account activity in service organizations. OEM Systems Merlin Legend Mail and Partner Mail Since 1990, Brooktrout has been the supplier of the Merlin Mail voice messaging/automated attendant system for the Lucent Merlin small business telephone system. In 1991, the Company introduced a second generation of Merlin Mail designed for Lucent's Merlin Legend system, a new, small business telephone system. In 1992, the Company introduced the Partner Mail voice messaging/automated attendant system for Lucent's Partner small business telephone system. In 1993, the Company introduced the third generation of Merlin Mail: Merlin Mail Multi-Lingual Version which incorporates English, Spanish and French languages in one system and is integrated with Lucent's Merlin Legend system. In 1997, the Company began shipping Merlin Legend Mail which delivers the Merlin Mail application software in a low-cost board integrated into the Merlin Legend system. The Merlin Mail, Partner Mail, Merlin Legend Mail and Merlin Mail Multi-Lingual Version products are based on the voice boards developed and manufactured by the Company. SALES AND MARKETING The Company markets its products primarily to service providers, OEMs and VARs. The TR Series, TruFax Series, Show N Tel and IP/Fax Router products provide fax and voice processing, computer telephony or fax routing functionality for systems sold by these customers. Network interface boards provide analog and digital connectivity for data, voice and video applications in multiple bus types. The Company's OEM systems encompassing a complete solution are sold to Lucent as part of that customer's products sold to end users. Service Providers and OEMs Providers of enhanced telecommunications services develop, or purchase from developers, large, complex systems incorporating the Company's products to deliver electronic messaging applications. These systems typically require long development times and result in periodic deployments of large systems. OEMs design, manufacture and market electronic messaging systems that include the Company's products. OEMs generally have long product design and development processes that precede the release of products. 9 Making sales to both of these types of customers can be a complex and time-consuming process which is often focused on technical requirements. To serve these customers in North America, the Company sells its products through a direct sales force located in Massachusetts, California, Connecticut, Illinois, Maryland and New Hampshire. VARs VARs typically purchase the Company's products for resale to an end-user customer together with application software purchased from an ISV. The Company has established a network of resellers, including many who are designated Brooktrout Authorized Resellers. The Company employs direct sales people and manufacturers' representatives to recruit, train and assist VARs. The Company also uses two tier distribution for some of its network interface and multiport modem products, utilizing national distributors who then sell to VARs. International The Company sells its products to service providers, OEMs and VARs internationally through a direct sales force organized by region. The Company has established sales offices in Belgium, England and Singapore. The Company's international sales efforts are initiated from corporate headquarters in the United States and internationally located sales and support offices. International sales, principally exports from the United States, accounted for approximately $13.4 million or 19% of revenue for the year ended December 31, 1997, $10.6 million or 18% of revenue for the year ended December 31, 1996 and $4.3 million or 11% of revenue for the year ended December 31, 1995. In addition to direct international sales, significant additional revenue is derived from international sales by Brooktrout's customers of systems which incorporate Brooktrout's products. 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. Approval of the Company's fax products in Germany, France and Japan has taken up to twelve months or more. The Company does not believe that these delays have had a material impact on the Company's operations. The Company has not yet encountered any situation in which it has proved impossible to obtain approval in a foreign jurisdiction. The Company, its distributors or its customers have received product approvals for certain Brooktrout fax and voice products from agencies in Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Malaysia, Netherlands, New Zealand, Singapore, Sweden, Switzerland, Mexico, Ireland, Norway, Denmark, India, Czech Republic, the United Kingdom, Austria, Belgium, Finland, Greece, Luxembourg, Portugal, Spain, China, Thailand, Argentina, Iceland and the United States. TECHNICAL SUPPORT Brooktrout seeks to deliver unmatched support and service to customers. By listening to customers and thoroughly understanding their requirements, the Company believes it can provide innovative high-value products which meet or exceed customer expectations. Beyond delivery, Brooktrout backs its products with responsive engineering level support. Generally, the Company's technical support staff members hold bachelor's degrees in electrical engineering or computer science. Staff members place the highest priority on providing timely, accurate information as well as advice on how to take advantage of Brooktrout's sophisticated product line. Brooktrout's technical support personnel have been a source of product improvements and new features and functions due to close working relationships with customers. Brooktrout's technical support department reports directly to the Company's President as further evidence of Brooktrout's commitment to provide partnership-level support to customers. The Company's technical support activities represent an integral element of its marketing strategy. The Company believes that its technical support capability represents a significant competitive advantage. 10 The Company warrants its hardware products against defects in materials and workmanship generally for twelve to eighteen months. Extended warranties of up to three years have been provided to some customers for additional consideration. The Company ordinarily sells its products on the basis of purchase orders received from customers. The Company has entered into agreements with many of its customers which establish terms and conditions for sales made under these agreements from time to time. These agreements generally do not establish any long-term fixed purchase or supply commitments for either party. In 1995, 1996 and 1997, sales to Lucent, the Company's largest customer, accounted for 36%, 33%, and 30% respectively, of the Company's total revenues. The Company sells essentially all of its major products to a number of separate business units within Lucent, although sales of the Merlin Legend Mail, Merlin Mail Multi-Lingual Version and Partner Mail systems have constituted 81%, 88% and 82% of the revenue from Lucent in 1995, 1996 and 1997, respectively. Merlin Legend Mail and Partner Mail and other products are sold to Lucent under purchase orders issued by Lucent on an as-required basis. The Company and Lucent consult closely with respect to expected future requirements and timing of orders. No other single customer accounted for more than 10% of the Company's total sales in 1995, 1996 or 1997. PRODUCT DEVELOPMENT The market for electronic messaging products is characterized by rapid technological change, changes in customer requirements, frequent new product introductions and enhancements and emerging industry standards. The Company focuses significant resources on improving its products in response to changes in operating systems, application software, computer and telephony hardware, networking software, programming tools and computer language technology. During the years ended December 31, 1995, 1996 and 1997 the Company spent approximately $4.8 million, $7.2 million and $13.6 million, or 12%, 12% and 19% of revenue, respectively, on research and development. Research and development expenses have generally been charged to operations as incurred. The Company is continuing its development efforts for its current products, as well as developing next generation versions of its current products. The Company believes significant investments in product development are required to remain competitive. As a consequence, the Company intends to continue to increase the dollar amount of its product development expenditures in the future. The Company believes that its software and hardware development team provides a significant competitive advantage for the Company. The team is comprised of members with experience in computer-based fax, voice processing, telephony, device driver development, object-oriented software development, graphical user interface ("GUI") development, and computer networking. The Company believes this assembly of diverse technical expertise contributes to the highly integrated functionality of its products. The Company's ability to attract and retain highly qualified employees will be one of the principal determinants of its success in maintaining technological leadership. COMPETITION The Company is in direct competition with companies offering similar products or products responsive to similar applications in each of its six major product lines. In addition, there is always the potential for new entrants into the Company's markets by other companies in related computer and communications companies including the Company's customers and suppliers. The Company believes that the principal competitive factors affecting the market for the Company's products and services include product functionality and features, product quality, performance and price, ease of product integration, and quality of customer support services. The relative importance of each of these factors depends upon the specific customer environment. Although the Company believes that its products and services currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors. 11 Many of the Company's current and potential competitors have longer operating histories, significantly greater financial, technical, product development and marketing resources, greater name recognition and larger customer bases than the Company. The Company's present or future competitors may be able to develop products comparable or superior to those developed by the Company, adapt more quickly than the Company to new technologies, evolving industry trends or customer requirements, or devote greater resources to the development, promotion and license of their products than the Company. Accordingly, there can be no assurance that competition will not intensify or that the Company will be able to compete effectively in its market. The Company expects that it will face increasing pricing pressures from its current competitors and new market entrants. The Company's competitors may engage in pricing practices that cause the Company to reduce the average selling prices of its products. To offset declining average selling prices, the Company believes that it must successfully develop and introduce on a timely basis new products or products that incorporate new features that can be sold at gross margins comparable to those on existing products. To the extent that such new products are not developed in a timely manner, do not achieve customer acceptance or do not generate comparable gross margins, the Company's profitability may decline. BACKLOG At December 31, 1997, the Company's backlog of orders for products and services was approximately $12,532,000 compared with approximately $11,362,000 at December 31, 1996. All of the backlog is expected to be shipped or provided before the end of 1998. All orders believed to be firm for products or services to be shipped or provided in the future are included in the backlog. The Company regards all orders as firm orders and has experienced an order cancellation rate in the past which the Company considers to be immaterial, although no assurance can be given that adverse effects may not result from order cancellations in the future. Because of the possibility of customer changes in delivery schedules or cancellation of orders, the Company's backlog as of any particular date may not be indicative of actual sales for any particular future period. The period of time between placement of an order and delivery of the product varies from one day for certain TR Series products to ten months for certain OEM systems products. MANUFACTURING Brooktrout's manufacturing operations consist primarily of final assembly and testing of components, subsystems and systems. The Company tests its products at various stages in the manufacturing process. Each product undergoes a final load and functional test at the Company's Needham, Massachusetts or Salem, New Hampshire facility prior to shipment. The Company uses independent manufacturers, one of which is Lucent, to perform printed circuit board assembly and testing. The Company believes it has good relationships with its subcontractors and has generally experienced timely delivery of products and satisfactory quality with respect to products manufactured by subcontractors. In December 1995, the Company's Needham, Massachusetts facility achieved ISO 9002 certification. PROPRIETARY TECHNOLOGIES The Company does not hold patents on a large part of its product line. The Company's software and firmware are protected by copyright laws. Because on-board and downloadable firmware represent an important element of the value of the Company's hardware products, the Company believes that it obtains significant protection for its proprietary interest in its hardware products, as well as its software products, from copyright laws. Certain design features, including ASICs (application specific integrated circuits), software and firmware, receive some protection under trade secret laws. 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 12 information of the Company. There can be no assurance, however, that copyright and trade secret protection will be sufficient to prevent competitors from developing software and other technology similar to the software and other technology upon which the Company relies for a significant portion of its revenue. The Company has acquired licenses under certain patents covering aspects of voice processing technology, and licenses from third parties of software for its voice and fax products. The Company pays royalties under these licenses with respect to its sales of certain products. The licenses generally extend for the life of the patent in question (in the case of patents) or in perpetuity (in the case of software), and are subject to termination only in the event of a breach. Royalties constitute a percentage of sales of particular products or product elements, or a fixed amount per unit of hardware or software distributed, and do not account for a material part of the Company's cost of product sold. The Company has periodically received, and may receive in the future, communications from third parties asserting patent rights with respect to certain of the Company's products and features. The Company is a defendant in two patent infringement cases, which it believes will not have a material effect on the Company. Except as described under Legal Proceedings below, there is no pending litigation against the Company regarding any of these claims, nor has the Company to date believed it necessary to license any patent rights referred to in such communications, except as described above and except for certain other minor cases involving no payment of ongoing royalties. EMPLOYEES As of December 31, 1997, the Company had 260 full-time employees, of which 113 were engaged in engineering and product development, 30 in administration, 33 in manufacturing and 84 in sales, marketing and technical support. None of the Company's employees are represented by any labor union and the Company believes its relations with its employees are good. 13 Telecommunications Union -- Telephony (ITU-T) facsimile standards. Mr. Duehren is also a member of the Institute of Electrical Electronic Engineers (IEEE) and has been a member of the SCSA work group on facsimile API standards. Mr. Duehren received a Bachelor of Science degree and Master of Science degree in Electrical Engineering from the Massachusetts Institute of Technology. Patrick T. Hynes is a Company founder and has been Vice President of Advanced Product Engineering since January 1994 and a Director of Brooktrout from the Company's inception in 1984. Mr. Hynes was Vice President of Engineering from the Company's inception to December 1993. Mr. Hynes is a member of the Institute of Electrical Electronic Engineers (IEEE). Mr. Hynes received a Bachelor of Science degree in Electrical Engineering from the Massachusetts Institute of Technology and a Master of Science degree in Electrical Engineering from Columbia University. Stephen A. Ide has been Senior Vice President and President of Interspeed, Inc. since January 1997. Mr. Ide was Senior Vice President of Sales and Marketing of Brooktrout from January 1993 to December 1996 and was Vice President of Sales and Marketing of Brooktrout from July 1987 to December 1992. Prior to joining the Company, Mr. Ide was co-founder and president of Computer Telephone Corporation. Mr. Ide also served as vice president of operations for Rolm of New England Corporation. Robert C. Leahy has been Vice President of Finance and Operations and Treasurer of Brooktrout since March 1988. Prior to joining Brooktrout, Mr. Leahy held the position of corporate controller and treasurer for Cambridge Robotics. Mr. Leahy is an active member in the Financial Executive Institute. Mr. Leahy received a Bachelor of Science degree in accounting and a Master of Business Administration degree from Bentley College. R. Andrew O'Brien has been Vice President of Marketing and Business Development of Brooktrout since July 1993, and Director of Marketing and Business Development from January 1993 to June 1993. Prior to joining the Company, Mr. O'Brien was at McKinsey & Company from September 1986 to January 1993. Mr. O'Brien received a Bachelor of Arts degree from Yale University and a Master of Business Administration degree from Harvard Business School. Jonathan J. Sirota has been Vice President of Engineering of Brooktrout since January 1994. Prior to joining the Company, Mr. Sirota was Senior Vice President of Engineering and Operations for ERGO Computing, Inc. from March 1989 to January 1994. Mr. Sirota received a Bachelor of Science degree in Electrical Engineering from Rensselaer Polytechnic Institute and a Master of Science degree in Electrical Engineering from Massachusetts Institute of Technology. Michael E. Donoghue has been Vice President of Worldwide Sales since January 1997. Mr. Donoghue was Director of International Sales from January 1995 to December 1996 and Managing Director of Brooktrout Technology Europe in Brussels, Belgium from January 1993 to December l995. He was a National Sales Manager from January l990 to December l992 and was a Major Account Manager from December l987 to December l989. Mr. Donoghue received a Bachelors of Science in Mechanical Engineering from the University of Massachusetts Amherst in l987. William F. Rosenberger has been a Vice President of Brooktrout Technology, Inc., since June 1997 and President of Netaccess since 1996. Prior to becoming president of Netaccess, Mr. Rosenberger held various executive management positions in communications and networking companies including Wang Laboratories, ACSYS Incorporated, Netronix Incorporated and the Yankee Group. Mr. Rosenberger has a Bachelors of Science degree from the State University of New York. Mark Flanagan has been the Vice President of Brooktrout Technology, Inc. and the General Manager of its Software and Systems Division since January 1998. Prior to joining Brooktrout, Mr. Flanagan was executive vice president of Lernout & Hauspie's Dictation Division and general manager of its PC Applications Group. Previously, he held senior management positions with International Data Group, Lotus Development Corporation and International Thomson Organisation. Mr. Flanagan holds 14 a Bachelor of Arts degree from the University of Rochester and he also attended the School of Management at Boston College. ITEM 2. PROPERTIES The Company leases a stand-alone facility in Needham, Massachusetts that is approximately 38,000 square feet. The lease commenced March 1, 1996 and expires October 31, 2006. The facility accommodates corporate headquarters as well as research and development, engineering, manufacturing, sales, marketing and administration. The Company also occupies approximately 16,515 square feet in Southborough, Massachusetts, which it took over as a lessee in connection with its acquisition of TSI. This facility accommodates research and development, engineering and technical support. The lease for this facility commenced on May 1, 1995 and expires on April 30, 2001. In 1997, the Company signed an additional lease for space in Needham, Massachusetts for its manufacturing operations. The stand alone facility is approximately 31,000 square feet. The lease commenced April 7, 1997 and expires April 6, 2006. The Company leases approximately 26,000 square feet in Salem, New Hampshire, for Netaccess' administrative, sales, marketing, engineering, and manufacturing operations. This lease commenced on May 1, 1997 and expires on August 31, 2000. The Company also leases Netaccess sales office space in Columbia, Maryland and Sunnyvale, California both of which are leased for six month periods with automatic renewal clauses. The Company leases Brooktrout Networks Group, Inc. approximately 3,200 square feet in Richardson, Texas for research and development. The Company signed a new lease for this facility which commenced on February 1, 1998 and expires on January 31, 2001. The Company has also signed operating lease commitments for office space in Belgium, Singapore, California, Connecticut, and Illinois. The Belgium lease is for a period of 2 years and the California lease is for 5 years, while the rest of the leases are for 1 year or less. The Company believes that its present facilities are adequate for its current needs and that suitable additional space will be available as needed. ITEM 3. LEGAL PROCEEDINGS In August 1995, Spectron Miscrosystems, Inc. ("Spectron"), a subsidiary of Dialogic Corporation ("Dialogic") filed a lawsuit against the Company in Federal District Court for the District of New Jersey, alleging infringement by the Company's products of patents owned by the plaintiff and seeking damages, special damages and injunctive relief. The Company has filed an Answer and Counterclaim asserting noninfringement and further asserting that the patent was licensed to the Company, and seeking declaratory and monetary relief. In February 1996, on motion of the Company, this action was transferred to the Federal District Court for the District of Massachusetts. In November, 1995, the Company filed, in the Federal District Court for the District of Massachusetts, a lawsuit against Dialogic and certain affiliated parties, seeking rescission of a Settlement Agreement entered into in settlement of prior litigation, damages, special damages, an order vacating the dismissal of the previously litigated cases, and specific enforcement of an earlier agreement regarding the settlement. Dialogic filed an Answer and Counterclaim on January 30, 1996. The Counterclaim seeks an award of damages and special damages. 15 In December, l996, the Defendants' Motion for Summary Judgment on the Company's claims for rescission and specific enforcement in the litigation described above was allowed. The Company's claim for special damages under Chapter 93A of the Massachusetts General Laws and the Defendants' counterclaims remain to be litigated. On October 4, l996, Syntellect Technology Corp. ("Syntellect") filed a Complaint against the Company in the United States District Court for the Northern District of Texas, alleging infringement of certain patents held by Syntellect relating to certain aspects of "automated attendant" technology. Syntellect's Complaint does not identify the products of the Company which allegedly infringe Syntellect's patents. The Complaint seeks injunctive relief, damages in an unspecified amount, and multiple damages on account of alleged willful infringement. In December, l996, the Company filed a Motion to Dismiss the action, which was denied in July 1997. In October 1997, the Company filed a Motion for summary judgment in the action which remains pending. The Company is reviewing the patents at issue, and intends to defend the case vigorously. The Company believes that neither the currently pending litigated cases nor an adverse decision in any of such cases will have a material adverse effect on the Company's business, financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS None. 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS Information in response to this item appears under the caption "Stock Market Information" of the Company's Annual Report for the year ended December 31, 1997, which is incorporated in this report by reference. ITEM 6. SELECTED FINANCIAL DATA Information in response to this item appears under the caption "Selected Consolidated Financial Data" of the Company's Annual Report for the year ended December 31, 1997, which is incorporated in this report by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Information in response to this item appears under the caption "Management's Discussion & Analysis of Financial Condition and Results of Operations" contained in the Company's Annual Report for the year ended December 31, 1997, which is incorporated in this report by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information in response to this item is contained in the Company's Annual Report for the year ended December 31, 1997, which is incorporated in this report by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 17 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors. The information appearing under the caption "Information Regarding Nominees and Directors" of the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders is incorporated in this report by reference. Executive Officers. Information with respect to executive officers appears under the caption "Executive Officers" in Item 1 of this report. ITEM 11. EXECUTIVE COMPENSATION Information in response to this Item appears under the caption "Executive Compensation" of the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders, which is incorporated in this report by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information in response to this Item appears under the captions "Principal Stockholders" and "Ownership by Management of Equity Securities" of the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders, which is incorporated in this report by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. 18 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements The following is included in Part II of this report, incorporated by reference from the Company's Annual Report for the year ended December 31, 1997: Page No. - -------------------------------------------------------------------------------- Independent Auditors' Report Consolidated Balance Sheets as of December 31, 1997 and 1996 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Stockholders Equity (Deficiency) for the Years Ended December 31, 1997, 1996 and 1995 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements (a)(2) Financial Statement Schedule The following are contained on the indicated pages of this report: Page No. Independent Auditors' Report on Schedule......................... Schedule IX Valuation and Qualifying Accounts.................... Schedules not listed above are omitted because they are not required or because the required information is given in the Consolidated Financial Statements or Notes thereto. 19 (a)(3) Exhibits The following exhibits are filed as part of this report. Where such filing is made by incorporation by reference to a previously filed statement, such statement is identified. Exhibit No. Title - ---------------------------------------------------------------------------- 3.1 Restated Articles of Organization of the Company (1) 3.2 Amended and Restated By-laws of the Company (2) 4.1 Specimen certificate for shares of Common Stock, $.01 par value, of the Company (2) 10.1 Lease between the Company and Trustees of Needham 152 Second Avenue Trust dated April 7, 1997 11.1 Computation of Earnings Per Share 13.1 1997 Annual Report of Brooktrout Technology, Inc. 21.1 Subsidiaries of the Company (see exhibit 13.1) 23.1 Independent Auditors' Consent 27.1 Financial Data Schedule - ------------------------ (1) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, as filed on March 31, 1993. (2) Filed as an exhibit to the Company's Registration Statement on Form S-1 with respect to its initial public offering of Common Stock as initially filed on August 28, 1992 (File No. 33-51424). 20 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BROOKTROUT TECHNOLOGY, INC. By: /s/ Eric R. Giler --------------------------- Eric R. Giler President Date: March 27, 1998 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. Signatures Title Date /s/ President and Director (Principal - -------------------- Eric R. Giler Executive Officer) /s/ Vice President of Finance - -------------------- Robert C. Leahy and Operations and Treasurer (Principal Financial and Accounting Officer) /s/ Vice President and Director - -------------------- David W. Duehren /s/ Vice President and Director - -------------------- Patrick T. Hynes /s/ Director - -------------------- Robert G. Barrett /s/ Director - -------------------- David L. Chapman /s/ Director - -------------------- W. Brooke Tunstall 21 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Brooktrout Technology, Inc.: We have audited the consolidated financial statements of Brooktrout Technology, Inc. as of December 31, 1997 and 1996, and for each of the three years in the period ended December 31, 1997, and have issued our report thereon dated February 11, 1998; such consolidated financial statements and report are included in your 1997 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules of Brooktrout Technology, Inc., listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. By: /s/ Deloitte & Touche LLP -------------------------- Deloitte & Touche LLP Deloitte & Touche LLP Boston, Massachusetts February 11, 1998 22 SCHEDULE IX BROOKTROUT TECHNOLOGY, INC. VALUATION AND QUALIFYING ACCOUNTS (In Thousands)
BALANCE AT CHARGED TO BALANCE BEGINNING COST AND AT END OF YEAR EXPENSES DEDUCTIONS OF YEAR ------------------------------------------------------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: For the year ended December 31, 1995 $364 $157 $(72) $449 For the year ended December 31, 1996 $449 $144 $(69) $524 For the year ended December 31, 1997 $524 $748 $(108) $1,164 ACCRUED WARRANTY COSTS: For the year ended December 31, 1995 $364 $251 $(278) $337 For the year ended December 31, 1996 $337 $207 $(98) $446 For the year ended December 31, 1997 $446 $672 $(268) $850
EX-10.1 2 LEASE BETWEEN THE COMPANY AND THE TRUSTEES 1 EXHIBIT 10.1 152 SECOND AVENUE, NEEDHAM, MASSACHUSETTS Lease by and between Trustees of Needham 152 Second Avenue Trust LANDLORD and Brooktrout Technology, Inc. TENANT dated as of April 7, 1997 2 TABLE OF CONTENTS ARTICLE NUMBER CAPTION PAGE - ------ ------- ---- ARTICLE I RENT..................................................................2 1.1...................................................................2 1.2 Additional Rent - Operating Expenses............................3 ARTICLE II CONDITION OF PREMISES: DELIVERY OF PREMISES TO TENANT........................................4 2.1...................................................................4 2.2...................................................................4 ARTICLE III LANDLORD'S INTEREST AND ASSIGNMENT OF WARRANTIES......................4 3.1...................................................................4 3.2...................................................................4 ARTICLE IV TENANT'S COVENANTS....................................................4 4.1...................................................................5 4.2...................................................................5 4.3...................................................................6 4.4...................................................................6 4.5...................................................................6 4.6...................................................................6 4.7...................................................................7 ARTICLE V MAINTENANCE AND REPAIRS...............................................7 5.1...................................................................7 5.2...................................................................7 5.3...................................................................7 (i) 3 ARTICLE VI SERVICES............................................................. 8 ARTICLE VII IMPROVEMENTS......................................................... 8 ARTICLE VIII ALTERATIONS.......................................................... 9 8.1 Non-structural Changes......................................... 9 8.2 Structural Changes............................................. 9 ARTICLE IX INSPECTION...........................................................10 ARTICLE X FIRE, EMINENT DOMAIN, ETC............................................11 10.1 Abatement of Rent..............................................11 10.2 Landlord's Right of Termination................................11 10.3 Restoration....................................................11 10.4 Award..........................................................12 ARTICLE XI INSURANCE............................................................12 11.1 ...............................................................12 11.2 ...............................................................12 11.3 ...............................................................13 11.4 ...............................................................14 ARTICLE XII TAXES................................................................14 12.1 ...............................................................14 12.2 ...............................................................14 12.3 ...............................................................14 12.4 ...............................................................15 12.5 ...............................................................15 (ii) 4 ARTICLE XIII SIGNS................................................................15 ARTICLE XIV DEFAULT..............................................................15 14.1 ................................................................15 14.2 ................................................................18 ARTICLE XV NOTICES..............................................................18 ARTICLE XVI ASSIGNMENT AND SUBLETTING............................................18 16.1 ................................................................18 16.2 ................................................................19 ARTICLE XVII MISCELLANEOUS PROVISIONS.............................................19 17.1 Extra Hazardous Use............................................19 17.2 Waiver.........................................................20 17.3 Covenant of Quiet Enjoyment....................................20 17.4 Landlord's Liability...........................................20 17.5 Notice to Mortgagee or Ground Lessor...........................21 17.6 Assignment of Rents and Transfer of Title......................21 17.7 Tenant's Indemnity.............................................22 17.8 Additional Charges.............................................22 17.9 Invalidity of Particular Provisions............................22 17.10 Provisions Binding, etc........................................22 17.11 Recording......................................................23 17.12 When Lease Becomes Binding.....................................23 17.13 Paragraph Headings.............................................23 17.14 Rights of Mortgagee or Ground Lessor...........................23 17.15 Status Report..................................................23 17.16 Remedying Defaults.............................................24 17.17 Brokerage......................................................24 17.18 First Option to Extend.........................................24 17.19 Second Option to Extend........................................25 17.20 Governing Law..................................................26 (iii) 5 LEASE PARTIES: THIS LEASE, made as of the 7th day of April, 1997, by and between ARTHUR G. CARLSON, JR. and WILLIAM J. FORD, JR., as TRUSTEES OF NEEDHAM 152 SECOND AVENUE TRUST under Declaration of Trust dated October 30, 1972, and registered with the Norfolk Registry District of the Land Court as Document No. 329795 on Certificate of Title No. 94585, having an office c/o William J. Ford, Jr., 119 Maple Street, Sherbom, MA 01770 (hereinafter, the "Landlord") and Brooktrout Technology, Inc., a ______ corporation having an office at 410 First Avenue, Needham, MA 02194 (hereinafter, the "Tenant"). WITNESSETH: PREMISES: LANDLORD hereby leases to Tenant and Tenant hereby hires and takes from Landlord all of the gross floor area in the building (the "Building") known and numbered as 152 Second Avenue, Needham, Massachusetts (consisting of approximately 30,888 rentable square feet, subject to verification as hereinafter provided), and the land upon which the Building is located described in Exhibit A annexed hereto, together with the appurtenances including but not limited to all fixtures and equipment therein, including, without limitation, all underground storage tanks, and all common walkways and driveways necessary for access to the Building and the exclusive right to use the parking spaces located in the open parking area adjacent to the Building, and any replacements thereof (hereinafter, collectively, the "Premises"). The term "Lot" shall mean all right, title and interest of the Landlord in and to the land described in Exhibit A plus any additions or deletions thereto resulting from the involuntary change of any abutting street line. The term "Property" shall mean the Building and the Lot. At any time prior to the two (2) month anniversary of the Commencement Date, Tenant may, at its sole cost and expense, have Tenant's architect measure (utilizing the Boston BOMA standard method of measurement) and confirm the actual rentable square footage of the Premises ("Premises Rentable Area"). Tenant shall promptly provide Landlord with a copy of said architects findings. If Landlord disputes such findings, Landlord shall, at its sole cost and expense, have Landlord's architect measure (utilizing the Boston BOMA standard method of measurement) and confirm the actual rentable square footage of the Premises ("Premises Rentable Area"). If Landlord and Tenant are unable to agree to the actual Premises Rentable Area, then the matter shall be submitted to arbitration. USE: To be used and occupied by Tenant for general office, research and development, light manufacturing and warehouse uses, but excluding retail sales (the "Permitted Uses"). It is specifically understood and agreed that Landlord is making no representations or warranties 6 that any or all of the Permitted Uses are allowable as of right under the Needham Zoning By-Law, or that there are sufficient parking spaces on the Lot for any or all of Tenant's Permitted Uses pursuant to said Zoning By-Law, or that the Premises comply with any and all applicable laws, ordinances and regulations. Tenant acknowledges that it has had an opportunity to examine the relevant Needham Zoning By-Law and to make its own independent determination as to the compliance of the Premises with applicable zoning requirements and such compliance or non-compliance shall not be a condition precedent to Tenant's full performance of its obligations under this Lease. TERM: For a term (the "Term") of five (5) years, commencing on April 7, 1997 (the "Commencement Date") and expiring at the close of the day on April 6, 2002, unless extended in accordance with Section 17.18, and if so extended then unless further extended in accordance with Section 17.19 hereof. As used herein, the term "Lease Year' shall mean the period commencing on the Commencement Date through and including the close of the day on the twelve (I 2) month anniversary of the Commencement Date, and each successive twelve (12) month period during the Term of this Lease. THIS LEASE is made upon the following additional terms and conditions, which Landlord and Tenant covenant and agree to keep and perform: ARTICLE I RENT 1.1 Tenant shall pay, promptly when due, without notice or demand, the Annual Fixed Rent calculated as follows: Lease Year Annual Fixed Rent ---------- ----------------- 1 $7.00 per square foot of Premises Rentable Area 2-5 $7.50 per square foot of Premises Rentable Area. Annual Fixed Rent (sometimes hereinafter referred to as "Rent") shall be paid in equal monthly installments of one-twelfth of such Annual Fixed Rent in advance on the first day of each full calendar month during the Term, and the corresponding fraction of said one-twelfth for any period of less than one month at the beginning or end of the Term. 2 7 1.2 ADDITIONAL RENT - OPERATING EXPENSES 1.2.1 Tenant shall be responsible for contracting and paying for all services, including but not limited to utilities, necessary for the operation and maintenance and repair of the Property, and Tenant agrees to pay, or cause to be paid, all Operating Expenses for the Property. Operating Expenses for the Property shall include, without limitation, the following: (a) premiums for insurance carried with respect to the Property as set forth in Article M hereinbelow, (b) reasonable compensation and fringe benefits, workmen's compensation insurance premiums and payroll taxes paid to, or with respect to all persons actually engaged by Tenant in the operating, maintaining, or cleaning of the Building or Lot, (c) steam, water, sewer, electric, gas, oil, and telephone charges, (d) cost of building and cleaning supplies and equipment, (e) cost of all maintenance, cleaning and repairs, except as set forth in Articles V and X below, (f) cost of snow removal and care of landscaping, and (g) payments under service contracts with independent contractors, and all other ordinary and necessary expenses paid or incurred in connection with the operation, cleaning and maintenance of the Building and Lot. 1.2.2 If any Operating Expense for the Property shall not have been paid as required hereinabove, then Landlord, after ten (10) days written notice thereof to Tenant, may, but shall not be required to, pay the same, and shall thereupon become entitled to repayment of the substantiated amount thereof by Tenant as Additional Rent. Notwithstanding the foregoing, if during said ten (10) day notice period Tenant provides Landlord with written notice that it wishes to contest all or any part of such Operating Expense, Landlord shall not pay such Operating Expense while Tenant contests same, but only if such delay in payment will not affect Landlord's tide to the Property by the placement of liens thereon or otherwise. 1.2.3 Except as otherwise specifically provided herein, any sum, amount item or charge designated or considered as Additional Rent in this Lease shall be paid by Tenant to Landlord on the first day of the month following the date on which Landlord notifies Tenant in writing of the amount payable (or on the fifteenth day after the giving of such notice, whichever shall be later). Any such notice shall specify in reasonable detail the basis of such Additional Rent. 1.3 Tenant will pay the Rent or Additional Rent due to Landlord, or to such other person as Landlord may from time to time designate in writing. 3 8 ARTICLE II CONDITION OF PREMISES: DELIVERY OF PREMISES TO TENANT 2.1 The Premises are being leased in their condition as of the Commencement Date "as is", without representation or warranty of any kind. Tenant specifically acknowledges that it has inspected the Building and Lot and has found same, including without limitation all mechanical systems, roof, structure, parking areas, and ceiling tiles, to be satisfactory to Tenant for its purposes. 2.2 If Landlord is prevented from delivering possession of the Premises to Tenant on the Commencement Date because of delays caused by strikes, riots, fire, acts of God, governmental intervention, refusal of current occupant to vacate, acts or omissions of Tenant, or other causes which are not within the reasonable control of Landlord (hereinafter, individually or collectively, "Excusable Delay"), then the Commencement Date shall be extended by one day for each day of an Excusable Delay. Notwithstanding the foregoing, in the event such Excusable Delay shall exceed an aggregate of 75 days, Tenant may, at its option, terminate this Lease by notice delivered to Landlord not later than twenty (20) days after the aggregate 75-day period (such right of termination being Tenant's sole and exclusive remedy at law or in equity against Landlord for Landlord's failure to so deliver possession of the Premises). ARTICLE III LANDLORD'S INTEREST AND ASSIGNMENT OF WARRANTIES 3.1 Landlord represents that it holds its interest in the Premises pursuant to a duly registered deed, and that it has the right to make this Lease for the Term aforesaid; that the provisions of this Lease do not conflict with or violate the provisions of existing agreements between Landlord and third parties. 3.2 Landlord shall assign to Tenant the benefit of any vendor's or contractors warranties received by Landlord on the Building or any component thereof or equipment located or installed therein. ARTICLE IV TENANT'S COVENANTS Tenant covenants during the Term and such further time as Tenant occupies any part of the Premises: 4 9 4.1 to pay when due all Annual Fixed Rent and Additional Rent and all other amounts due hereunder; 4.2 (a) except as otherwise provided in Section 4.2(b) and in Articles V and X hereof, at Tenant's sole cost and expense to keep the Premises, including without limitation all underground storage tanks, if any, walks, drives, exterior walls, mechanical systems and parking area, in good order, repair and condition, reasonable wear and tear, damage by fire and other insured casualty and eminent domain only excepted, and all glass windows (except glass in exterior walls unless the damage thereto is attributable to Tenant's negligence or misuse) and doors of the Premises whole and in good condition with glass of the same quality as that injured or broken, damage by fire and other insured casualty and eminent domain only excepted, and at the expiration or termination of this Lease peaceably to yield up the Premises and all alterations and additions thereto in good order, repair and condition, reasonable wear and tear, damage by fire, insured casualty and eminent domain only excepted, first removing all goods and effects of tenant and, to the extent specified by Landlord by notice to Tenant at the time it consents to the installation of same, all alterations and additions made by Tenant or on behalf of Tenant and all partitions, and repairing any damage caused by such removal and restoring the Premises and leaving them clean and neat. If, based upon Tenant's use of the Premises or upon any incident occurring on or about the Property during the Term of this Lease, Landlord reasonably believes that the Property may have been contaminated, then upon Landlord's written request Tenant will furnish to Landlord, not later than the Termination of this Lease, a report, prepared at Tenant's expense by an engineering firm qualified to make reports under Massachusetts General Laws Chapter 21E and reasonably acceptable to Landlord, stating that the Building and Lot have been examined for oil and hazardous waste contamination and that no such contamination was found on the Building or Lot (or that such contamination was found, but cleaned up and disposed of by Tenant and that the Building and Lot are now free of such substances). Notwithstanding the foregoing, if Tenant can demonstrate by clear and convincing evidence (including for example the chemical nature, off-Premises geographical source, the third-party responsible for, and approximate time of the subject discharges) that any such contamination or identifiable portion thereof was caused by a third party for whose conduct Tenant is not legally responsible, Tenant shall not be liable to Landlord for cleanup or removal or remediation of such contamination or identifiable portion thereof, as the case may be. If requested by Landlord, Tenant shall, at its cost, provide Landlord with an analysis by an environmental engineering from qualified pursuant to Massachusetts General Laws Chapter 21E to support any conclusion of non-liability advanced by Tenant. (b) Tenant shall, not later than June 15, 1997, furnish to Landlord a report, prepared at Tenant's expense by an engineering firm qualified to make reports under Massachusetts General Laws Chapter 21E and reasonably acceptable to Landlord, stating that environmental testing has been performed in the vicinity of the existing underground storage tank on the Lot. Tenant shall indemnify and hold Landlord harmless from any and all damage, cost and expense incurred by Landlord as a result of the performance of such environmental testing. If the report indicates that oil and/or hazardous waste contamination was found on the 5 10 Lot, and any remediation of same is required by applicable laws, Landlord shall indemnify and hold Tenant harmless from the costs and expenses of remediating such contamination whether performed by the Landlord or any third party. Notwithstanding the foregoing, if Landlord can demonstrate by clear and convincing evidence that any such contamination or identifiable portion thereof was caused by Tenant or a third party for whose conduct Tenant is legally responsible, Tenant shall be liable to Landlord for cleanup or removal or remediation of such contamination or identifiable portion thereof, as the case may be. 4.3 continuously from the Commencement Date to use and occupy the Premises for the Permitted Uses, and not to injure or deface the Premises, Building or Lot, nor permit in the Premises and inflammable fluids or chemicals (except in accordance with law and with prior written notice to Landlord of Tenant's intention to use same), or nuisance, or the emission from the Premises of any objectionable noise or odor, nor use or devote the Premises or any part thereof for any purpose other than the Permitted Uses, nor any use thereof which is inconsistent with the maintenance of the Building as an office building of the first class in the quality of its maintenance, use and occupancy, or which is improper, offensive, contrary to law or ordinance or which would invalidate or increase the premiums for any insurance on the Building or its contents or which would render necessary any alteration or addition to the Building. Notwithstanding the foregoing, Tenant may vacate all or any part of the Premises during the Term, provided that (i) Tenant provides Landlord with reasonable prior written notice, (ii) Tenant continues to pay Rent and all other charges for the remainder of the Term, and (iii) Tenant takes all measures necessary to keep the Building secure; 4.4 to comply with all reasonable rules and regulations now or hereafter made by Landlord of which Tenant has been given advance written notice, for the care and use of the Building and Lot and their facilities and approaches; 4.4 in its use of the Premises, to comply with the requirements of all applicable governmental laws, rules and regulations and to keep the Premises equipped with all safety appliances required by law or ordinance or any other regulation of any public authority, and to procure all required licenses and permits and to comply with such licenses and permits. Without limiting the generality of the foregoing, Tenant shall be responsible, in connection with Tenant's use of the Premises, for compliance with the Americans with Disabilities Act of 1990 (42 U.S.C. ss.12101 ET SEQ.) and the regulations and Accessibility Guidelines for Buildings and Facilities issued pursuant thereto (collectively, the "ADA Requirements"); 4.5 not to place a load upon the Premises exceeding an average rate of 75 pounds of live load per square foot of floor area (partitions shall be considered as part of the live load); and not to move any safe, vault or other heavy equipment in, about or out of the Premises except in such manner and at such time as Landlord shall in each instance authorize, such authorization not to be unreasonably withheld or delayed; 4.6 to pay promptly when due all taxes which may be imposed upon personal property (including, without limitation, fixtures and equipment) in the Premises to whomever assessed; and, 6 11 4.7 to vacate the Premises upon the end of the Term should Tenant hold over after the termination of this Lease, by lapse of time or otherwise, Tenant shall become a daily tenant at sufferance at a rate equal to the then fair market rental rate of the Premises but in no event less than 1 1/2 times the Annual Fixed Rent in effect on the expiration or termination date. Tenant shall also pay Landlord all direct and foreseeable damages (including any loss of a tenant or rental income), sustained by reason of any such holding over. Otherwise, such holding over shall be on the terms and conditions set forth in this Lease as far as applicable. ARTICLE V MAINTENANCE AND REPAIRS 5.1 During the Term of this Lease Tenant shall take reasonable care of the Premises and Landlord's fixtures and appurtenances therein and thereon and shall perform all maintenance and make all repairs and replacements to the Premises not specifically imposed upon Landlord by the express provisions hereof. All repairs and replacements made by Tenant shall be equal in quality to that in place on the Commencement Date. Notwithstanding the foregoing, with respect to the three (3) 200 ton chillers located on the roof of the Building, and any other mechanical system serving the Premises, Tenant shall repair same and keep same in good working order throughout the Term of this Lease. Should any of such chillers or other mechanical system or component thereof require replacement during the Term of this Lease, Tenant may replace same with a chiller or mechanical system or component thereof, as the case may be, of size, capacity, function and quality customarily found in buildings the size and type of the Building in the Route 128 area, which shall provide the Building with adequate heat, air conditioning and ventilation (or other mechanical service, as the case may be) for the Permitted Uses. 5.2 Landlord's obligations under this Article shall consist of making all structural repairs, replacements and alterations (but excluding general maintenance and repairs of a non-structural nature) to the exterior and bearing walls of the Building and support beams, and columns and lateral support thereto, and to perform all repairs and restoration required by Article X. Landlord's obligations do not include, without limitation. repairs to or maintenance or replacement of plumbing or sewer lines, underground storage tanks, or the repair or replacement of the roof membrane and deck, the HVAC systems or the primary distribution electrical service equipment, all of which shall be Tenant's responsibility at Tenant's expense during the Tenant of this Lease or any extension thereof. 5.3 Landlord reserves the right to stop any service or utility system, when necessary by reason of accident or emergency, or until necessary repairs which Landlord is obligated to perform pursuant to the Terms of this Lease have been completed, but only to the extent that such stoppage is reasonably necessary under the circumstances; provided, however, that in each instance of stoppage, Landlord shall exercise reasonable diligence to eliminate the cause thereof. Except in case of emergency repairs, Landlord will give Tenant reasonable advance 7 12 notice of any contemplated stoppage and will use reasonable efforts to avoid unnecessary inconvenience to Tenant by reason thereof. Landlord shall not be liable to Tenant for any compensation or reduction of rent by reason of inconvenience or annoyance or for loss of business arising from the necessity of Landlord or its agents entering the Premises for any of the purposes in this Lease authorized, or for repairing the Premises or any portion of the Building however the necessity may occur. In case Landlord is prevented or delayed from making any repairs, alterations or improvements, or furnishing any services or performing any other covenant or duty to be performed on Landlord's part, by reason of any cause reasonably beyond Landlord's control, Landlord shall not be liable to Tenant therefor, nor, except as expressly otherwise provided in Section 10.1, shall Tenant be entitled to any abatement or reduction of rent by reason thereof, nor shall the same give rise to a claim in Tenant's favor that such failure constitutes actual or constructive, total or partial, eviction from the Premises. ARTICLE VI SERVICES Landlord shall not be required to furnish any services or utilities to the Premises during the Term of this Lease, the Tenant hereby assuming full and sole responsibility for the supply of and payment for such services and utilities. ARTICLE VII IMPROVEMENTS Subject to compliance with Articles IV and VM hereof, Tenant may place partitions, trade or other fixtures (including lighting fixtures), personal property, machinery, equipment and the like in the Premises (collectively, hereinafter "FF&E') and may make such improvements and alterations therein and thereon as it may desire at its own expense. All such things heretofore or hereafter made or installed by or for Tenant and paid for by Tenant shall remain the property of Tenant and in case of damage or destruction thereto by fire or other causes, Tenant shall have the right to recover the value thereof as its own loss from any insurance company with which it has insured the same, notwithstanding that any of such things might be considered a part of the Premises. At the expiration or earlier termination of the Term, Tenant shall remove all of FF&E and, to the extent specified by Landlord at the time it consents to the installation of same, all alterations and additions made by Tenant and all partitions, and shall repair any damage to the Premises caused by such removal. Any of such things which remain in the Premises after the expiration or termination of this Lease shall be deemed conclusively to have been abandoned, and either may be retained by Landlord as its property or may be disposed of in such manner as Landlord may see fit, at Tenant's sole cost and expense. Notwithstanding the foregoing, Tenant shall not be required to remove pipes, 8 13 wires and the like from walls, ceilings or floors, provided Tenant properly cuts, disconnects and caps such pipes and wires and seals them off, if necessary, in a safe and lawful manner. ARTICLE VIII ALTERATIONS 8.1 NON-STRUCTURAL CHANGES. Tenant shall have the right, upon prior written notice to Landlord, at Tenants sole cost and expense, to make non-structural changes, alterations, additions, or improvements to or upon the Premises which do not interfere with any heating, air-conditioning, electrical or plumbing systems or structural element or the exterior of the Building, provided Landlord is furnished copies of all working drawings prepared in connection with such changes at least ten (10) days prior to the commencement of such work (except as to changes which involve primarily the movement of unfixed partitions, the configuration of Tenant space, painting, flooring, relocation of doors, and replacement of hung ceiling panels, in which event Landlord need not be furnished with copies of working drawings). Non-structural changes, alterations, additions and improvements shall include, without limitation, the installation, removal or relocation of light fixtures, trade fixtures and partitions that are not bearing walls. If any such non-structural changes, alterations, additions or improvements are not readily adaptable to normal office and/or engineering and research and development uses at reasonable expense, Landlord may, by notice delivered within ten (10) days of Landlord's receipt of plans with respect thereto (or if no plans are required, within ten (10) days of Landlord's receipt of prior written notice of the installation thereof), require Tenant, upon expiration of the Lease, to restore those portions of the Premises containing such modifications to the condition existing prior to the making of such modifications. 8.2 STRUCTURAL CHANGES. Tenant shall have the right, at Tenant's sole cost and expense, to make structural changes, alterations, additions or improvements to or upon the Premises, provided that Tenant obtains the prior written consent of Landlord, which consent shall not be unreasonably withheld or delayed. Landlord shall not be deemed unreasonable for withholding approval of any alterations or additions which (a) affects or might affect any structural or exterior element of the Building, or (b) will require unusual expense to re-adapt the Premises to normal office and/or engineering and research and development uses upon termination of the Lease or increase the cost of insurance or taxes on the Building unless Tenant first gives assurance acceptable to Landlord for payment of such increased cost and that such re-adaptation will be made prior to such termination without expense to Landlord. 8.2.1 At least thirty (30) days prior to commencing such work, Tenant shall furnish Landlord with copies of the plans and specifications for such work. Landlord agrees to review such plans and specifications promptly upon receipt thereof, and to notify Tenant of its approval or any comments within (30) days of such receipt. 9 14 8.2.2 As a condition of its consent, and simultaneously with the grant thereof, Landlord may, in its reasonable discretion: (i) require Tenant, at Tenant's sole cost and expense, to perform certain additional work if such work is necessary to correct impairments to the structure of the Building or to mechanical systems which would be caused by the proposed changes; and/or (ii) notify Tenant that Landlord will require Tenant, upon expiration of the Lease, to restore portions or all of the Premises to the condition existing prior to the making of such modifications if (but only if) such structural changes, alterations, additions or improvements are unusual in nature or not readily adaptable to normal engineering and research and development uses at a reasonable expense. 8.3 With respect to all work by Tenant pursuant to Section 8.1 or 8.2 hereof, Tenant shall secure all licenses and permits necessary therefor, and, if requested by. Landlord, deliver to Landlord a statement of the names of all Tenant's contractors and subcontractors and the estimated cost of all labor and material to be furnished by them. In the course of such work, Tenant agrees (i) to use labor compatible with that being employed by Landlord for work in or to the Building, and not to employ or permit the use of any labor or otherwise take any action which might result in a labor dispute involving personnel providing services in the Building. Tenant's contractors shall (i) carry general liability insurance with limits of at lease $1,000,000/$3,000,000, and property damage insurance with limits of at least $1,000,000 (all insurance to be written in companies reasonably approved by Landlord and insuring Landlord and Tenant as well as the contractors), and deliver to Landlord certificates of all such insurance, and (ii) in the event that the cost of such work exceeds $250,000.00, have filed with Landlord lien bonds and the like in form acceptable to Landlord. 8.4 Tenant agrees to pay promptly when due the entire cost of work to be done on the Premises by Tenant, its agents, employees, or independent contractors, and not to cause or permit any liens for labor or materials performed or furnished in connection therewith to attach to the Premises and immediately to discharge any such liens which may so attach. 8.5 All construction work required or permitted by this Lease shall be done in a good and workmanlike manner and in compliance with all applicable laws and ordinances, regulations and orders of governmental authority and insurers of the Building, and shall be coordinated with any work being performed by Landlord. ARTICLE IX INSPECTION The Landlord shall, upon at least twenty-four (24) hours prior verbal notice (except in the case of emergency) to Tenant's designated representative, have the right at all reasonable times during business hours to inspect the Premises and show the same to prospective mortgagees, purchasers and/or tenants, and at all times to make repairs or replacements as 10 15 required by this Lease or as may be necessary, provided, however, that Landlord shall use all reasonable efforts not to disturb Tenant's use and occupancy of the Premises. ARTICLE X FIRE, EMINENT DOMAIN, ETC. 10.1 ABATEMENT OF RENT. If the Premises shall be damaged by fire or casualty, Annual Fixed Rent and other charges payable by Tenant shall abate proportionately for the period in which, by reason of such damage, there is substantial interference with Tenant's use of the Premises, having regard to the extent to which Tenant may be required to discontinue Tenant's use of all or a portion of the Premises, but such abatement or reduction shall end upon the date on which Landlord shall have substantially restored the Premises (excluding any alterations, additions or improvements made by Tenant) to the condition in which they were prior to such damage. If the Premises or access thereto shall be affected by any exercise of the power of eminent domain, Annual Fixed Rent and other charges payable by Tenant shall be jointly and equitably abated and reduced according to the nature and extent of the loss of use thereof suffered by Tenant. In no event shall Landlord have any liability for damages to Tenant for inconvenience, annoyance, or interruption of business arising from such fire, casualty or eminent domain. 10.2 LANDLORD'S RIGHT OF TERMINATION. If the Premises are substantially damaged by fire or casualty (the term "substantially damaged" meaning damage of such a character that the same cannot, in ordinary course, reasonably be expected to be repaired within two-hundred seventy (270) days from the time the repair work would commence), or if there is insufficient insurance proceeds available to restore the Premises and the loss is not covered by insurance referred to in Section 11.1 hereinbelow, or if any material part of the Building is taken by any exercise of the right of eminent domain, then Landlord shall have the right to terminate this Lease (even if Landlord's entire interest in the Premises may have been divested) by giving notice of Landlord's election so to do within 90 days after the occurrence of such casualty or the effective date of such Notice, whereupon this Lease shall terminate thirty (30) days after the date of such notice with the same force and effect as if such date were the date originally established as the expiration date hereof. 10.3 RESTORATION. If the Premises shall be damaged by fire or casualty which is covered by the insurance referred to in Section 11.1 hereinbelow, or a portion thereof taken by the exercise of the right of eminent domain and if this Lease shall not be terminated pursuant to Section 10.2, Landlord shall thereafter use due diligence to restore the Premises (excluding any alterations, additions or improvements made by Tenant) to proper condition for Tenant's use and occupation, provided that Landlord's obligation shall be limited to the amount of insurance proceeds or eminent domain award available therefor. If, for any reason, such restoration shall not be substantially completed within six months after the expiration of the 90-day period referred to in Section 10.2 (which six-month period may be extended for such periods of time as Landlord is prevented from proceeding with or completing such restoration for any cause 11 16 beyond Landlord's reasonable control), Tenant shall have the right to terminate this Lease by giving notice to Landlord thereof within thirty (30) days after the expiration of such period (as so extended). Upon the giving of such notice, this Lease shall cease and come to an end without further liability or obligation on the part of either party unless, within such 30-day period, Landlord substantially completes such restoration. Such right of termination shall be Tenant's sole and exclusive remedy at law or in equity for Landlord's failure so to complete such restoration. 10.4 AWARD. Landlord shall have and hereby reserves and excepts, and Tenant hereby grants and assigns to Landlord, all rights to recover for damages to the Property and leasehold interest hereby created, and to compensation accrued or hereafter to accrue by reason of such taking, damage or destruction, and by way of confirming the foregoing, Tenant hereby grants and assigns, and covenants with Landlord to grant and assign to Landlord, all rights to such damages or compensation. Nothing contained herein shall be construed to prevent Tenant from prosecuting in any condemnation proceedings a claim for the value of any of Tenant's removable property, leasehold improvements or FF&E installed in the Premises by Tenant at Tenant's expense and for relocation expenses, provided that such action shall not affect the amount of compensation otherwise recover-able by Landlord from the taking authority. ARTICLE XI INSURANCE 11.1 Tenant shall, from and after the Commencement Date hereof, maintain insurance covering the Building against loss, damage or destruction caused by boiler explosion, fire and the perils specified in the standard extended coverage endorsement, and by vandalism and malicious mischief, and by earthquake and flood, and for other risks customarily insured against by owners of similar buildings in the vicinity of the Building. Coverage shall equal one hundred percent (100%) of the replacement cost of the Building. Tenant shall also maintain (i) liability insurance in the amount of at least $1,000,000/$3,000,000, (ii) property damage insurance in the amount of at least $3,000,000, or such greater amounts as Landlord shall from time to time reasonably request, and (iii) rent loss insurance covering at least twelve (12) months of rent. All such policies shall be in form and substance reasonably acceptable to Landlord and shall name Landlord (and those in privity of estate with Landlord), Landlord's mortgagee and Tenant as a loss payee, and shall bear the endorsement that such policies shall not be cancelled until after thirty (30) days written notice to Landlord. Tenant shall deposit promptly with Landlord certificates evidencing such coverage. In the event of any casualty or other insured damage to the Building, all insurance proceeds shall be made available for the restoration of the Building, and any mortgage covering the Building shall so provide, subject, however, to the terms and conditions of such mortgage which govern the application and disbursement of insurance proceeds for restoration. 11.2 Notwithstanding anything else to the contrary in this Lease contained, the parties hereto agree that neither party, nor its agents, employees, contractors or invitees, shall 12 17 be liable to the other for loss or damage caused by any risk covered by any of the insurance coverages herein described, and in implementation hereof, the parties hereby agree as follows: (a) If Landlord shall suffer any loss, damage, liability or expense for which Tenant shall be obligated to pay Landlord, Tenant shall have as an offset against said obligation the greater of (i) the net proceeds of any insurance that Landlord receives with respect to such loss, damage, liability or expense or (ii) the amount of insurance coverage Landlord has agreed to obtain, regardless of whether Landlord actually has obtained it, if such loss, damage, liability or expense shall have resulted from a risk or peril required hereunder to have been covered by such insurance. (b) If Tenant shall suffer any loss, damage, liability or expense for which Landlord shall be obligated to pay Tenant, Landlord shall have as an offset against said obligation the greater of (i) the net proceeds of any insurance that Tenant receives with respect to such loss, damage, liability or expense or (ii) the amount of insurance coverage Tenant has agreed to obtain, regardless of whether Tenant actually has obtained it, if such loss, damage, liability or expense shall have resulted from a risk or peril required hereunder to have been covered by such insurance. (c) Notwithstanding the foregoing with respect to the offset in the amount of insurance proceeds received, the parties acknowledge that such offset shall not cause the insurer which has paid the proceeds to declare the governing policy invalid. The parties therefore mutually agree that each shall obtain a rider to, endorsement on, or clause in, any insurance policy covering the Premises and the Building and personal property, fixtures and equipment located therein by which their insurers shall waive subrogation. By virtue of such rider, endorsement, or clause, the parties hereby agree that they will not make any claim against or seek to recover from each other for any loss or damage to their own property or to the property of others by reason of a risk or peril covered by such insurance. 11.3 Tenant agrees and acknowledges that all of the furnishings, fixtures, equipment, effects and property of every kind, nature and description of Tenant and of all persons claiming by, through or under Tenant which, during the continuance of this Lease or any occupancy of the Premises by Tenant or anyone claiming under Tenant, may be on the Premises or elsewhere in the Building or on the Lot, shall be at the sole risk and hazard of Tenant, and if the whole or any part thereof shall be destroyed or damaged by fire, water or otherwise, or by the leakage or bursting of water pipes, steam pipes, or other pipes, by theft or from any other cause, no part of said loss or damage is to be charged to or be borne by Landlord. 13 18 11.4 Tenant hereby covenants that in the event of any loss, damage or destruction of the Building and improvements on the Premises which Landlord is required by the operation of Article X to repair and restore, the proceeds which are payable under policies of insurance carried by Tenant, together with the amount of any deductible limits established by Tenant, shall upon request of Landlord, first be paid over to Landlord to repair and reconstruct the Building and improvements on the Premises to the extent required by this Lease, before such proceeds are applied in any other manner including, without limitation, the satisfaction of Tenant's debts secured by a mortgage or other lien instrument, or interest thereon. ARTICLE XII TAXES 12.1 (a) For the purposes of this Article, the term "Tax Year" shall mean the twelve-month period commencing on the July 1 immediately pending the Commencement Date and each twelve-month period thereafter commencing during the Term of this Lease. The term "Taxes" shall mean real estate taxes and other taxes, levies and assessments imposed upon the Property; charges, fees, assessments and payments for transit, housing, police, fire or other governmental services or purported benefits to the Property; and service or user payments in lieu of taxes. Betterment assessments and interest thereon shall be apportioned equally over the longest period permitted by law. Taxes for the years in which this Lease commences and terminates shall be prorated. (b) Tenant shall pay all Taxes assessed on the Property during the Term of this Lease on or before the date upon which they are due to be paid without interest. Promptly after receipt by Landlord of bills for such Taxes, Landlord shall advise Tenant of the amount thereof (and shall provide Tenant with a copy of same) and the computation of Tenant's payment on account thereof Landlord shall have the same rights and remedies for the non-payment by Tenant of any payments due on account of Taxes as Landlord has hereunder for the failure of Tenant to pay Annual Fixed Rent. 12.2 (a) If some method or type of taxation shall replace the current method of assessment of real estate taxes in whole or in part, or the type thereof, or if additional types of taxes are imposed upon the Property or Landlord relating to the Property, Tenant agrees that Tenant shall pay the same as an additional charge. (b) If a tax (other than Federal or State income tax) is assessed on account of the rents or other charges payable by Tenant to Landlord under this Lease, Tenant agrees to pay the same as an additional charge within ten (10) days after billing therefor, unless applicable law prohibits the payment of such tax by Tenant. 12.3 Tenant shall have the right, by appropriate proceedings, to protest or contest any assessment or re-assessment for Taxes, or any special assessment, or the validity of either, or of any change in assessments or the tax rate. 14 19 12.4 In any such contest or proceedings, Tenant may act in its own name and/or the name of Landlord and Landlord will, at Tenant's request, cooperate with Tenant in any way Tenant may reasonably require in connection with such contest or proceedings. Landlord shall sign such consents or other documents as Tenant may reasonably request. Any contest or proceedings conducted by Tenant shall be at Tenant's expense and, in the event any penalties, interest or late charges become payable with respect to the Taxes as a result of such contest, Tenant shall pay the same. Landlord shall be solely responsible for the payment of any penalties, interest or late charges which are imposed through no fault of Tenant. 12.5 Tenant shall be entitled to receive any tax refunds properly allocable to the Term of this Lease, as it may be extended, and relating to Taxes paid by Tenant, as a result of any such contests or proceedings. ARTICLE XIII SIGNS Tenant shall have the exclusive right to place its signs anywhere in, on and about the Building, the Lot and land, provided the same are in compliance with all applicable laws and ordinances, are in good taste and in keeping with a quality industrial park, are first approved by Landlord which approval shall not be unreasonably withheld or delayed, are purchased and installed at the sole cost and expense of Tenant and are removed from the Premises at the expiration or earlier termination of the Term hereof. ARTICLE XIV DEFAULT 14.1 (a) If at any time subsequent to the date of this Lease any one or more of the following events (herein referred to as a "Default of Tenant') shall happen: (i) Tenant shall fail to pay the Annual Fixed Rent or other charges hereunder when due and such failure shall continue for five (5) full business days after Tenant's receipt of written notice; or (ii) Tenant shall neglect or fail to perform or observe any other covenant herein contained on Tenant's part to be performed or observed, and Tenant shall fail to remedy the same within thirty (30) days after written notice to Tenant specifying such neglect or failure, or if such failure is of such a nature that Tenant cannot reasonably remedy the same within such thirty (30) day period, Tenant shall fail to commence promptly to remedy the same and to prosecute such remedy to completion with diligence and continuity; or 15 20 (iii) Tenant's leasehold interest in the Premises shall be taken on execution or by other process of law directed against Tenant; or (iv) Tenant shall make an assignment for the benefit of creditors or shall file a voluntary petition in bankruptcy or shall be adjudicated bankrupt or insolvent, or shall file any petition or answer seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief for itself under any present or future Federal, State or other statute, law or regulation for the relief of debtors, or shall seek or consent to or acquiesce in the appointment of any trustee, receiver or liquidator of Tenant or of all or any substantial part of its properties, or shall admit in writing its inability to pay its debts generally as they become due; or (v) A petition shall be filed against Tenant in bankruptcy or under any other law seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any present or future Federal, State or other statute, law or regulation and shall remain undismissed or unstayed for an aggregate of sixty (60) days (whether or not consecutive), or if any debtor in possession (whether or not Tenant) trustee, receiver or liquidator of Tenant or of all or any substantial part of its properties or of the Premises shall be appointed without the consent or acquiescence of Tenant and such appointment shall remain unvacated or unstayed for an aggregate of sixty (60) days (whether or not consecutive); then in any such case (1) if such Default of Tenant shall occur prior to the Commencement Date, this Lease shall IPSO FACTO, and without further act on the part of Landlord, terminate, and (2) if such Default of Tenant shall occur after the Commencement Date, Landlord may terminate this Lease by notice to Tenant, and thereupon this Lease shall come to an end as fully and completely as if such date were the date herein originally fixed for the expiration of the Term of this Lease, and Tenant will then quit and surrender the Premises to Landlord, but Tenant shall remain liable as hereinafter provided. (b) If this Lease shall be terminated as provided in this Article, or if any execution or attachment shall be issued against Tenant or any of Tenant's property whereupon the Premises shall be taken or occupied by someone other than Tenant, then Landlord may, without notice, re-enter the Premises, either by summary proceedings, ejectment or otherwise, and remove and dispossess Tenant and all other persons and any and all property from the same, as if this Lease had not been made, and Tenant hereby waives the service of notice of intention to reenter or to institute legal proceedings to that end. (c) In the event of any termination, Tenant shall pay the Annual Rent and other sums payable hereunder up to the time of such termination, and thereafter Tenant, until the end of what would have been the Term of this Lease in the absence of such termination, and whether or not the Premises shall have been relet, shall be liable to Landlord for, and shall 16 21 pay to Landlord, as liquidated current damages, the Annual Fixed Rent and other sums which would be payable hereunder if such termination had not occurred, less the net proceeds, if any, of any reletting of the Premises, after deducting all reasonable expenses in connection with such reletting, including, without limitation, all repossession costs, brokerage commissions, legal expenses, attorneys' fees, advertising, expenses of employees, alteration costs and expenses of preparation for such reletting. Tenant shall pay such current damages to Landlord monthly on the days which the Annual Rent would have been payable hereunder if this Lease had not been terminated. (d) At any time after such termination, whether or not Landlord shall have collected any such current damages: as liquidated final damages and in lieu of all such current damages beyond the date of such demand, at Landlord's election Tenant shall pay to Landlord an amount equal to the aggregate of the Annual Fixed Rent and other charges accrued under the Lease in the twelve (12) months ended next prior to such termination (or such shorter period of time as would have remained in the Term but for such termination) plus the amount of Annual Fixed Rent and other charges of any kind accrued and unpaid at the time of termination. (e) In the case of any Default of Tenant, re-entry, expiration and dispossession by summary proceeding or otherwise, Landlord may (i) re-let the Premises or any part or parts thereof, either in the name of Landlord or otherwise, for a term or terms which may at Landlord's option be equal to or less than or exceed the period which would otherwise have constituted the balance of the Term of this Lease and may grant reasonable concessions or free rent-to the extent that Landlord considers advisable and necessary to re-let the same and (ii) may make such alterations, repairs and decorations in the Premises as Landlord in its sole judgment considers advisable and necessary for the purpose of re-letting the Premises; and the making of such alterations, repairs and decorations shall not operate or be construed to release Tenant from liability hereunder as aforesaid. Landlord shall in no event be liable in any way whatsoever for failures to re-let the Premises provided that Landlord agrees to use commercially reasonable efforts to re-let the Premises, or, in the event that the Premises are re-let, for inability reasonably to collect the rent under such re-letting. Tenant hereby expressly waives any and all rights of redemption granted by or under any present or future laws in the event of Tenant being evicted or dispossessed, or in the event of Landlord obtaining possession of the Premises, by reason of the violation by Tenant of any of the covenants and conditions of this Lease. (f) The specified remedies to which Landlord may resort hereunder are not intended to be exclusive of any remedies or means of redress to which Landlord may at any time be entitled to lawfully, and Landlord may invoke any remedy (including the remedy of specific performance) allowed at law or in equity as if specific remedies were not herein provided for. 17 22 (g) All reasonable costs and expenses incurred by or on behalf of Landlord (including, without limitation, attorneys' fees and expenses) in enforcing its rights hereunder or occasioned by any Default of Tenant shall be paid by Tenant. 14.2 Landlord shall in no event be in default of the performance of any of Landlord's obligations hereunder unless and until Landlord shall have failed to perform such obligations within thirty (30) days, or such additional time as is reasonably required to correct any such default, after notice by Tenant to Landlord specifying wherein Landlord has failed to perform any such obligations. ARTICLE XV NOTICES Whenever, by the terms of this Lease, notices, consents or approvals shall or may be given either to Landlord or to Tenant such notices, consents or approvals shall be in writing and shall be sent by registered or certified mail, postage prepaid, or by a recognized national courier service ("Courier"): If intended for Landlord, addressed to Landlord at Landlord's address first set forth above (or to such other address as may from time to time hereafter by designated by Landlord by like notice), with a copy to William S. Abbott, Esq., 50 Congress Street, Suite 925, Boston, MA 02109. If intended for Tenant, addressed to Tenant at Tenant's address first set forth above until the Commencement Date and thereafter to the Premises (or to such other address or addresses as may from time to time hereafter be designated by Tenant by like notice), Attention: Robert Leahy, CFO, with a copy to Paul L. Baccari, Esq., Masterman, Culbert & Tully, One Lewis Wharf, Boston, MA 02110. All such notices shall be effective when deposited in the United States Mail within the Continental United States, or the next day if sent by Courier, provided that the same are received in ordinary course at the address to which the same were sent. ARTICLE XVI ASSIGNMENT AND SUBLETTING 16.1 Tenant may assign this Lease or sublet the Premises or any portion thereof only with the prior written consent of Landlord, which consent may be withheld at Landlord's sole discretion except as hereinafter expressly otherwise provided. Landlord agrees not to withhold its consent to any subletting of all or any portion of the Premises, provided Tenant requests same in writing ("Tenant's Request"), and provided (i) at the time thereof Tenant is not in default under this Lease beyond any applicable cure period; (ii) Landlord, in its discretion 18 23 reasonably exercised, determines that the proposed sublessee is not financially irresponsible, and that the reputation, business, proposed use of the Premises by the proposed sublessee are satisfactory to Landlord; (iii) any sublessee shall expressly assume all obligations of this Lease on Tenant's part to be performed; (iv) such consent, if given, shall not release Tenant of any of its obligations under this Lease (including, without limitation, its obligation to pay rent) and Tenant's liability after any subletting shall be joint and several with the sublessee; (v) Tenant shall reimburse Landlord promptly for reasonable legal and other expenses incurred by Landlord in connection with Tenant's Request; (vi) Tenant agrees specifically to pay over to Landlord, as additional rent, fifty percent (50%) of all sums provided to be paid under the terms and conditions of such sublease which are in excess of the amounts otherwise required to be paid pursuant to this Lease; and (vii) a consent to one subletting to any other person shall not be deemed to be a consent to any subsequent subletting. Any assignment subletting or occupancy without Landlord's prior consent shall be void and shall, at the option of Landlord, constitute a default under this therein shall be assignable as to the interest of Tenant by operation of law without the prior written consent of Landlord, which consent may be arbitrarily withheld. Tenant agrees that in the event that Landlord withholds its consent to Tenant's Request contrary to the provisions of this paragraph, Tenant's sole remedy shall be to seek an injunction in equity to compel performance by Landlord to give its consent to Tenant's Request, and Tenant expressly waives any right to damages in the event of such withholding of consent by Landlord to Tenant's Request. 16.2 The provisions of Section 16.1 shall apply to a transfer (by one or more transfers) of a majority of the stock or partnership interests, or other evidences of ownership of Tenant as if such transfer were an assignment of this Lease; but such provisions shall not apply to transactions with an entity into or with which Tenant is merged or consolidated or to which substantially all of Tenant's assets are transferred or to any entity which controls or is controlled by Tenant or is under common control with Tenant, provided that in any of such events (i) the successor to Tenant has a net worth computed in accordance with generally accepted accounting principles at least equal to the net worth of Tenant immediately prior to such merger, consolidation or transfer, (ii) proof satisfactory to Landlord of such net worth shall have been delivered to Landlord at least 10 days prior to the effective date of any such reaction, and (iii) the assignee agrees directly with Landlord, by written instrument in form satisfactory to Landlord, to be bound by all the obligations of Tenant hereunder including, without limitation, the covenant against further assignment or subletting; and provided further that this Section 16.2 shall not apply to the transfer of stock of Tenant so long as the stock of Tenant is publicly traded on a nationally recognized stock exchange. ARTICLE XVII MISCELLANEOUS PROVISIONS 17.1 EXTRA HAZARDOUS USE. Tenant covenants and agrees that Tenant will not do or permit anything to be done in or upon the Premises, or bring in anything keep anything therein, which shall increase the rate of property or liability insurance on the Premises or of 19 24 the Building above the standard rate applicable to premises being occupied for Permitted Uses unless Tenant notifies Landlord in advance of such event and then promptly pays to Landlord, on demand, any such increase resulting therefrom which shall be due and payable as an additional charge hereunder, or provides to Landlord insurance certificates indicating coverage for same at Tenant's sole expense protecting Landlord and Tenant. 17.2 WAIVER. (a) Failure on the part of Landlord or Tenant to complain of any action or non-action on the part of the other, no matter how long the same may continue, shall never be a waiver by Tenant or Landlord, respectively, of any of the other's rights hereunder. Further, no waiver at any time of any of the provisions hereof by Landlord or Tenant shall be construed as a waiver of any of the other provisions hereof, and a waiver at any time of any of the provisions hereof shall not be construed as a waiver at any subsequent time of the same provisions. The consent or approval of Landlord or Tenant to or of any action by the other requiring such consent or approval shall not be construed to waive or render unnecessary Landlord's or Tenant's consent or approval to or of any subsequent similar act by the other. (b) No payment by Tenant, or acceptance by Landlord, of a lesser amount than shall be due from Tenant to Landlord shall be treated otherwise than as a payment on account of the earliest installment of any payment due from Tenant under the provisions hereof. The acceptance by Landlord of a check for a lesser amount with an endorsement or statement thereon, or upon any letter accompanying such check, that such lesser amount is payment in full, shall be given no effect, and Landlord may accept such check without prejudice to any other rights or remedies which Landlord may have against Tenant. 17.3 COVENANT OF QUIET ENJOYMENT. Tenant, subject to the terms and provisions of this Lease, on payment of the Annual Fixed Rent and all other charges and observing, keeping and performing all of the other terms and provisions of this Lease on Tenant's part to be observed, kept and performed, shall lawfully, peaceably and quietly have, hold, occupy and enjoy the Premises during the term hereof, without hindrance or ejection by any persons lawfully claiming under Landlord to have title to the Premises superior to Tenant; the foregoing covenant of quiet enjoyment is in lieu of any other covenant, express or implied. 17.4 LANDLORD'S LIABILITY. (a) Tenant specifically agrees to look solely to Landlord's then equity interest in the Property at the time owned, for recovery of any judgment from Landlord; it being specifically agreed that Landlord (original or successor) shall never be personally liable for any such judgment, or for the payment of any monetary obligation to Tenant. The provision contained in the foregoing sentence is not intended to, and shall not, limit any right that Tenant might otherwise have to obtain injunctive relief against Landlord or Landlord's successors in interest, or to take any action not involving the personal liability of Landlord (original or successor) to respond in monetary damages from Landlord's assets other than Landlord's equity interest in the Property. (b) With respect to any services to be furnished by Landlord to Tenant, Landlord shall in no event be liable for failure to furnish the same when prevented from doing 20 25 so by strike, lockout, breakdown, accident, order or regulation of or by any governmental authority, or failure of supply, or inability by the exercise of reasonable diligence to obtain supplies, parts or employees necessary to furnish such services, or because of war or other emergency, or for any cause beyond Landlord's reasonable control, or for any cause due to any act or neglect of Tenant or Tenant's servants,, agents, employees, licensees or any person claiming by, through or under Tenant. (c) In no event shall Landlord ever be liable to Tenant for any indirect or consequential damages suffered by Tenant from whatever cause. (d) With respect to any repairs or restoration which are required or permitted to be made by landlord, the same may be made during normal business hours and Landlord shall have no liability for damages to Tenant for inconvenience, annoyance or interruption of business arising therefrom; provided that Landlord agrees to use reasonable efforts to minimize interference with Tenant's business. 17.5 NOTICE TO MORTGAGEE OR GROUND LESSOR. After receiving notice from any person, firm or other entity that it holds a mortgage or a ground lease which includes the Premises, no notice from Tenant to Landlord alleging any default by Landlord shall be effective unless and until a copy of the same is given to such holder or ground lessor (provided Tenant shall have been furnished with the name and address of such holder or ground lessor), and the curing of any of Landlord's defaults by such holder or ground lessor shall be treated as performance by Landlord. 17.6 ASSIGNMENT OF RENTS AND TRANSFER OF TITLE. (a) With reference to any assignment by Landlord of Landlord's interest in this Lease, or the rents payable hereunder, conditional in nature or otherwise, which assignment is made to the holder of a mortgage on property which includes the Premises, Tenant agrees that the execution thereof by Landlord, and the acceptance thereof by the holder of such mortgage, shall never be treated as an assumption by such holder of any of the obligations of Landlord hereunder unless such holder shall, by notice sent to Tenant, specifically otherwise elect and that, except as aforesaid, such holder shall be treated as having assumed Landlord's obligations hereunder only upon foreclosure of such holder's mortgage and the taking of possession of the Premises. (b) In no event shall the acquisition of Landlord's interest in the Property by a purchaser which, simultaneously therewith, leases Landlord's entire interest in the Property back to the seller thereof be treated as an assumption by operation of law or otherwise, of Landlord's obligations hereunder, but Tenant shall look solely to such seller-lessee, and its successors from time to time in title, for performance of Landlord's obligations hereunder. In any such event, this Lease shall be subject and subordinate to the lease to such purchaser. For all purposes, such seller-lessee, and its successors in title, shall be the Landlord hereunder unless and until Landlord's position shall have been assumed by such purchaser lessor. In the event of a sale or leaseback, the purchaser and the fee holder shall provide to Tenant a non-disturbance and attornment agreement whereby such purchaser and fee holder, as the case 21 26 may be, agrees to recognize the Lease (and Tenant agrees to attorn in such event) in the event that the seller/lessee defaults. (c) Except as provided in paragraph (b) of this Section, in the event of any transfer of title to the Property by Landlord, Landlord shall thereafter be entirely freed and relieved from the performance and observance of all covenants and obligations hereunder arising after the date of such transfer. 17.7 TENANT'S INDEMNITY. To the maximum extent this agreement may be made effective according to law, Tenant agrees to defend, indemnify and save harmless Landlord from and against all claims, loss, liability, costs and damages of whatever nature arising from any default by Tenant under this Lease or from the following: (i) from any accident, injury or damage whatsoever to any person, or to the property of any person, occurring in or about the Building or Lot (except those due to Landlord's negligence or willful misconduct); or (ii) in connection with the conduct or management of the Premises or of any business therein, or any thing or work whatsoever done, or any condition created (other than by Landlord) in or about the Premises; and, in any case, occurring after the date of this Lease, until the end of the Term of this Lease, and thereafter so long as Tenant is in occupancy of the Premises. This indemnity and hold harmless agreement shall include indemnity against all reasonable costs, expenses and liabilities incurred in, or in connection with, any such claim or proceeding brought thereon, and the defense thereof, including, without limitation, reasonable attorneys' fees and costs at both the trial and appellate levels. 17.8 ADDITIONAL CHARGES. If Tenant shall fail to pay when due any sums under this Lease as an additional charge, Landlord shall have the same rights and remedies as Landlord has hereunder for failure to pay Annual Fixed Rent. 17.9 INVALIDITY OF PARTICULAR PROVISIONS. If any term or provision of this Lease, or the application thereof to any person or circumstance shall, to any extent, be invalid or unenforceable, the remainder of this Lease, or the application of such term or provision to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby, and each term and provision of this Lease shall be valid and be enforced to the fullest extent permitted by Law. 17.10 PROVISIONS BINDING, ETC. Except as herein otherwise provided, the terms hereof shall be binding upon and shall inure to the benefit of the successors and assigns, respectively, of Landlord and Tenant and, if Tenant shall be an individual, upon and to his heirs, executors, administrators, successors and assigns. Each term and each provision of this Lease to be performed by Tenant or Landlord shall be construed to be both a covenant and a condition. The reference contained to successors and assigns of Tenant is not intended to constitute a consent to assignment by Tenant, but has reference only to those instances in which Landlord may later give consent to a particular assignment as provided elsewhere in this Lease. 22 27 17.11 RECORDING. Tenant agrees not to record this Lease, but each party hereto agrees, on the request of the other, to execute a so-called notice of lease in form recordable and complying with applicable law and reasonably satisfactory to Landlord's attorneys. In no event shall such document set forth the rent or other charges payable by Tenant under this Lease; and any such document shall expressly state that it is executed pursuant to the provisions contained in Lease, and is not intended to vary the terms and conditions of this Lease. 17.12 WHEN LEASE BECOMES BINDING. The submission of this document for examination and negotiation does not constitute an offer to lease, or a reservation of, or option for, the Premises, and this document shall become effective and binding only upon the execution and delivery hereof by both Landlord and Tenant. All negotiations, considerations, representations and understandings between Landlord and Tenant are incorporated herein and this Lease expressly supersedes any proposals or other written documents relating hereto. This Lease may be modified or altered only by written agreement between Landlord and Tenant and no act or omission of any employee or agent of Landlord shall alter, change or modify any of the provisions hereof. 17.13 PARAGRAPH HEADINGS. The paragraph headings throughout this instrument are for convenience and reference only, and the words contained therein shall in no way be held to explain, modify, amplify or aid in the interpretation, construction, or meaning of the provisions of this Lease. 17.14 RIGHTS OF MORTGAGEE OR GROUND LESSOR. This Lease shall be subordinate to any mortgage or ground lease from time to time encumbering the Premises, whether executed and delivered prior to or subsequent to the date of this Lease, if the holder of such mortgage or ground lease shall so elect provided that the holder of such mortgage or ground lease shall provide Tenant with a subordination, non-disturbance and attornment agreement (the "Agreement") in form and substance reasonably acceptable to Tenant (it being agreed that the form and substance of the Subordination, Non-Disturbance and Attornment Agreement attached hereto as Exhibit ND is reasonably acceptable to Tenant). If this Lease is subordinate to any mortgage or ground lease and the holder thereof (or successor) shall succeed to the interest of Landlord, Tenant shall attorn to such holder (or successor) and this Lease shall continue in full force and effect between such holder (or successor) and Tenant in accordance with the terms of the Agreement. Tenant agrees to execute such Agreement in confirmation of the foregoing provisions as such holder may request, and Tenant hereby appoints such holder (or successor) as Tenant's attorney-in-fact to execute such Agreement upon default of Tenant in complying with such holder's (or successor's) request. 17.15 STATUS REPORT. Recognizing that both parties may find it necessary to establish to third parties, such as accountants, banks, mortgagees, ground lessors, or the like, the then current status of performance hereunder, either party, on the request of the other made from time to time, will promptly furnish to the Landlord, or the holder of any mortgage or ground lease encumbering the Premises, or to Tenant, as the case may be, a statement of the status of 23 28 any matter pertaining to this Lease, including, without limitation, acknowledgment that (or the extent to which) each party is in compliance with its obligations under the terms of this Lease. 17.16 REMEDYING DEFAULTS. Landlord shall have the right, but shall not be required, to pay such sums or to do any act which requires the expenditure of monies which may be necessary or appropriate by reason of the failure or neglect of Tenant to perform any of the provisions of this Lease, and in the event of the exercise of such right by Landlord, Tenant agrees to pay to Landlord forthwith upon demand all such sums, together with interest thereon at a rate equal to 4% over the prime rate in effect from time to time at the First National Bank of Boston as an additional charge. Any payment of Annual Fixed Rent or other sums payable hereunder not paid when due shall, at the option of Landlord, bear interest at a rate equal to 4% over the prime rate in effect from time to time at the First National Bank of Boston from the due date thereof and shall be payable forthwith on demand by Landlord, as an additional charge. 17.17 BROKERAGE. Tenant warrants and represents that Tenant has dealt with no broker in connection with the consummation of this Lease other than Lynch, Murphy, Walsh & Partners Incorporated (the "Broker") and, in the event of any brokerage claims against Landlord predicated upon prior dealings with Tenant, Tenant agrees to defend the same and indemnify Landlord against any such claim (except any claim by the Broker). Landlord shall hold Tenant harmless with respect to any brokerage commissions due to the Broker in connection with the consummation of this transaction, except to the extent that Tenant has breached the foregoing warranty. 17.18 FIRST OPTION TO EXTEND. Tenant shall have the option to extend the initial Term as to the entire Premises for one (1) period of four (4) years (the "First Extension Period"), upon the same terms and conditions then in effect with respect to the Premises, except for Annual Fixed Rent, which shall be determined as provided hereinbelow, provided that at the time such option to extend is exercised and at the expiration of the initial Term Tenant shall not be in default under this Lease beyond any applicable cure period. The Annual Rent for the First Extension Period payable with respect to the Premises shall be the greater of (i) 90% of the prevailing fair market rental rate for the Premises as of the date of commencement of the First Extension Period, as determined as hereinafter set forth, or (ii) the Annual Fixed Rent payable by Tenant with respect to the Premises for the last Lease Year during the initial Term. At any time after November 15, 2000 and prior to February 1, 2001, Tenant may request Landlord to inform Tenant of the prevailing fair market rental rate for the Premises which will be in effect for the First Extension Period, and in such event Landlord shall within thirty (30) days thereafter notify Tenant as to the prevailing fair market rental rate for the First Extension Period as of the commencement of the First Extension Period, as determined by Landlord. 24 29 If Tenant elects to exercise the First Option to Extend, Tenant shall do so by written notice to Landlord ("Tenant's Exercise") given not later than March 14, 2001. If Tenant fails to exercise the First Option to Extend within the aforesaid time period, Tenant's right to any extension of the Term of this shall expire. Tenant's Exercise shall contain a statement from Tenant that it either accepts or rejects Landlord's determination of the prevailing fair market rental rate for the Premises. If Tenant rejects Landlord's determination of the prevailing fair market rental rate for the Premises. then Tenant's Exercise shall also contain the name of one qualified appraiser. In such event Landlord shall, within thirty (30) days of Landlord's receipt of Tenant's Exercise, provide Tenant with written notice of a second qualified appraiser, and these two qualified appraisers shall name a third. It shall then be the duty of the appraisers to ascertain the prevailing fair market rental rate for the Premises, and if any appraiser shall neglect or refuse to appear at any meeting appointed by the appraisers, a majority may act in the absence of such appraiser. An appraisers' determination of the prevailing fair market rental rate for the Premises shall be conclusive and shall be binding upon Landlord and Tenant. Landlord and Tenant shall each be responsible for the costs of their respective appraiser, and Landlord and Tenant shall each be responsible for fifty percent (50%) of the costs of the third appraiser. An appraiser hereunder shall be deemed qualified if a member in good standing of the American Institute of Real Estate Appraisers or a comparable recognized professional organization and such appraiser has at least five years experience in providing fair market rental value appraisals of commercial real estate in Route 128 area. The third appraiser that is selected by the two appraisers that are appointed by Landlord and Tenant respectively must not have undertaken appraisal or other such work on behalf of either party or any affiliates of either party during the firm year period before such third appraiser's selection. 17.19 SECOND OPTION TO EXTEND. Tenant shall have the option to further extend the Term as to the entire Premises for one (1) period of five (5) years (the "Second Extension Period"), upon the same terms and conditions then in effect with respect to the Premises, except for Annual Fixed Rent, which shall be determined as provided hereinbelow, provided that (i) Tenant has exercised its First Option to Extend in a. timely manner in accordance with Section 17.18, and (ii) at the time such option to extend is exercised and at the expiration of the First Extension Period Tenant shall not be in default under this Lease beyond any applicable cure period. The Annual Rent for the Second Extension Period payable with respect to the Premises shall be the greater of (i) 90% of the prevailing fair market rental rate for the Premises as of the date of commencement of the Second Extension Period, as determined as hereinafter set forth, or (ii) the Annual Fixed Rent payable by Tenant with respect to the Premises for the last Lease Year during the First Extension Period. At any time after November 15, 2004 and prior to February 1, 2005, Tenant may request Landlord to inform Tenant of the prevailing fair market rental rate for the Premises which will be in effect for the Second Extension Period, and in such event Landlord shall within thirty (30) days thereafter notify Tenant as to the prevailing fair market rental rate for 25 30 the Second Extension Period as of the commencement of the Second Extension Period, as determined by Landlord. If Tenant elects to exercise the Second Option to Extend, Tenant shall do so by written notice to Landlord ("Tenant's Exercise") given not later than March 14, 2005. If Tenant fails to exercise the Second Option to Extend within the aforesaid time period, Tenant's right to any extension of the Tenant of this Lease shall expire. Tenant's Exercise shall contain a statement from Tenant that it either accepts or rejects Landlord's determination of the prevailing fair market rental rate for the Premises. If Tenant rejects Landlord's determination of the prevailing fair market rental rate for the Premises, then Tenant's Exercise shall also contain the name of one qualified appraiser. In such event Landlord shall, within thirty (30) days of Landlord's receipt of Tenant's Exercise, provide Tenant with written notice of a second qualified appraiser, and these two qualified appraisers shall name a third. It shall then be the duty of the appraisers to ascertain the prevailing fair market rental rate for the Premises, and if any appraiser shall neglect or refuse to appear at any meeting appointed by the appraisers, a majority may act in the absence of such appraiser. The appraisers' determination of the prevailing fair market rental rate for the Premises shall be conclusive and shall be binding upon Landlord and Tenant Landlord and Tenant shall each be responsible for the costs of their respective appraiser, and Landlord and Tenant shall each be responsible for fifty percent (50%) of the costs of the third appraiser. An appraiser hereunder shall be deemed qualified if a member in good standing of the American Institute of Real Estate Appraisers or a comparable recognized professional organization and such appraiser has at least five years experience in providing fair market rental value appraisals of commercial real estate in Route 128 area. The third appraiser that is selected by the two appraisers that are appointed by Landlord and Tenant respectively must not have undertaken appraisal or other such work on behalf of either party or any affiliates of either party during the three year period before such third appraisers selection. 17.20 GOVERNING LAW. This Lease shall be governed exclusively by the provisions hereof and by the laws of the Commonwealth of Massachusetts, as the same may from time to time exist. 26 31 IN WITNESS WHEREOF, Landlord and Tenant have caused this Lease to be duly executed, under seal, by persons hereunto duly authorized, in multiple copies, each to be considered an original hereof, as of the date first set forth above. NEEDHAM 152 SECOND AVENUE TRUST By: ------------------------------------------ Arthur G. Carlson, Jr., as Trustee but not individually By: ------------------------------------------ William J. Ford, Jr., as Trustee but not individually TENANT: BROOKTROUT TECHNOLOGY, INC. By: ------------------------------------------ Hereunto duly authorized Title: 27 32 Exhibit A Description of Premises The following described real property, together with the buildings and improvements constructed thereon, situated on Second Avenue in the New England Industrial Center, in Needham, County of Norfolk, Massachusetts, bounded and described as follows: PARCEL I (Registered Land): SOUTHWESTERLY by Second Avenue, two hundred twenty six and 56/100 (226.56) feet; NORTHWESTERLY by lot numbered 29, as indicated on plan hereinafter referred to, two hundred thirty nine and 80/100 (239.80) feet; NORTHEASTERLY by lands now or formerly of Christopher Kalinowski et al and of John Mroczka et al, one hundred forty six and 51/100 (146.51) feet; NORTHERLY by land now or formerly of said John Mroczka et al, eighty six and 31/100 (86.31) feet; SOUTHEASTERLY one hundred eight and 89/100 (108.89) feet; NORTHEASTERLY seventy seven and 03/100 (77.03) feet, by land now or formerly of Chester Mickowski; SOUTHEASTERLY by lot numbered 36, as shown on said plan, one hundred sixty eight and 02/100 (168.02) feet; and SOUTHERLY by land now or formerly of Orono Corporation, one hundred eighteen and 97/100 (118.97) feet. Said parcel is shown as lot numbered 37 on a plan drawn by William S. Crocker Inc., Civil Engineer, dated April 22, 1957, as approved by the Land Court, filed in the Land Registration Office as No. 24606H, a copy of a portion of which is filed in Norfolk Registry District with Certificate No. 59771, Sheet 1, Book 299. So much of the above described land as is included within the limits of said Second Avenue is subject to such highway easements as were taken therein by the Town of Needham under instrument dated April 13, 1954 and duly recorded in Book 3253, Page 315; to such easement for sewer, water and drainage purposes as set forth in a grant made by Gerald W. Blakeley, Jr., et al, Trustees to the Town of Needham, dated May 18, 1954, duly recorded in 33 Book 3263, Page 57; and to such private rights and easements as may exist in, under or over the same at date of original decree. So much of the above described land as is included within the area marked "The New York, New Haven and Hartford Railroad Company Easement" on said plan is subject to rights and easements as set forth in a grant made by Gerald W. Blakeley, Jr., et al, Trustees to the New York, New Haven and Hartford Railroad Company, dated March 26, 1954, duly recorded in Book 3252., Page 421. The above described land is subject to rights and easements as set forth in a grant made by Gerald W. Blakeley, Jr., et al, Trustees to the Company and New England Telephone and Telegraph Company, dated March 12, 1954, duly recorded in Book 3248, Page 3. The above described land is subject also to and has the benefit of the rights, restrictions etc., as set forth or referred to in Document No. 194917. PARCEL 2 (Recorded Title not registered) SOUTHWESTERLY by Second Avenue, 16 feet; NORTHWESTERLY 28 feet on a line in said Second Avenue and by a curved line by said lot 37,79.21 feet; SOUTHWESTERLY 77.27 feet and 28 feet on a line in said Second Avenue by land now or formerly of Orono Corporation; Or however otherwise said premises may be bounded and described and be all or any of said measurements and contents more or less. Said parcel is shown as Lot I on said Plan 24606H, filed in the Engineer's Office of the Land Court and contains 774 square feet to side line of Second Avenue according thereto. Title to said parcel is not registered. This Parcel is Parcel 2 described in three deeds, one to each of the Grantor Trusts which are the Landlord's predecessors in title, and recorded with the Norfolk Registry of Deeds in Book, 3598, Page 417-419. These Premises are subject to and with the benefit of rights, covenants and restrictions referred to therein. Parcels 1 and 2 are also subject to a mortgage to the Provident Institution for Savings in the Town of Boston, Registered as Document No. 329796, and recorded in Book 4892, Page 181. 2 34 EXHIBIT ND SUBORDINATION, NONDISTURBANCE AND ATTORNMENT AGREEMENT THIS SUBORDINATION, NONDISTURBANCE AND ATTORNMENT AGREEMENT, dated as of , is made among , a corporation with a principal place of business at , (hereinafter, the "Tenant"), , having an address , (hereinafter, collectively the "Borrower"), and having a usual place of business at (hereinafter, the "Bank"), the Mortgagee under a certain Mortgage and Security Agreement granted by the Borrower to the Bank dated on the date hereof and filed for registration herewith (hereinafter, the "MORTGAGE". WITNESSETH: WHEREAS, the Borrower is the owner of real property with buildings and improvements thereon located at , Needham, Massachusetts (hereinafter, the "Premises") as further described in Certificate of Title No. filed with the Norfolk District Land Registry Office (hereinafter, the "Registry"); and WHEREAS, the Tenant and the Borrower have entered into a certain Lease Agreement dated June 18, 1996 (hereinafter, said Lease Agreement shall be referred to as the "LEASE") with respect to the Premises, Notice of which Lease is filed herewith; and WHEREAS, the Borrower has entered into a loan arrangement with the Bank pursuant to which the Borrower has granted the Mortgage to the Bank and collaterally assigned the Borrower's interest in the Lease to the Bank, as provided in the Collateral Assignment of Leases and Rents dated on the date hereof filed for registration herewith (the "Collateral Assignment"); and WHEREAS, the Bank has indicated that the Bank requires as a condition to the establishment of such loan arrangement an agreement with the Tenant as to the priority of the Lease and the relative rights of the Bank and Tenant thereto, NOW THEREFORE, in consideration of the foregoing and the mutual covenants hereinafter contained, the Tenant, the Borrower, and the Bank hereby agree as follows: 1. REPRESENTATIONS BY TENANT AND BORROWER. The Tenant and the Borrower hereby represent and warrant the following to be true as of the date hereof. (a) That the Lease is a complete statement of the agreement between the parties thereto with respect to the letting of the Premises; 35 (b) That the Lease is currently in full force and in effect according to its terms and is a binding obligation of the Tenant and the Borrower as of the date hereof; and (c) That the Tenant is not now in default (beyond applicable notice and cure periods) under any term or terms of the Lease and that, to the best of the Tenant's present knowledge, there is no default or claim of default on the pail of, or claim of offset against the rent or any other sum or sums payable under the terms of the Lease to, the Borrower under the Lease. (d) That the Tenant has not made any assignment for the benefit of creditors nor filed any petitions or instituted any proceedings under the bankruptcy or similar laws of the United States or of any state, and that there are currently no such petitions or proceedings pending or threatened against the Tenant. 2. CONSENT TO ASSIGNMENT BY TENANT. The Tenant hereby consents to the assignment of the Lease and the rents thereunder to the Bank pursuant to the Mortgage and the Collateral Assignment. Upon notification by the Bank to the Tenant of the exercise of the Bank's rights under the Mortgage and/or the Collateral Assignment, the Tenant shall pay rent and any other sums payable under the terms of the Lease directly to the Bank. Without limiting the foregoing, the Tenant hereby acknowledges and agrees that the Bank shall have no duties or obligations with respect to the Lease until the Bank has notified the Tenant of the Bank's assumption of the Borrower's obligations under the Lease, or until the Bank has made entry under or foreclosed upon the Mortgage or has taken actual possession of the Premises and Landlord shall hold Tenant harmless from following such directions by Bank to Tenant. 3. COVENANTS. Regardless of whether or not the Bank has notified the Tenant of the exercise by the Bank of its rights under the Mortgage and/or the Collateral Assignment, the -Tenant hereby agrees as follows: (a) Except as otherwise provided in the Lease, not to cancel terminate, surrender, amend or modify the Lease or any term thereof, nor consent to or accept any such cancellation, termination, surrender, amendment or modification thereof, nor permit any event reasonably within the Tenant's control which would operate to terminate, surrender, or cancel the Lease provided that Tenant is so obligated under the terms of the Lease; (b) Except as otherwise provided in the Lease, or as previously approved by Landlord, not, without prior written consent of the Bank, to make or cause to be made, any structural additions, alterations, or improvements, to the Premises. 4. BANK'S OPPORTUNITY TO CURE DEFAULT. Regardless of whether the Bank has notified the Tenant of the Bank's exercise of its rights under the Mortgage and/or the Collateral Assignment, the Tenant shall notify the Bank of any default on the part of the 2 36 Borrower under the Lease. Except as otherwise provided in the Lease, no such default shall entitle or allow the Tenant to cancel or terminate the Lease, or abate the rent or any other sums owing thereunder, or exercise any other remedy afforded by the Lease or applicable law, unless the Bank fails to cure or cause to be cured, the specified default within 30 days of receipt of such notice, or within such longer time as may be required for cure due to the nature of such default, provided the cure is commenced within said 30-day period and thereafter diligently prosecuted to completion, and provided that said notice is duly given. 5. SUBORDINATION OF LEASE. The Tenant hereby agrees and acknowledges that the Lease and any extensions of said Lease or its terms shall be subordinate and subject to the lien of the Mortgage and any renewals, extensions, modifications or replacements thereof as though the Mortgage and any such renewal, extension, modification, or replacement thereof had been executed, acknowledge and delivered prior to the Lease and recorded prior to the Lease or any notice of the Lease. 6. ATTORNMENT BY TENANT. The Tenant further attorn to the Bank and agrees that, in the event of the exercise by the Bank of its rights under the Mortgage, and the taking of possession or the acquisition of tide by the Bank, pursuant to the Mortgage, whether through foreclosure proceedings or otherwise, the Tenant shall recognize the Bank and its successors, whether through foreclosure sale or otherwise, as the landlord under the Lease and the Lease shall continue in full force and effect in accordance with its terms and the Bank and Tenant shall be bound thereby. The Tenant agrees that any person to which the Tenant shall attorn hereunder shall not be liable for any action or omission of any prior landlord under the Lease including the Borrower, nor shall such person be subject to any offsets or claims thereof or defenses which the Tenant may have against any prior landlord, including the Borrower, except as expressly provided under the Lease. 7. NONDISTURBANCE BY BANK. The Bank hereby agrees that for so long as the Tenant duly and promptly performs all its obligations under the Lease (within applicable notice and cure periods), the Bank will not, in taking possession of or acquiring tide to the Premises or otherwise exercising its rights under the Mortgage and/or the Collateral Assignment, whether through foreclosure or otherwise, disturb the possession or other rights of the Tenant under the Lease and shall recognize Tenant's rights under the Lease and accept the Tenant as lessee under the terms and conditions and for the entire duration of the term of the Lease. The Bank shall not, however, be bound by any amendments or modifications of the Lease made without the written consent of the Bank (which consent shall not be unreasonably withheld or delayed), or by any liabilities of the Borrower arising under the Lease prior to the date the Tenant has given notice thereof to the Bank nor shall the Bank be bound by any representations or warranties given by Landlord under the Lease; Anything to the contrary herein notwithstanding, Tenant may not recover from the taking award, or from any taking authority, except for moving expenses separately awarded to Tenant which do not reduce Landlord's award, until the Bank has been paid in full. In addition, the provisions of the Mortgage shall control* with respect to the disposition and 3 37 application of insurance proceeds in the event of a casualty and disposition of the taking award in the event of a taking of all or any portion of the Property. *provided they are consistent with the provisions of Section 11.1 of the Lease, 8. EXTENSIONS AND RENEWALS. This Agreement shall include and apply to any extensions and renewals of the term permitted by the Lease. 9. AMENDMENTS. This Agreement may not be waived, changed, or discharged orally, but only by agreement in writing and signed by the Bank, the Borrower, and the Tenant, and any oral waiver, change, or discharge of this Agreement or any provision hereof shall be without authority and shall be of no force and effect. 10. CAPTIONS. Paragraph captions are included herein for reference only, and shall in no way constitute any part of this Agreement nor define or limit any of the provisions hereof. 11. SEVERABILITY. The invalidity of any provision of this Agreement, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provisions hereof . 12. SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon each party's respective heirs, executors, administrators, representatives, successors, and assigns and shall inure to the benefit of each party's successors and assigns. 13. NOTICES. All notices, demands and other communications made in this Agreement shall be made to the following addresses (each of which may be changed upon seven (7) days written notice to all others) given by hand, or by certified or registered mA return receipt requested, or by Federal Express or other recognized same-day or overnight courier with receipt, as follows: If the Bank: with a copy to: If to the Tenant: 4 38 with a copy to: If to the Borrower: With a copy to: Any such notice shall be deemed received the earlier of (i) two (2) days after the mailing of such notice in accordance with the terms and conditions and to the addresses provided above, or (ii) the date on which the notice is delivered by hand or by telegram to the address and to the individual provided above, or (iii) one business day following delivery of such notice to such overnight courier and addressed to the individual as provided above. 14. APPLICABLE LAW. This Agreement and all rights and obligations hereunder, including matters of construction, validity and performance, shall be governed by the laws of the Commonwealth of Massachusetts. The Tenant submits itself to the jurisdiction of the courts of said Commonwealth for all purposes with respect to this Agreement and the Tenant's relationship with the Bank. Witness the execution hereof under seal the day and year first above written. 5 EX-11.1 3 COMPUTATION OF EARNINGS PER SHARE 1 EXHIBIT 11.1 BROOKTROUT TECHNOLOGY, INC. COMPUTATION OF INCOME PER COMMON SHARE (In Thousands, Except per Share Data)
DECEMBER 31, ------------ 1997 1996 1995 ---- ---- ---- Basic Income Per Share: Weighted Average Number of Common and Common Equivalent Shares Outstanding: Common Stock .................................. 10,702 9,947 9,661 Common equivalent shares resulting from options -- -- -- ------- ------- ------- Total ........................................ 10,702 9,947 9,661 ======= ======= ======= Net income ........................................ $ 2,651 $ 6,865 $ 5,203 ======= ======= ======= Basic income per Common Share ..................... $ 0.25 $ 0.69 $ 0.54 ======= ======= ======= Diluted Income Per Share: Weighted Average Number of Common and Common Equivalent Shares Outstanding: Common Stock .................................. 10,702 9,947 9,661 Common equivalent shares resulting from options 598 954 416 ------- ------- ------- Total ........................................ 11,300 10,901 10,077 ======= ======= ======= Net income ........................................ $ 2,651 $ 6,865 $ 5,203 ======= ======= ======= Diluted income per Common Share ................... $ 0.23 $ 0.63 $ 0.52 ======= ======= =======
EX-13.1 4 1997 ANNUAL REPORT 1 EXHIBIT 13.1 Brooktrout had an excellent year in 1997. The company finished the year very strong and turned in record revenues for the last six months and for the year as a whole. It was also a year in which we were able to strengthen our market leadership in LAN fax and expand that leadership into the fast-growing field of data communications and Internet telephony. Revenues for the year rose by nearly 23 percent to more than $72 million, while our overall gross margin continued at a healthy 55 percent. EXPANSION INTO DATA COMMUNICATIONS The acquisition of Netaccess, Inc. of Salem, New Hampshire, was an important step in our strategy to position Brooktrout as a world leader in electronic messaging -- providing fax, voice, and data communications technology. Netaccess is a leading supplier of Primary Rate ISDN telephone network interface products and multiport modems in the data communications segment and is already proving to be an outstanding addition to the company. Earlier in the year, Brooktrout formed a wholly owned subsidiary to address this data communications segment. Interspeed, Inc. was established to develop hardware and software that can meet the growing needs for high-speed network access in the telecommunications industry. As new uses emerge for private data networks and the Internet, more companies and organizations will provide their employees with network connections, driving the need for faster, higher-volume access to these data networks. Together, Netaccess and Interspeed complement our overall business strategy by giving Brooktrout a major position in the fast-growing market for high-speed, high-density data communications and network access. A FOCUS ON INTERNET GROWTH Although Internet telephony -- using packet data networks such as the Internet instead of conventional phone lines for voice, fax, and data -- is still in its infancy, it is already having a significant effect on the telecommunications industry. At Brooktrout, we see 2 opportunities in several businesses. The most notable example is the Internet. A growing portion of our shipments are now related to Internet technologies, particularly in the fax segment. We expect this growth to continue as companies and service providers migrate their voice, fax, and data traffic from public phone lines to more economical private data networks or the Internet. To address this developing market, this fall we introduced the TR2000(TM) Series, an important new line of IP telephony products. Based on our open-systems BOSTON architecture, the TR2000 Series is a suite of standards-based software and hardware products that enable our customers to develop Internet voice and Internet fax applications as well as more traditional electronic messaging applications using common software and hardware platforms. BOSTON OPEN SYSTEMS ARCHITECTURE The introduction of BOSTON, the Brooktrout Open System Telephony architecture, was a major event during the year and one that brings significant long-term value to our customers. BOSTON is Brooktrout's first open system architecture developed exclusively for computer telephony. It establishes a standard development architecture as the foundation for current and future telephony applications. BOSTON will enable a host of hardware and software products that Brooktrout customers will use to develop their own unique messaging solutions. Its Universal Port(TM) approach makes it possible to combine voice and fax on the same platform, eliminating the need for separate system components for each function. And most important, BOSTON offers seamless migration from customers' existing applications, allowing customers to enhance their existing applications without abandoning their software investment. Developers can also use the company's intuitive Show N Tel(R) software to create custom applications using more than 300 graphical icons that represent common operations in computer telephony applications. Show N Tel runs on Brooktrout boards as 3 well as on other major brands and is considered the industry's best and easiest-to-use tool for developing computer telephony applications. NEW INTELLIGENT FAX PRODUCTS DRIVE A GROWING MARKET In the area of network fax and enhanced fax services, Brooktrout's major share of the market reflects its position as a leading developer of intelligent fax platforms worldwide. In keeping with our tradition of expanding the market through product innovation, the company introduced several industry firsts during the year. Among these is the TR Series(TM) PCI product line, the first commercially available multichannel fax and voice boards for the new PCI bus computers. The PCI version provides the same functionality, robustness, and reliability as the current ISA bus versions of Brooktrout's industry-leading TR114(TM) fax and voice boards. Because the TR Series PCI line mirrors the existing TR114 Series ISA boards, no changes are required to existing software applications. In addition, Brooktrout became the first company to offer a multichannel fax platform with on-board ISDN capabilities when it introduced the TR114 ISDN Series for direct connection to high-speed ISDN lines. This is particularly valuable and cost-effective in Europe, where ISDN is widely used. Our existing products also continue to enjoy strong market acceptance. Lucent Technologies remains our largest customer, with Brooktrout supplying Lucent's popular Merlin Legend Mail and Partner Mail automated voice messaging systems. THE FUTURE IS BRIGHT Looking ahead to 1998 and beyond, we believe that Brooktrout is a company in the right markets, with the right technologies, at exactly the right time. Our strategy of bringing together the three key segments of the electronic messaging business -- voice, fax, and data -- is giving Brooktrout a unique position in the marketplace. Our reputation 4 for delivering the best, most reliable technology of the highest quality continues to win us new business and new customers. And our belief that market success is forged from strong partnerships with suppliers and customers alike is allowing Brooktrout to set the technical pace in electronic messaging. At Brooktrout, we're excited about the challenges and opportunities that lie ahead. Our markets are expanding, our customers are growing, our products are at the leading edge of innovation, and our employees are the best in the business. We look forward to shaping the future of electronic messaging. Sincerely, Eric Giler, President 5 THE REVOLUTION HAS BEGUN. ELECTRONIC MESSAGING IS TRANSFORMING THE WORKPLACE AND REDEFINING VIRTUALLY EVERYTHING WE DO THERE. Although it might seem like another age, it was just a few short years ago when terms like electronic mail, broadcast faxing, file transfer, and even voice mail were unknown to most people. In business, the challenge of keeping up with the pace of change is difficult and risky. Every decision has an impact on productivity across the organization as well as its ability to compete in its marketplace. Which technologies to adopt? How quickly to proceed across the enterprise? How much change is feasible? And, at what cost? At Brooktrout, the answers to these questions are the foundation of what we do. Our business is electronic messaging. Our hardware and software products enable corporations, network systems vendors, and telecommunications service providers to centralize and streamline their voice, fax, and data communication systems. They help customers build cost-effective and integrated messaging systems, and help to pave the way for even more advanced systems in the years to come. LEADING THE MARKET IN NETWORK FAXING Brooktrout laid the groundwork for the network fax market nearly a decade ago and has led the market ever since, both in developing new innovations and capturing new business. The problem was basic then and for many companies, remains so even today -- how to use the local area network(LAN) to stem the rising cost of proliferating fax machines. Brooktrout engineers pioneered a solution that can deliver faxes directly to individual users while keeping those faxes secure. Today, networked employees around the world have their own private fax numbers made possible by Brooktrout multichannel fax boards. Using Direct Inward Dialing technology, Brooktrout is providing corporations with a centralized and cost-effective solution to handle the growing corporate appetite for fax capability -- and giving users a time-saving and increasingly productive communications tool. In addition, Brooktrout has established close working relationships with the development teams of each of the leading makers of network fax software -- including Alcom, Cheyenne/Computer Associates, CommercePath, Symantec Delrina Group, Equisys, Fenestrae, Global Village, Lotus, Microsoft, Mitek, Open Port Technology, Optus, Omtool, RightFAX, T4 Systems, Traffic Software, and Teubner. This ensures that Brooktrout hardware runs smoothly with whichever major LAN fax or network fax software package our customers might select. ENABLING ENHANCED FAX MESSAGING Enhanced fax service is the marriage of computers with high-density, high-volume fax capabilities. It includes such applications as fax broadcasting, sending a fax to many 6 addresses at once; fax-on-demand, which allows callers to request faxes for transmission; never-busy fax, which can successfully send faxes on the first try without regard for busy signals; personal fax needs, mailboxes, which allow users to receive and store faxes for later use; and store-and-forward faxing, which can hold faxes for transmission during off-peak hours when the toll charges are lower. These services are rapidly becoming more available in the marketplace and each is made possible by Brooktrout TR Series fax and voice boards. This range of services has also attracted a variety of companies that are bringing these specialized services to end users. Brooktrout provides its products and services to customers in several categories: original equipment manufacturers (OEMs), value-added resellers (VARs), corporate customers, and telecommunications service providers. These customers range from such well-known commercial names as Deutsche Telekom, Lucent Technologies, MCI, Nortel, and PR Newswire to more specialized firms such as Applied Voice Technology, Centigram, Glenayre, and Voicetek. A REPUTATION FOR QUALITY AND TECHNICAL INNOVATION In every case, our success is based on a reputation for unmatched quality, reliability, and performance. Brooktrout products, led by the flagship TR114(TM) Universal Port multichannel fax and voice boards, enjoy a reputation for delivering the best and most reliable performance of any in the electronic messaging marketplace. The TR114 Series is the company's most extensive product line. TR Series boards are in use at customer locations worldwide and meet the requirements for use in more than 32 countries. For the smaller company or general purpose customer, the lower-cost TruFax(R) Series has many of the same features and is designed to appeal to network administrators and MIS managers installing general purpose network fax systems. The Brooktrout TR Series Universal Port boards were the first in the industry to combine full fax and voice processing on a single multichannel board. This eliminates the need for the customer to maintain separate dedicated fax and voice systems and the hardware that goes with them. It enables a single system to operate on the same incoming and outgoing phone line and moves the network closer to the goal of totally integrated messaging. At the heart of each board are software-controlled digital signal processors that provide fax and voice processing to each channel independently and support board-level functions through downloadable firmware. For telecommunications service providers and developers, the Universal Port technology enables them to be more competitive by offering their customers a variety of enhanced fax and voice services. USING THE INTERNET TO CUT COMMUNICATION COSTS Another important factor driving change across the telecommunications marketplace is, of course, the Internet. Virtually overnight, the Internet has become an indispensable part of our daily lives. It has rapidly provided business with new ways to reach markets and 7 promote products. Today, Brooktrout is pioneering the technology that is allowing customers to use the Internet to make worldwide communications among facilities, partners, and customers more efficient and less costly. Now, the company has introduced a new line of products and application development tools designed specifically to help customers develop voice and fax services over IP (Internet Protocol) data networks such as the Internet. Brooktrout's new IP product line, the TR2000 Series, supports the full spectrum of IP telephony applications for both voice and fax. The TR2001 provides up to 60 channels of real-time IP voice and fax processing on a single DSP resource board. It also includes integrated telephone and data network interfaces which reduce cost and increase system performance. Since all of Brooktrout's IP telephony products are based on a common software base, customers can upgrade and grow with Brooktrout products as their needs change and new technology becomes available. BOSTON -- AN OPEN ARCHITECTURE FOR SYSTEM GROWTH The Brooktrout Open System Telephony architecture, known as BOSTON, is the technology that makes this design flexibility possible. BOSTON provides a foundation technology that developers can use to create applications without fear that their investment of programming time and resources will be lost when the next generation of product is introduced. Products based on BOSTON will be backward compatible and fully scaleable well into the next century. It is providing the foundation for the company's next generation of application development tools as well as Universal Port voice, fax and data communication platforms. New products based on BOSTON will operate on a range of hardware platforms and will support a wide variety of applications including Internet telephony, network communication, and unified messaging. This provides system integrators and developers with a reliable, expandable, and completely predictable development environment where they can create innovative products and bring them to market far more quickly. PROVIDING A USER-FRIENDLY INTERFACE FOR THE CUSTOMER Even the best technology will miss the mark if its user interface just isn't friendly. It's a pretty simple concept really, but one that eludes all too many high-tech manufacturers. For Brooktrout customers, the Show N Tel(R) graphical user interface allows them to create their own computer telephony applications including audiotext, Interactive Voice Response (IVR), fax-on-demand, fax broadcast, voice and fax messaging, and intelligent call routing. Using Show N Tel's award-winning development methods, customers can drag and drop more than 300 icons to create and quickly deploy a variety of messaging applications. Each icon represents a separate operation that can be strung together into powerful finished applications. This innovative, easy-to-master approach gives companies and organizations of all sizes the flexibility to customize applications that 8 would be too expensive and time-consuming to handle any other way. Since its introduction in 1995, Show N Tel has become the industry's premier computer telephony development platform for Microsoft Windows NT.(R) STRENGTHENING THE DATA COMMUNICATIONS BUSINESS During the year, Brooktrout moved boldly on the third segment of its electronic messaging strategy -- increasing its presence in the emerging data communications segment of the business. The company's data strategy during the year has taken on three forms: entrepreneurship, acquisition, and internal development. The first came with the company's establishment of a new subsidiary, Interspeed, Inc., to pursue new data communications opportunities. As new uses for the Internet and other digital data networks continue to develop and grow and organizations bring more and more of their people on-line using more and more data, high-speed network access technology will become an even greater critical need. To serve precisely that need, Interspeed was established as an independent venture-style subsidiary with a separate management team and a unique charter -- to develop and market carrier-class communications hardware and software products that can address the high-speed data access needs in the rapidly expanding telecommunications industry. The second stage of Brooktrout's data strategy came when it acquired Netaccess, Inc. from Xircom, Inc. Netaccess is a leading supplier of Primary Rate ISDN telephone network interface products and multiport modems. The acquisition expands Brooktrout's leadership as a provider of value-added software and hardware products for electronic messaging by adding a full line of network interface products and high-density data modems. Netaccess ISDN interface products are used by data communication equipment makers such as Motorola and 3Com and by telephony system vendors such as Lucent Technologies. The acquisition expands Brooktrout's global offerings to customers who create computer telephony products and standards-based remote access servers for the Windows NT and Novell(R) operating systems. The third part of the data strategy is an ongoing commitment to internal product development. Early in 1997, Brooktrout introduced the TR Series Network Interface Card, which provides customers with a seamless way to connect Brooktrout's TR114 fax and voice boards to T1 digital telephone lines for up to 24 fax and voice channels. Now, with the acquisition of Netaccess in June, product development teams are working on the next-generation of network interface cards and high-density modem products. CRAFTING A STRATEGY FOR THE NEW MILLENNIUM The business of electronic messaging requires cutting-edge technology, a clear understanding of the changes taking place in the marketplace, and a healthy dose of vision to appreciate the opportunities of tomorrow and where they will lead. For Brooktrout, success in the future comes down to a handful of fundamental ideas -- ideas 9 that form the basis for everything the company has done during the past year and shape the strategy that will carry us well into the next century. This is our blueprint for growth and leadership as we approach the new millennium: OPEN ARCHITECTURE -- The concept of open systems architecture is proven. It encourages broader development efforts, lowers investment risk, and speeds the pace of new applications. Brooktrout's BOSTON architecture promises to launch new and existing developers into the millennium by empowering them with easy software migration, full scaleability, and rapid time-to-market. INTEGRATED HARDWARE -- Systems that incorporate a range of technologies into a unified and easily managed network and the direction for the future in both corporate customers and telecommunications service providers. Brooktrout's Universal Port technology will serve as the foundation for those integrated applications. VALUE-ADDED SOFTWARE -- The competitive and fast-changing nature of today's marketplace requires every software developer to react to market needs more quickly than ever before. Products like Show N Tel and the Brooktrout Application Programmers Interface give developers the tools to shorten development time and get their products to market fast. PRODUCT BREADTH -- To become the leading technology provider for our customers' fax, voice, and data communications needs, our product line must continue to be the most extensive available in market segments offering the broadest range of products covering the full spectrum of fax, voice, and data. Brooktrout is an acknowledged leader in providing the tools to bring these functions together. MULTI-LEVEL PARTNERSHIPS -- Brooktrout is committed to developing close working relationships with its customers, resellers, suppliers, and technology partners. We believe that this mission-driven business philosophy will continue to produce the best results. CUTTING-EDGE TECHNOLOGY -- The foundation of any successful technology company is to innovate, adapt, and innovate again. Brooktrout was built on being the first with the best technology. It's a tradition that will continue to be our beacon as we navigate the future. 10 Brooktrout Technology, Inc. Selected Consolidated Financial Data (In Thousands, Except Per Share Data)
YEARS ENDED DECEMBER 31. STATEMENT OF OPERATIONS DATA 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- Revenue................................... $72,192 $58,827 $38,673 $24,888 $18,060 Costs and expenses: Cost of product sold ................... 32,381 26,059 17,759 12,055 8,734 Research and development.................. 13,627 7,175 4,822 3,523 2,584 Purchased research and development........ 3,746 -- -- -- -- Selling, general and administrative....... 19,970 13,666 9,144 5,686 4,294 Merger related charges.................... -- 1,236 -- -- -- ------- ------- ------- ------- ------- Income from operations.................... 2,468 10,691 6,948 3,624 2,448 Other income (expense): Interest/other income..................... 1,688 1,283 967 604 494 Interest expense.......................... (11) (1) (7) (10) (15) ------- -------- ------- ------- ------- Total other income..................... 1,677 1,282 960 594 479 ------- ------- ------- ------- ------- Income before income tax provision and extraordinary item........................ 4,145 11,973 7,908 4,218 2,927 Income tax provision...................... 1,494 5,108 2,705 1,589 986 ------- ------- ------- ------- ------- Income before extraordinary item........... 2,651 6,865 5,203 2,629 1,941 Extraordinary item (1)..................... -- -- -- -- 337 ------- ------- ------- ------- ------- Net income................................. $2,651 $6,865 $5,203 $2,629 $2,278 ======= ======= ======= ======= ======= Basic income per common share: Before extraordinary item................. $0.25 $0.69 $0.54 $0.27 $0.20 Net income................................ $0.25 $0.69 $0.54 $0.27 $0.24 Shares for basic.......................... 10,702 9,947 9,661 9,570 9,483 Diluted income per common share: Before extraordinary item................. $0.23 $0.63 $0.52 $0.26 $0.19 Net income................................ $0.23 $0.63 $0.52 $0.26 $0.23 Shares for diluted........................ 11,300 10,901 10,077 9,843 9,783 DECEMBER 31, 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- BALANCE SHEET DATA Cash and marketable securities............. $36,378 $39,714 $22,154 $18,951 $14,468 Working capital............................ 41,741 43,408 24,823 19,825 17,217 Total assets............................... 65,415 58,366 34,581 25,461 20,903 Long-term debt, less current portion....... -- -- -- 6 30 Stockholders' equity....................... $50,444 $47,592 $26,445 $20,898 $18,241
(1) Effect of change in accounting for income taxes of $337,000 in 1993. 11 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Except for the historical information contained herein, the matters discussed in this annual report are forward-looking statements which involve risk and uncertainties. The uncertainties include, but are not limited to, economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices, and other factors discussed in the Company's filings with the Securities and Exchange Commission. INTRODUCTION On June 30, 1997, the Company acquired the assets of Netaccess, Inc. (Netaccess), a manufacturer of Primary Rate ISDN equipment. The acquisition was accounted for as a purchase, and accordingly, the results of operations of Netaccess are included with those of the Company from the date of acquisition. YEARS ENDED DECEMBER 31, 1997 AND 1996 Revenue during the year ended December 31, 1997 increased by approximately 23%, to $72.2 million, up from $58.8 million in 1996. The increase in 1997 revenue was primarily attributable to an increase in Primary Rate ISDN telephone network interface products sold. Cost of product sold was $32.4 million, or 45% of revenue in 1997, compared to $26.1 million, or 44% of revenue, in 1996. Gross profit percentage was 55% for 1997 and 56% for 1996. The decrease in the gross profit percentage was related to product mix caused by an increased proportion of lower margin network interface cards. The decrease was partially offset by margin improvements obtained through cost reduction programs instituted in 1997 on the TR Series product line. Research and development expense was $13.6 million, or 19% of revenue in 1997, compared with $7.2 million, or 12% of revenue in 1996. The increase reflects the Company's development efforts for the next generation of Netaccess products and for continued development of the TR Series product family, computer telephony software development tools, Brooktrout Open Systems Telephony Architecture (BOSTon), Brooktrout Interspeed, Inc., as well as fax and OEM systems development. The Company intends to continue to commit significant resources to product development. Selling, general and administrative expense was $20.0 million in 1997, compared with $13.7 million in 1996. This higher expense level resulted from increased staffing, promotional activities and depreciation. Selling, general and administrative staff levels increased from 75 employees at December 31, 1996 to 114 employees at December 31, 1997. As a percentage of revenue, selling, general and administrative expense was 28% of revenue for 1997 and 23% of revenue for 1996. On June 30, 1997, the Company recorded a charge of $3.7 million, representing the portion of the purchase price of Netaccess allocated to in-process research and development efforts as of the date of acquisition. 12 Interest and other income was $1.7 million in 1997, compared with $1.3 million in 1996, reflecting higher investable cash balances prior to the purchase of Netaccess, Inc. The Company's effective tax rate was 36% for the year ended December 31, 1997 and 43% for the year ended December 31, 1996. The effective rate for 1997 decreased due to increased tax benefits derived from the use of a foreign sales corporation for certain export sales and certain nondeductible merger costs recorded in 1996 and not repeated in 1997. YEARS ENDED DECEMBER 31, 1996 AND 1995 Revenue during the year ended December 31, 1996 increased by approximately 52%, to $58.8 million, up from $38.7 million in 1995. The increase in 1996 revenue was attributable to increased shipments of TR Series products, OEM voice systems and fax systems. Increased sales reflect the growth of the principal market segments served by the Company's products, especially the manufacture and sale of fax products for use on local area networks and the manufacture and sale of fax and OEM systems. Cost of product sold was $26.1 million, or 44% of revenue in 1996, compared to $17.8 million, or 46% of revenue, in 1995. Gross profit percentage was 56% for 1996 and 54% for 1995. This increase in gross profit percentage was the result of a higher proportion of TR Series product shipments, which carry a comparatively higher gross margin than OEM systems. Research and development expense was $7.2 million, or 12% of revenue in 1996, compared with $4.8 million, or 13% of revenue in 1995. The dollar increase in 1996 reflects the Company's continuing development efforts for its TR Series product family and computer telephony development tools, as well as fax and OEM systems development. As a result of a higher dollar increase in the Company's revenues, however, the percentage decreased. Selling, general and administrative expense was $13.7 million in 1996, compared with $9.1 million in 1995. This higher expense level resulted from increased staffing, promotional activities and travel. The Company's promotional activities in 1996 were directed primarily towards increased levels of advertising in industry publications and participation in trade shows. As a percentage of revenue, selling, general and administrative expense was 23% of revenue for 1996 and 24% of revenue for 1995. During the year ended December 31, 1996, the Company incurred approximately $1.2 million in costs related to the acquisition of and merger with Technically Speaking, Inc. (TSI). These costs primarily related to professional and investment banking fees. Interest and other income was $1.3 million in 1996, compared with $967,000 in 1995, reflecting higher investable cash balances coupled with higher interest rates. The Company's effective tax rate was 43% for the year ended December 31, 1996 and 34% for the year ended December 31, 1995. The effective rate for 1996 increased due primarily to certain merger related costs which are not deductible for tax purposes. 13 LIQUIDITY AND CAPITAL RESOURCES On June 30, 1997, the Company acquired the assets and assumed certain liabilities of Netaccess, Inc., a worldwide supplier of Primary Rate ISDN network interface products and multiport modem products for open, standards-based remote access and computer telephony systems. The purchase price was $9.9 million, paid in cash, and the Company also agreed to assume certain liabilities aggregating $2.0 million. Based upon independent appraisals, the Company has recorded a charge of $3.7 million ($2.3 million, net of tax benefits) representing the portion of the purchase price allocated to Netaccess' research and development efforts in-process. The estimated cost to complete these product development efforts approximates $1.4 million and all work is expected to be completed and the products available for general release by the end of 1998. During 1997, 1996 and 1995, the Company funded its operations primarily through operating revenue. In July 1997, 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 1998 and at that time any outstanding balances would be payable in full. The Company expects to renew the line of credit on similar terms as those in place at present. Any amounts borrowed under the line would be subject to interest at the bank's prime rate. At December 31, 1997 there were no commitments outstanding on letters of credit; no borrowings have been made during any period presented. The Company's working capital decreased from $43.4 million at December 31, 1996 to $41.7 million at December 31, 1997. The decrease in working capital was primarily caused by the payment of $9.9 million in cash to acquire the assets of Netaccess, which was partially offset by an increase in working capital of $5.2 million representing the working capital of Netaccess. Other increases in working capital represented increases in cash, receivables and inventory consistent with the positive cash flow from operations and the growth in the business experienced during the year ended December 31, 1997. During 1997, 1996 and 1995, the Company purchased approximately $2,700,000, $3,400,000, and $646,000, respectively, in equipment. The Company currently has no material commitments for additional capital expenditures. The pricing of the Company's products and costs of its goods are generally determined by current market conditions. Market conditions can be impacted by inflation, however, the Company believes that inflation has not had a significant effect on its operations to date. The Company has operating lease commitments for its office and manufacturing facilities expiring through 2006 with options to renew for periods of up to 10 years. Certain lease agreements require the Company to pay all of the building's taxes, insurance and maintenance costs (see Note 7 to the consolidated financial statements). The Company anticipates that cash flows from operations, 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. 14 RECENT ACCOUNTING PRONOUNCEMENTS In 1998, the Company will be required to adopt the provisions of AICPA Statement of Position No. 97-2, "Software Revenue Recognition" (SOP 97-2), Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130), and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131). Adoption of SOP 97-2 and SFAS 130 is not expected to have a material effect on financial position or the results of operations; the Company has not yet determined the operating segments to be reported under SFAS 131. YEAR 2000 The Company has conducted a review of its computer systems to identify those areas that could be affected by the "Year 2000" issue and is developing an implementation plan to resolve the issue. The Company implemented a new enterprise information system during 1997 which has been designed by the vendor to properly process transactions which could be impacted by the "Year 2000" problem. The Company presently believes, with modification to existing software and the conversion to new software, the "Year 2000" problem will not pose significant operational problems and costs to complete this process are not anticipated to be material to its financial position or results of operations in any given year. 15 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Brooktrout Technology, Inc.: We have audited the accompanying consolidated balance sheets of Brooktrout Technology, Inc. and its subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and its subsidiaries at December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP Deloitte & Touche LLP Boston, Massachusetts February 11, 1998 16 BROOKTROUT TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, ---------------------------- NOTES 1997 1996 ----- ---- ---- ASSETS Current assets: Cash and equivalents............................................ 1 $27,916 $30,738 Marketable securities........................................... 1 8,462 8,976 Accounts receivable (less allowance for doubtful accounts of $1,164 and $524 in 1997 and 1996, respectively)................ 1 9,804 7,107 Inventory........................................................ 1 7,801 5,504 Deferred tax assets.............................................. 1,861 726 Prepaid expenses................................................. 613 899 ------- ------- Total current assets............................................. 56,457 53,950 ------- ------- Equipment and furniture: 1 Computer equipment............................................... 6,182 2,822 Furniture and office equipment................................... 3,696 2,476 ------- ------- Total............................................................ 9,878 5,298 Less accumulated depreciation and amortization................... (3,253) (1,438) ------- ------- Equipment and furniture -- net................................... 6,625 3,860 Deferred tax assets.............................................. 4 1,234 -- Investments and other assets..................................... 1 1,099 556 ------- ------- Total............................................................ $65,415 $58,366 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and other accruals............................. $10,510 $ 7,633 Accrued compensation and commissions............................ 2,321 1,996 Customer deposits............................................... 325 263 Accrued warranty costs.......................................... 1 850 446 Accrued income taxes............................................ 4 710 204 ------- ------- Total current liabilities..................................... 14,716 10,542 ------- ------- Deferred rent.................................................... 7 255 232 Commitments and contingencies.................................... 9 -- -- Stockholders' equity: 1,5 Preferred stock, $1.00 par value; authorized 100,000 shares; issued and outstanding, none.................................... -- -- Common stock, $.01 par value; authorized 25,000,000 shares; issued and outstanding, 10,741,195 and 10,683,352 in 1997 and 1996, respectively..................................... 107 107 Additional paid-in capital....................................... 31,978 31,785 Unrealized gains (losses) on marketable securities............... -- (8) Retained earnings................................................ 18,359 15,708 ------- ------- Total stockholders' equity....................................... 50,444 47,592 ------- ------- $65,415 $58,366 Total........................................................ ======= =======
See notes to consolidated financial statements. 17 BROOKTROUT TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, ---------------------------------------- NOTES 1997 1996 1995 -------- -------- -------- ------- Revenue.................................... 1,6,8 $72,192 $58,827 $38,673 Cost and expenses: Cost of product sold...................... 32,381 26,059 17,759 Research and development................. 1 13,627 7,175 4,822 Purchased research and development........ 2 3,746 -- -- Selling, general and administrative....... 19,970 13,666 9,144 Merger related charges.................... -- 1,236 -- ------ ------- ------- Total cost and expenses............... 69,724 48,136 31,725 ------ ------- ------- Income from operations..................... 2,468 10,691 6,948 Other income (expense): Interest and other income................. 1,688 1,283 967 Interest expense.......................... (11) (1) (7) ------ ------- ------- Total other income......................... 1,677 1,282 960 ------ ------- ------- Income before income tax provision......... 4,145 11,973 7,908 Income tax provision....................... 1,4 1,494 5,108 2,705 ------- ------- ------- Net income................................. $ 2,651 $ 6,865 $ 5,203 ======= ======= ======= Income per common share: 1 Basic................................... $ 0.25 $ 0.69 $ 0.54 ======= ======= ======= Shares for basic........................ 10,702 9,947 9,661 ======= ======= ======= Diluted................................. $ 0.23 $ 0.63 $ 0.52 ======= ======= ======= Shares for diluted...................... 11,300 10,901 10,077 ======= ======= =======
See notes to consolidated financial statements. 18 BROOKTROUT TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
UNREALIZED GAINS COMMON STOCK ADDITIONAL (LOSSES) ON ------------------------ PAID-IN MARKETABLE RETAINED SHARES AMOUNT CAPITAL SECURITIES EARNINGS TOTAL ---------- -------- --------- ----------- --------- ------- Balance, January 1, 1995 ................. 9,606,122 $ 96 $16,663 ($ 95) $ 4,234 $20,898 Issuance of common stock for cash ........ 76,994 1 114 -- -- 115 Tax benefit of stock options ............. -- -- 107 -- -- 107 Unrealized gains on marketable securities -- -- -- 144 -- 144 Distributions to stockholders ............ (22) (22) Net income ............................... -- -- -- -- 5,203 5,203 ---------- ---- ------- ----- ------- ------- Balance, December 31, 1995 ............. 9,683,116 97 16,884 49 9,415 26,445 Issuance of common stock for cash ........ 1,000,236 10 12,718 -- -- 12,728 Tax benefit of stock options ............ -- -- 2,183 -- -- 2,183 Unrealized losses on marketable securities -- -- -- (57) -- (57) Distributions to stockholders ............ -- -- -- -- (572) (572) Net income ............................... -- -- -- -- 6,865 6,865 ---------- ---- ------- ----- ------- ------- Balance, December 31, 1996 .............. 10,683,352 107 31,785 (8) 15,708 47,592 Issuance of common stock for cash ....... 57,843 -- 193 -- -- 193 Unrealized gains on marketable securities -- -- -- 8 -- 8 Net income ............................... -- -- -- -- 2,651 2,651 ---------- ---- ------- ----- ------- ------- Balance, December 31, 1997 .............. 10,741,195 $107 $31,978 $ -- $18,359 $50,444 ========== ==== ======= ===== ======= =======
See notes to consolidated financial statements. 19 BROOKTROUT TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, -------------------------------------------- 1997 1996 1995 -------- -------- -------- Cash flows from operating activities: Net income ................................ $ 2,651 $ 6,865 $ 5,203 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization ............. 1,815 586 648 Purchased research and development ........ 3,746 -- -- Amortization of (premium) discount on marketable securities ..................... (44) 18 21 Deferred income taxes ..................... (2,369) (272) (50) Increase (decrease) in cash from (net of acquisition): Accounts receivable ....................... 1,083 (1,010) (3,026) Inventory ................................. 957 (1,626) (2,237) Other prepaid expenses .................... 346 (533) (123) Accounts payable and other accruals ....... 1,368 2,694 3,547 -------- -------- -------- Cash provided by operating activities ................................ 9,553 6,722 3,983 -------- -------- -------- Cash flows from investing activities: Expenditures for equipment and furniture . (2,717) (3,413) (646) Acquisition of Netaccess (net of cash acquired) .......................... (9,909) -- -- other assets ............................ (258) 43 (11) Investment ................................ (250) -- (500) Purchases of marketable securities ........ (8,754) (4,532) (10,801) Maturities of marketable securities ....... 9,320 3,405 11,544 -------- -------- -------- Cash used for investing activities ..... (12,568) (4,497) (414) -------- -------- -------- Cash flows from financing activities: Proceeds from the sale of common stock ... 193 12,728 115 Disqualifying dispositions ................ -- 2,183 107 Distributions to stockholders ............. -- (572) (22) Net proceeds from (repayments of) line of credit ........................... -- (50) 50 Repayment of long-term debt ............... -- (6) (24) -------- -------- -------- Cash provided by financing activities ..... 193 14,283 226 -------- -------- -------- Increase (decrease) in cash and equivalents (2,822) 16,508 3,795 Cash and equivalents, beginning of year .. 30,738 14,230 10,435 -------- -------- -------- Cash and equivalents, end of year ......................... $ 27,916 $ 30,738 $ 14,230 ======== ======== ========
See notes to consolidated financial statements. 20 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business -- Brooktrout Technology, Inc. (the Company) supplies computer software and hardware products to system vendors and service providers in the electronic messaging market. The Company's products enable its customers to deliver a wide range of solutions for the integration and cost effective management of image (fax), voice and data communications. The Company conducts business primarily in the United States, with manufacturing, research and sales operations centered in Massachusetts, New Hampshire and Texas. The Company sells its products to service providers, original equipment manufacturers, and value-added resellers. Use of Estimates -- The preparation of financial statements requires, of necessity, the use of estimates to determine the appropriate carrying value of certain assets and liabilities. Actual results could differ from those estimates. Principles of Consolidation -- The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Technically Speaking, Inc. (TSI), Brooktrout Securities Corporation, Brooktrout Technology (Europe) Limited (U.K.), Brooktrout Technology Europe, Ltd. (U.S.), Brooktrout Networks Group, Inc., Brooktrout Technology Foreign Sales Corporation, Brooktrout Interspeed, Inc., Brooktrout Business Trust, Brooktrout Holding, Inc. and Netaccess, Inc. All significant intercompany balances and transactions have been eliminated. Revenue Recognition -- Revenue from product or software sales is recognized upon the shipment or delivery of product when no significant obligations remain. Revenue from maintenance and support contracts is deferred and recognized ratably over the service period. Maintenance and support revenue included with an initial license fee is unbundled and recognized ratably over the service period. Concentration of Credit Risk -- The Company sells its products to various customers in several industries. The Company generally requires no collateral; however, to reduce credit risk the Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses. At December 31, 1997 and 1996, 17% and 35%, respectively, of the Company's accounts receivable were from one customer (see Note 6). 21 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Inventory -- Inventory is carried at the lower of cost (first-in, first-out basis) or market and consisted of the following:
DECEMBER 31, ----------------------------------- 1997 1996 ---------- ---------- Raw materials .................................................. $3,268,000 $3,740,000 Work inprocess ................................................. 1,606,000 1,104,000 Finished goods ................................................. 2,927,000 660,000 ---------- ---------- Total ................................................... $7,801,000 $5,504,000 ========== ==========
Equipment and Furniture -- Purchased equipment and furniture is recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets (three or five years). Software Development Costs -- Certain software development costs are capitalized following attainment of technological feasibility. No such costs were capitalized in 1997, 1996 or 1995. Research and Development Costs -- Research and development costs, other than software development costs, are expensed as incurred. Warranty Costs -- Estimated costs of warranty repairs are provided at the time of sale of the related product. Income Taxes -- Deferred tax assets and liabilities are provided to recognize temporary differences between the book and tax bases of the Company's assets and liabilities. These assets and liabilities are measured using currently enacted rates. Investments -- The Company has investments in the common stock of two companies operating in the computer telephony industry. One of the Company's investments aggregated $500,000 at December 31, 1997 and 1996, and the other investment aggregated $250,000 at December 31, 1997. Both investments represent less than 20% of the voting interest. Because the common stock of the two companies is not readily marketable, the investments are carried at cost and periodically assessed for potential impairment in value. 22 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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:
YEARS ENDED DECEMBER 31, --------------------------------------------------- 1997 1996 1995 ---- ---- ---- Cash paid for interest................. $ -- $ 1,000 $ 7,000 Cash paid for income taxes.............. 2,401,000 3,702,000 2,219,000
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 recorded as a separate component of stockholders' equity. Marketable securities consist primarily of U.S. Treasury securities, with some funds held in investment grade corporate notes. At December 31, 1997 and 1996, the amortized cost of these securities was $8,461,000 and $8,984,000, respectively. Gross unrealized gains at December 31, 1997 were $10,000 and gross unrealized losses were ($10,000). During the three years ended December 31, 1997, there were no significant realized gains or losses from sales of these securities. Income per Common Share - In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Prior to 1997, the Company computed income per common share using the method outlined in Accounting Principles Board Opinion No. 15, Earnings Per Share, and its interpretations (APB 15). Income per common share previously reported using the provisions of APB 15 in 1995 and 1996 was $0.52 and $0.63 per share, respectively. Basic income per common share is computed using the weighted average number of common shares outstanding during each year. Diluted income per common share reflects the effect of the Company's outstanding options (using the treasury stock method), except where such options would be antidilutive. 23 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation of weighted average shares used for the basic and diluted computations is as follows:
------------------------------------------------------------ 1997 1996 1995 ---------- ---------- ---------- Weighted average shares for basic . 10,702,000 9,947,000 9,661,000 Dilutive effect of stock options .. 598,000 954,000 416,000 ---------- ---------- ---------- Weighted average shares for diluted 11,300,000 10,901,000 10,077,000 ========== ========== ==========
Fair Value of Financial Instruments -- Financial instruments held or used by the Company consist of cash, marketable securities, accounts receivable, accounts payable and letters of credit issued under the Company's line of credit (Note 3). Marketable securities are carried at fair value at each balance sheet date. Management estimates that carrying value approximates fair value for all other financial instruments. Stock-Based Compensation -- Compensation expense associated with awards of stock or options to employees is measured using the intrinsic value method of Accounting Principles Board Opinion No. 25. NEW ACCOUNTING PRONOUNCEMENTS Revenue Recognition -- In October 1997, the American Institute of Certified Public Accountants released Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2), which the Company will be required to adopt in 1998. The Company does not believe that the adoption of the provisions of SOP 97-2 will result in significant changes to the Company's revenue recognition practices and, accordingly, SOP 97-2 is not expected to have a material impact on financial position, results of operations or cash flows of the Company. Segment Reporting -- In June 1997, the Financial Accounting Standards Board released Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131), which the Company will be required to adopt in 1998. SFAS 131 will require the Company to provide information about the segments of its business based upon internal information used to make operating decisions. In addition, SFAS 131 requires that such information be provided in greater detail than currently required. The Company is currently evaluating its lines of business to determine reportable segments, but has not yet completed its evaluation. 24 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Comprehensive Income -- In June 1997, the Financial Accounting Standards Board released Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130), which the Company will be required to adopt in 1998. SFAS 130 will require that the Company provide a prominent display of the components of items of other comprehensive income. The only items that the Company currently records as other comprehensive income are unrealized gains or losses on available for sale marketable securities. Adoption of SFAS 130 will not have an effect on reported results of operations or financial position. 2. ACQUISITIONS Netaccess, Inc. On June 30, 1997, the Company acquired the assets and assumed certain liabilities of Netaccess, Inc., a worldwide supplier of Primary Rate ISDN network interface products and multiport modem products for open, standards-based remote access and computer telephony systems. The purchase price was $9.9 million, paid in cash, and the Company agreed to assume certain liabilities aggregating $2.0 million. The acquisition has been accounted for as a purchase, and accordingly, the results of operations of Netaccess, Inc. have been included in the Company's consolidated financial statements from the date of acquisition. The purchase price has been allocated to the assets acquired based upon their fair values using independent appraisals. The Company has recorded a charge of $3.7 million ($2.3 million, net of tax benefits) in 1997 representing the estimated value of Netaccess' research and development efforts in-process. Such efforts had not yet reached technological feasibility and did not possess alternative uses. Had the acquisition occurred as of January 1, 1996, revenue on a pro forma basis would have been $79,375,000 for the year ended December 31, 1997 and $84,943,000 for the year ended December 31, 1996. Net income on a pro forma basis would have been $2,999,000 for the year ended December 31, 1997 and $7,383,000 for the year ended December 31, 1996. Basic and diluted income per share would have been $0.28 and $0.27, respectively, for the year ended December 31, 1997 and $0.74 and $0.68, respectively, for the year ended December 31, 1996. 25 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Technically Speaking, Inc. (TSI) On May 29, 1996, the Company acquired TSI. In connection with the acquisition, the Company issued 713,000 shares of common stock to TSI stockholders in exchange for all of their interest in TSI. The acquisition qualified for pooling-of-interests accounting treatment and, accordingly, the Company's consolidated financial statements have been retroactively restated to include the accounts of TSI for all periods presented. In connection with the acquisition, the Company recorded a charge of $1,236,000 representing costs associated with this transaction. 3. BANK LINE OF CREDIT The Company has a line of credit with a bank. 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. At December 31, 1997, there were no commitments outstanding on letters of credit; no borrowings have been made during any period presented. Any amounts outstanding under the line of credit would bear interest at the bank's prime rate. The line is subject to annual renewal and expires in July 1998. 4. INCOME TAXES The provision for income taxes is approximately as follows:
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Federal--current ............ $ 3,092,000 $ 2,428,000 $ 1,935,000 State--current .............. 771,000 769,000 713,000 Federal--deferred ........... (1,886,000) (207,000) (37,000) State--deferred ............. (483,000) (65,000) (13,000) Tax benefit of disqualifying dispositions of stock options ................. -- 2,183,000 107,000 ----------- ----------- ----------- Provision ................... $ 1,494,000 $ 5,108,000 $ 2,705,000 =========== =========== ===========
26 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation of the statutory federal rate to the effective tax rate is as follows:
YEARS ENDED DECEMBER 31, ------------------------------------------ 1997 1996 1995 ---- ---- ---- Statutory tax rate ............................... 34% 34% 34% Acquisition related charges not deductible for tax -- 3 -- State taxes, net of federal benefit .............. 6 6 7 Foreign sales corporation ........................ (4) -- -- TSI income not subject to taxation ............... -- -- (5) Other ............................................ -- -- (2) --- -- --- Effective tax rate ................................ 36% 43% 34% === == ===
The tax effects of significant items comprising the Company's net deferred tax asset as of December 31, 1997 and 1996 are as follows:
1997 1996 ---------- --------- Deferred Tax Assets: Current: Reserves and accruals not currently deductible for tax purposes ................................. $1,861,000 $ 746,000 Long-Term: In-process research and development, capitalized for tax but expensed for book ................ 1,234,000 -- Equipment and furniture, principally depreciation methods ......................... -- (20,000) ---------- --------- Long-term tax assets (liabilities) .................. 1,234,000 (20,000) ---------- --------- Net deferred tax asset ............................. $3,095,000 $ 726,000 ========== =========
5. STOCKHOLDERS' EQUITY Stock Option Plans -- The Company has three stock option plans in place providing for the granting of options to purchase up to 2,325,000 shares of common stock: the 1984 Plan, the Executive Plan and the 1992 Plan. No further options are being granted under the 1984 Plan and the Executive Plan. Exercise prices are at fair value at the date of grant, in the case of incentive stock options, or at the discretion of the Board of Directors in the case of nonqualified options. Options generally vest over five years; in some instances, vesting can accelerate upon the completion of certain defined milestones set by the Compensation Committee at the date of grant. There have been no option grants at exercise prices different from fair value. 27 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following is a summary of stock option activity under all plans:
WEIGHTED AVERAGE NUMBER OF SHARES EXERCISE PRICE --------------------- --------------------- Outstanding at January 1, 1995 1,189,440 $4.90 Granted 184,430 $6.67 Exercised (61,280) $0.66 Expired (337) $6.33 ----- Outstanding at December 31, 1995 1,312,253 $5.31 Granted 565,875 $22.50 Exercised (367,078) $5.63 Expired (1,687) $4.56 ------- Outstanding at December 31, 1996 1,509,363 $11.61 Granted 478,875 $11.80 Exercised (40,249) $0.82 Expired (19,851) $17.07 -------- Outstanding at December 31, 1997 1,928,138 $11.92 =========
28 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table sets forth information regarding options outstanding at December 31, 1997:
WEIGHTED AVERAGE WEIGHTED WEIGHTED EXERCISE RANGE OF AVERAGE AVERAGE NUMBER PRICE FOR EXERCISE NUMBER OF EXERCISE REMAINING CURRENTLY CURRENTLY PRICES SHARES PRICE LIFE (YEARS) EXERCISABLE EXERCISABLE $0.20-$5.56 202,739 $ 1.91 4.03 195,313 $ 1.82 $5.61-$6.11 3,375 $ 5.94 5.42 2,700 $ 5.94 $6.33 586,179 $ 6.33 6.18 577,179 $ 6.33 $6.44-$10.00 202,745 $ 8.10 7.78 72,579 $ 6.75 $10.13-$10.63 201,750 $10.61 9.64 46,875 $10.63 $10.75-$22.00 200,975 $14.74 8.43 15,131 $15.97 $22.50 487,500 $22.50 8.47 243,750 $22.50 $23.50-$27.25 33,875 $25.87 5.26 8,906 $27.25 $29.91 5,000 $29.91 8.83 1,000 $29.91 $31.50 4,000 $31.50 8.92 800 $31.50 ------------ --------- ------ ---- --------- ------ $0.20-$31.50 1,928,138 $11.92 7.29 1,164,233 $ 9.48 ============ ========= ====== ==== ========= ======
At December 31, 1996 and 1995,options to purchase 630,371 and 563,199 shares were exercisable. Stock Purchase Plan -- In August 1992, the Board of Directors adopted and the stockholders approved the Company's 1992 Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan provides for sales to participating employees of up to 112,500 shares of common stock, at prices not less than 85% of fair market value on the beginning or ending date of the six month offering period provided for purchase, whichever is lower. Through December 31, 1997, 72,886 shares had been issued. 29 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Pro Forma Disclosure -- As described in Note 1, the Company uses the intrinsic value method to measure compensation expense associated with grants of stock options or awards to employees. Had the Company used the fair value method to measure compensation, reported net income and earnings per share would have been as follows:
1997 1996 1995 Net income $855,000 $5,078,000 $5,050,000 Basic income per common share $ 0.08 $ 0.51 $ 0.52 Diluted income per common share $ 0.08 $ 0.47 $ 0.50
For purposes of determining the above disclosure required by Statement of Financial Accounting Standards No. 123, the fair value of options on their grant date was measured using the Black/Scholes option pricing model. Key assumptions used to apply this pricing model were as follows:
1997 1996 1995 Risk-free interest rate 5.2% 5.6% 6.1% Expected life of option grants 5.0 5.0 5.0 Expected volatility of underlying stock 82% 68% 66%
The pro forma presentation only includes the effects of grants made subsequent to January 1, 1995. The estimated weighted average fair value of option grants made during 1997, 1996 and 1995 was $8.29, $13.71 and $3.95, respectively, per option. The estimated weighted average fair value of grants made under the Purchase Plan during 1997, 1996, and 1995 was $3.64, $7.61 and $1.71, respectively, computed using the assumptions described above with an expected life of 6 months for the option feature present in the Purchase Plan awards. Reserved Shares -- The Company has reserved 2,188,639 shares of common stock for issuance upon the exercise of stock options and purchase of stock under the Purchase Plan. 30 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Subsidiary Stock Plans -- Two of the Company's subsidiaries have stock option plans in place, providing for the grant of options to employees of that subsidiary. None of these options are convertible into or can be settled in Company stock. The following table demonstrates the dilutive effect of these plans on the Company's ownership interest in each subsidiary assuming all options in each category were exercised:
Maximum Dilution to Company's Currently Maximum Interest in Outstanding Available Subsidiary Options Options ---------- ------- ------- Subsidiary A (Weighted exercise price of $1.20) 14% 1,163,000 1,620,000 B (Weighted exercise price of $6.07) 29% 240,600 400,000
The options of Subsidiary A and Subsidiary B vest over a period of 5 years. At December 31, 1997, none of the options of Subsidiary A were exerciseable and 30,913 options of Subsidiary B were exerciseable. To date, neither of these plans has been dilutive to the Company's interest in the earnings of the affected subsidiaries. Distributions to Stockholders -- TSI and its stockholders had elected to be treated as a Subchapter S corporation under the Internal Revenue Code. As a result, TSI's income was taxed at the stockholder level and no provision for income taxes was made. This election terminated effective on the date of consummation of the merger, and TSI is subject to corporate income taxes on a prospective basis. TSI's policy prior to the acquisition was to distribute annually to its stockholders an amount sufficient to pay the income taxes on the Subchapter S income reported on their personal income tax returns. In 1996 and 1995, distributions of $572,000 and $22,000 were made based upon 1994, 1995 and 1996 taxable income, respectively. Equity Offering -- In August 1996, the Company sold 649,632 shares of common stock to the public generating proceeds of approximately $11.1 million. 6. MAJOR CUSTOMER One customer accounted for 30%, 33% and 36% of net revenue for the years ended December 31, 1997, 1996 and 1995, respectively. 31 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. LEASE COMMITMENTS The Company has operating lease commitments for office and manufacturing facilities. Two of the lease agreements expire in October 2006; the Company has the option to extend one of the leases for up to 10 years and the other for 5 years. Both lease agreements require the Company to pay all taxes, insurance and maintenance costs. Another office and manufacturing lease expires in 2000 and the Company has the option to extend the lease for 3 additional years. These leases contain rent holiday and escalation clauses. In addition, the Company leases other office facilities under noncancelable operating leases. Rent expense under these leases is recognized on a straight-line basis. Rent expense under all operating leases aggregated $1,547,000, $660,000 and $511,000 for each of the years ended December 31, 1997, 1996 and 1995, respectively. Minimum Lease Payments Under Non-Cancelable Operating Leases
Years Ending December 31, ------------------------- 1998..................................................................... $1,202,000 1999..................................................................... 1,080,000 2000..................................................................... 1,017,000 2001..................................................................... 714,000 2002..................................................................... 664,000 Thereafter............................................................... 2,207,000 ---------- Total........................................................... $6,884,000 =========
8. INTERNATIONAL SALES International sales, principally exports from the United States, accounted for approximately 19%, 18% and 11% of revenue for the years ended December 31, 1997, 1996 and 1995, respectively. 9. CONTINGENCIES The Company is a party to a number of legal actions which arise in the normal course of business. The Company, taking into account advice of counsel, does not believe the eventual outcome of these matters will have a material effect on the Company's consolidated financial condition or results of operations. 32 BROOKTROUT TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. RETIREMENT PLANS The Company has a 401(K) retirement plan available to qualified employees. Employees are allowed to contribute up to 18% of their salary to the plan. The Company matches contributions equal to $.25 per dollar contributed up to a maximum of 6% of a participant's salary. The Company contributed $121,000 to the plan in 1997. 11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ----------- ----------- ----------- ----------- 1997 Revenue ..................... $15,070,000 $14,725,000 $19,493,000 $22,904,000 Gross profit ................ 8,548,000 8,182,000 10,689,000 12,392,000 Income (loss) from operations ................ 2,117,000 (2,936,000) 1,020,000 2,267,000 Net income (loss) .......... 1,560,000 (1,475,000) 816,000 1,750,000 Basic income (loss) per common share............... $ 0.15 ($ 0.14) $ 0.08 $ 0.16 Diluted income (loss) per common share .............. $ 0.15 ($ 0.14) $ 0.07 $ 0.15 1996 Revenue ..................... $11,300,000 $13,445,000 $15,874,000 $18,208,000 Gross profit ................ 6,203,000 7,737,000 8,726,000 10,102,000 Income from operations ...... 1,663,000 1,555,000 3,369,000 4,104,000 Net income .................. 1,166,000 694,000 2,218,000 2,787,000 Basic income per common share .............. $ 0.12 $ 0.07 $ 0.22 $ 0.28 Diluted income per common share .............. $ 0.11 $ 0.07 $ 0.20 $ 0.25
33 DIRECTORS & EXECUTIVE OFFICERS DIRECTORS Eric R. Giler President Brooktrout Technology, Inc. David W. Duehren Vice President of Research & Development Brooktrout Technology, Inc. Patrick T. Hynes Vice President of Advanced Product Engineering Brooktrout Technology, Inc. Robert G. Barrett General Partner Battery Ventures, Inc. W. Brooke Tunstall President Brooke Tunstall Associates David L. Chapman President NorthPoint Software Ventures, Inc. EXECUTIVE OFFICERS Eric R. Giler President David W. Duehren Vice President of Research and Development Stephen A. Ide Senior Vice President, President, Interspeed, Inc. Robert C. Leahy Vice President of Finance and Operations, and Treasurer Jonathan J. Sirota Vice President of Engineering R. Andrew O'Brien Vice President of Marketing and Business Development 34 DIRECTORS & EXECUTIVE OFFICERS (CONTINUED.) Patrick T. Hynes Vice President of Advanced Product Engineering Michael Donoghue Vice President of Worldwide Sales William Rosenberger Vice President, President, Netaccess, Inc. Mark Flanagan Vice President, General Manager, Brooktrout Software and Systems 35 OFFICES CORPORATE HEADQUARTERS Brooktrout Technology, Inc. 410 First Avenue Needham, Massachusetts 02194-2703 Fax-on-Demand: 1-800-7-BROOKT info@brooktrout.com www.brooktrout.com Phone 781-449-4100 Fax 781-449-3171 SOFTWARE & SYSTEMS 333 Turnpike Road Southborough, Massachusetts 01772 Phone 508-229-7777 Fax 508-229-8777 SUBSIDIARIES Netaccess, Inc. 18 Keewaydin Drive Salem, New Hampshire 03079 info@netacc.com www.netacc.com Phone 603-898-1800 Fax 603-894-4545 Interspeed, Inc. 601 South Union Street Lawrence, Massachusetts 01843 info@interspeed.com www.interspeed.com Phone 978 688-6164 Phone 978-688-6327 Fax 978-688-4798 Brooktrout Networks Group, Inc. Arapaho Creek Business Park 1350 East Arapaho Road Richardson, Texas 75081 Phone 972-907-0885 Fax 972-907-0889 36 OFFICES (CONTINUED.) Brooktrout Technology Europe, Ltd. Hoeilaart Office Center Vandammestraat 5, Box 2 1560 Hoeilaart Belgium Phone +32-2-658-0170 Fax +32-2-658-0180 SALES & SUPPORT OFFICES EAST COAST OFFICES Brooktrout Technology, Inc. 410 First Avenue Needham, Massachusetts 02194-2703 Phone 781-449-4100 Fax 781-449-3171 Interspeed, Inc. 601 South Union Street Lawrence, Massachusetts 01843 Phone 978 688-6164 Fax 978-688-4798 Netaccess, Inc. 18 Keewaydin Drive Salem, New Hampshire 03079 Phone 603-898-1800 Fax 603-894-4545 Brooktrout Technology, Inc. 12 Godfrey Place Wilton, Connecticut 06897 Phone 203-834-2405 Fax 203-761-9769 Netaccess, Inc. 9891 Broken Land Parkway Columbia, Maryland 21046 Phone 410-312-5745 Fax 410-381-3909 37 OFFICES (CONTINUED.) CENTRAL OFFICES Brooktrout Technology, Inc. 1600 Golf Road, Suite 1200 Rolling Meadows, Illinois 60008 Phone 847-981-5062 Fax 847-981-5063 WEST COAST OFFICES Brooktrout Technology, Inc. 2890 Zanker Road, Suite 107 San Jose, California 95134 Phone 408-232-0300 Fax 408-232-0795 Netaccess, Inc. 1250 Oakmead Parkway, Suite 210 Sunnyvale, California 94086 Phone 408-730-2662 Fax 408-730-2667 INTERNATIONAL OFFICES Brooktrout Technology Europe, Ltd. Hoeilaart Office Center Vandammestraat 5, Box 2 1560 Hoeilaart Belgium Phone +32-2-658-0170 Fax +32-2-658-0180 Brooktrout Technology, Inc. No. 10 Overline House Station Way, Crawley Crawley West Sussex, UK RHIO IJA Phone +44 (0) 1293-522-881 Fax +44 (0) 1293-613-567 Brooktrout Technology, Inc. International Plaza 10 Anson Road, #19-06A Singapore 079903 Phone +65-224-0313 Fax +65-224-0337 38 Stock Price Information
1997 1996 QUARTER ENDED HIGH LOW CLOSE QUARTER ENDED HIGH LOW CLOSE March 31 $27.75 $14.50 $14.88 March 31 $24.83 $11.11 $23.00 June 30 $16.88 $10.00 $11.88 June 30 $32.66 $15.50 $28.00 September 30 $17.38 $9.50 $15.88 September 30 $38.00 $14.00 $36.50 December 31 $16.75 $9.50 $11.56 December 31 $42.25 $25.00 $28.00
GENERAL COUNSEL Goodwin, Procter & Hoar LLP Boston, Massachusetts INDEPENDENT AUDITORS Deloitte & Touche LLP Boston, Massachusetts TRANSFER AGENT State Street Bank & Trust Company Boston EquiServe, Limited Partnership P.O. Box 8040 Boston, MA 02266-8040 781-575-3400 www.equiserve.com INFORMATION REQUESTS A copy of the Form 10-K filed with the Securities and Exchange Commission may be obtained without charge upon written request to the Company. PLEASE ADDRESS REQUESTS TO: Investor Relations Robert C. Leahy Vice President of Finance and Operations, and Treasurer Brooktrout Technology, Inc. 410 First Avenue Needham, Massachusetts 02194-2703 ANNUAL MEETING Thursday, May 14, 1998 Fleet Bank 75 State Street Boston, Massachusetts 02109 EX-23.1 5 INDEPENDENT AUDITORS CONSENT 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-55708 on Form S-8, and in Registration Statement No. 33-55900 on Form S-8 of our reports dated February 11, 1998, appearing in and incorporated by reference in the Annual Report on Form 10-K of Brooktrout Technology, Inc. for the year ended December 31, 1997. DELOITTE & TOUCHE LLP Boston, Massachusetts March 27, 1998 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BROOKTROUT TECHNOLOGY, INC.'S CONDENSED CONSOLIDATED BALANCE SHEET AND STATEMENTS OF INCOME FOR THE PERIOD ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH BROOKTROUT TECHNOLOGY, INC.'S 10-K FOR THE PERIOD ENDED DECEMBER 31, 1997. 1,000 US DOLLARS 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 1 27,916 8,462 9,804 1,164 7,801 56,457 9,878 3,253 65,415 14,716 0 0 0 107 0 65,415 72,192 72,192 32,381 32,381 37,343 0 11 4,145 1,494 2,651 0 0 0 2,651 .25 .23
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