Prepared by MERRILL CORPORATION

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended September 30, 2001

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

For the transition period from ____ to ____

Commission File No. 000-20698

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

Massachusetts		04-2814792
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification number)

250 First Avenue, Suite 300		02494-2814
Needham, Massachusetts		02494-2814
(Address of principal executive offices)		(Zip code)

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

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

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

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

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements

	Unaudited Condensed Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000

	Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2001 and September 30, 2000

	Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2001 and September 30, 2000

	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and September 30, 2000

	Notes to Unaudited Condensed Consolidated Financial Statements

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

	Introduction

	Three Months Ended September 30, 2001 and September 30, 2000

	Nine Months Ended September 30, 2001 and September 30, 2000

	Liquidity and Capital Resources

	Risk Factors

Item 3.	Quantitative and Qualitative Disclosures about Market Risk

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 6.	Exhibits and Reports on Form 8-K

	Signatures

Brooktrout, Inc.
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share data)

	September 30, 2001			December 31, 2000

ASSETS
Current assets:
Cash and equivalents	$	28,092		$	23,294
Marketable securities	7,041			2,693
Accounts receivable, net	8,426			21,820
Inventory	15,697			19,609
Deferred tax assets	6,047			7,873
Prepaid expenses and other current assets	4,869			3,749
Total current assets	70,172			79,038

Equipment and furniture, less accumulated depreciation and amortization	5,795			7,574
Deferred taxes	4,361			6,584
Intangible assets, less accumulated amortization	9,872			11,186
Investments	6,597			2,660
Other assets	2,442			2,171
Total assets	$	99,239		$	109,213

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Accounts payable and other accruals	$	12,562		$	15,171
Accrued compensation and commissions	3,488			3,442
Customer deposits	607			558
Accrued warranty costs	1,103			1,499
Net liabilities related to discontinued operations	914			6,024
Total current liabilities	18,674			26,694

Deferred rent	251			260
Contingencies (note 9)

Shareholders’ equity:
Common stock, $0.01 par value; authorized, 40,000,000 shares; issued and outstanding 12,426,028 shares in 2001 and 12,366,927 in 2000	124			124
Additional paid-in capital	63,642			63,348
Loans to officers	(11,760		)	(11,760		)
Accumulated other comprehensive loss	(147		)	(188		)
Retained earnings	32,215			34,495
Treasury stock, 255,384 shares in 2001 and 2000	(3,760		)	(3,760		)
Total shareholders’ equity	80,314			82,259
Total liabilities and shareholders’ equity	$	99,239		$	109,213

See notes to unaudited condensed consolidated financial statements.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2001			2000			2001			2000

Revenue	$	17,213		$	38,684		$	62,120		$	109,177

Cost and expenses:
Cost of product sold	8,268			14,394			27,912			40,279
Research and development	5,171			6,045			16,365			17,442
In-process research and development	-			2,550			-			2,550
Selling, general and administrative	7,661			9,358			25,135			29,017
Total cost and expenses	21,100			32,347			69,412			89,288

Operating income (loss)	(3,887		)	6,337			(7,292		)	19,889
Other income (expense):
Interest income, net	312			469			928			1,598
Equity in loss of affiliates	(3,081		)	(596		)	(4,478		)	(1,996		)
Total other income (expense)	(2,769		)	(127		)	(3,550		)	(398		)
Income (loss) before income taxes	(6,656		)	6,210			(10,842		)	19,491

Income tax provision (benefit)	(1,468		)	2,372			(2,489		)	7,445
Income (loss) from continuing operations	(5,188		)	3,838			(8,353		)	12,046

Discontinued operations:
Loss from discontinued operations, net of taxes	—			(5,993		)	—			(12,349		)
Gain on disposal of discontinued operations, net of taxes	—			—			6,073			—
Total gain (loss) from discontinued operations	—			(5,993		)	6,073			(12,349		)

Net loss	$	(5,188	)	$	(2,155	)	$	(2,280	)	$	(303	)
Income (loss) per common share:
Continuing operations, basic	$	(0.43	)	$	0.32		$	(0.69	)	$	1.03
Continuing operations, diluted	(0.43		)	0.29			(0.69		)	0.94
Net loss, basic	(0.43		)	(0.18		)	(0.19		)	(0.03		)
Net loss, diluted	$	(0.43	)	$	(0.16	)	$	(0.19	)	$	(0.02	)

Shares for basic	12,171			12,030			12,143			11,742

Shares for diluted	12,171			13,147			12,143			12,766

See notes to unaudited condensed consolidated financial statements.

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

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

See notes to unaudited condensed consolidated financial statements.

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

	Nine Months Ended September 30,
	2001			2000

Cash flows from operating activities:
Net loss	$	(2,280	)	$	(303	)
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Gain on disposal of discontinued operations	(6,073		)	—
Depreciation and amortization	4,209			4,646
Equity in loss of affiliates	4,478			610
Non-cash compensation and warrants	—			1,766
Tax benefit of stock options	—			1,562
Minority interest	—			(7,945		)
Deferred income taxes and other	(924		)	(508		)
Increase (decrease) in cash from:
Accounts receivable	13,394			(4,312		)
Inventory	3,912			(15,273		)
Prepaid expenses and other current assets	(1,056		)	(1,427		)
Accounts payable and other accruals	(8,693		)	7,645
Cash provided by (used in) operating activities	6,967			(13,539		)

Cash flows from investing activities:
Purchases of investments	(1,525		)	(3,574		)
Proceeds from the sale of a business segment	4,927			—
Expenditures for equipment and furniture	(940		)	(4,642		)
Expenditures for acquired software	(455		)	(1,982		)
Purchases of marketable securities	(4,481		)	(1,000		)
Other investing	11			(444		)

Cash used in investing activities	(2,463		)	(11,642		)

Cash flows from financing activities:
Proceeds from the sale of common stock	294			4,767
Proceeds from exercise of Interspeed options and warrants	—			726
Purchase of treasury stock	—			(311		)
Cash provided by financing activities	294			5,182
Increase (decrease) in cash and equivalents	4,798			(19,999		)
Cash and equivalents, beginning of period	23,294			48,541
Cash and equivalents, end of period	$	28,092		$	28,542

See notes to unaudited condensed consolidated financial statements.

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

1. Summary of Significant Accounting Policies and Practices

(a) Description of Business

Brooktrout, Inc. (the "Company" or "Brooktrout") delivers communications hardware and software products that enable the development of applications ranging from Internet Protocol ("IP") telephony and embedded voicemail to wireless messaging for the new global communications network. The Company sells its products to system vendors, service providers, enterprise customers, original equipment manufacturers ("OEMs"), and value-added resellers ("VARs") through a direct sales force and a two-tiered distribution system. The Company’s operations consist of one reportable operating segment, Brooktrout Technology, Inc. ("Brooktrout Technology"). Prior to February 8, 2001, the Company was organized and reported the results of its operations in the following three business segments: Brooktrout Technology, Brooktrout Software, Inc. ("Brooktrout Software"), and Interspeed, Inc. ("Interspeed"). Two of these segments have been classified as discontinued operations for the periods presented in these condensed consolidated financial statements (see note 2).

(b) Principles of Consolidation and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 2000.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the interim periods presented.

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

(c) Discontinued Operations

The condensed consolidated statements of operations for periods prior to 2001 have been reclassified to separately report the results of discontinued operations and the results of continuing operations. Disclosures included herein pertain to the Company's continuing operations unless otherwise indicated (see note 2).

(d) Earnings Per Share

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

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

A reconciliation of weighted average shares used for the basic and diluted computations is as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2001	2000	2001	2000
Weighted average shares for basic	12,171,000	12,030,000	12,143,000	11,742,000
Dilutive effect of stock options	—	1,117,000	—	1,024,000
Weighted average shares for diluted	12,171,000	13,147,000	12,143,000	12,766,000

Stock options to purchase 2,323,183 shares and 132,700 shares were not included in the computation of diluted earnings per share in 2001 and 2000, respectively. These options are excluded from the calculation because to include them would have been antidilutive.

(e) Recent Accounting Pronouncements

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

In June of 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets.” SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. For business combinations with an acquisition date before July 1, 2001 and that were accounted for using the purchase accounting method, any reclassifications between intangible assets and goodwill resulting from the implementation of SFAS No. 141 will take place as of the date that SFAS No. 142 is initially applied in its entirety. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. Any impairment loss incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge to current period earnings. SFAS No.142 is effective for fiscal years beginning after December 15, 2001, with early adoption permitted for companies with fiscal years beginning after March 15, 2001 if their first quarter financial statements have not previously been issued. The Company is currently evaluating the provisions of SFAS No. 141 and SFAS No. 142 and has not yet determined the effect that adoption of these standards will have on its consolidated financial statements.

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

2. Discontinued Operations

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

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

The sale of Brooktrout Software resulted in a net gain on disposal of discontinued operations during the nine months ended September 30, 2001of $6,073, net of taxes.

As of September 30, 2001, the balance of net liabilities related to discontinued operations consists of $574 for accruals of expenses related to the sale of Brooktrout Software, and $340 of liabilities associated with the Interspeed business.

	Three Months Ended September 30,					Nine Months Ended September 30,
	2001		2000			2001		2000

Loss from discontinued operations per common share:
Basic	$	—	$	(0.50	)	$	—	$	(1.05	)
Diluted	—		(0.46		)	—		(0.97		)

Gain on disposal of discontinued operations per common share:
Basic	$	—	$	—		$	0.50	$	—
Diluted	—		—			0.50		—

3. Accounts receivable

Accounts receivable balances are net of allowance for doubtful accounts and allowance for sales returns of the following:

	September 30, 2001		December 31, 2000
Allowance for doubtful accounts	$	1,939	$	1,617
Allowance for sales returns	982		1,030
Total	$	2,921	$	2,647

4. Inventory

Inventory is carried at the lower of cost or market, on a first-in first-out basis, and consisted of the following:

	September 30, 2001		December 31, 2000
Raw materials	$	3,351	$	3,008
Work in process	754		1,576
Finished goods	11,592		15,025
Total	$	15,697	$	19,609

5. Income Taxes

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

6. Investments

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

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

In 2001, the Company’s Board of Directors authorized an equity investment of up to $3,050 in one or more tranches, in Pelago. On August 6, 2001, the Company purchased 1,525,000 preferred shares for $1,525. A second tranche was committed to in September 2001 and closed on October 2, 2001. The Company purchased an additional 1,525,000 preferred shares for $1,525. In applying the equity method for the quarter and nine months ended September 30, 2001, the Company included in its investment account its commitment to purchase the additional shares on October 2, 2001. Accordingly, in that such investments funded past losses incurred by Pelago, Brooktrout recorded a charge of $2,818. The Company’s percentage ownership did not change as a result of these transactions. The carrying amount of the Company’s investment in Pelago as of September 30, 2001 is $232.

The Company’s investment in Telchemy has been written down to zero as of September 30, 2001 as the Company has absorbed its proportional share of losses of this entity. The Company has no further commitments relative to Telchemy and, accordingly, has ceased recording its equity in Telchemy’s losses.

7. Segment Reporting

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

Product Sales—Brooktrout Technology groups its product sales based on their applications in the New Network™ and their applications in Today's Network. For the three months ended September 30, 2001, sales of products for use in the New Network accounted for approximately 36% of total revenue as compared to 64% of total revenue for the same period in the prior year. For the nine months ended September 30, 2001, sales of products for use in the New Network accounted for approximately 42% of total revenue compared to 60% of total revenue for the same period in the prior year.

Major Customers—One customer accounted for approximately 16% and 6% of revenue for the three months ended September 30, 2001 and September 30, 2000, respectively. A different customer accounted for 26% of revenue for the quarter ended September 30, 2000; however, this customer represented approximately 1% of revenue in the quarter ended September 30, 2001. The two above-mentioned customers accounted for approximately 12% and 9% of revenue respectively for the nine months ended September 30, 2001, and 6% and 21% of revenue respectively, for the nine months ended September 30, 2000.

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

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

8. Line of Credit

The Company is currently negotiating a renewal of its working capital line of credit. Under the renewed line of credit, the Company will be able to borrow up to $5,000 on a secured basis, all of which could be used for issuance of letters of credit, subject to compliance with certain covenants. Any amounts borrowed under the line of credit will be subject to interest at the lender's prime rate. The Company may issue letters of credit against the bank line from time to time in the ordinary course. As of September 30, 2001, outstanding letters of credit issued against the Company’s existing line amount to $1,000 and relate to the collateralizing of certain lease commitments.

9. Contingencies

In October 2000, several shareholder class action complaints were filed in the United States District Court for the District of Massachusetts (the "Court") by certain shareholders of Interspeed and of the Company. Certain of the complaints named, among others, the Company and certain of its current directors and certain current and former officers as defendants. The lawsuits were filed after Interspeed's October 6, 2000 announcement that it would be restating its unaudited financial results for certain prior quarters of its fiscal year 2000. The complaints included allegations that the Company or certain of its officers and directors participated in and approved the issuance of the financial statements of Interspeed, that defendants are "controlling persons" of Interspeed, and that the defendants made false or misleading statements regarding the Company's own consolidated financial results. Following settlement discussions among the parties, (i) complaints filed by shareholders of the Company were voluntarily dismissed in April 2001 and (ii) the Court entered final approval of the settlement of the litigation brought by shareholders of Interspeed in July 2001. The dismissal and settlement of these actions did not have a material adverse effect on the Company's financial position or results of operations.

10. Purchase of In-Process Research and Development

The Company recorded a one-time charge of $2,550 in 2000 for the purchased research and development rights in STS-1 technology, which has not yet reached technological feasibility, has no alternative future use, and for which successful development is uncertain. During the quarter ended September 30, 2001, the Company ceased development of the product for which this technology was originally intended. The Company will seek to utilize certain elements of the in-process STS-1 technology in future research and development efforts where it is deemed feasible.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

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

This Quarterly Report contains certain statements that are "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995 and releases issued by the Securities and Exchange Commission. The words "believes," "expects," "anticipates," "intends," "estimates" and other expressions that are predictions of or indications of future events and trends and that do not relate to historical matters, identify forward-looking statements. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond the control of Brooktrout, Inc. (the "Company" or "Brooktrout"), which may cause the actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on information, plans, and estimates at the date of this document and the Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

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

Introduction

Brooktrout delivers communications hardware and software products that enable the development of applications ranging from Internet Protocol ("IP") telephony and embedded voicemail to wireless messaging for the new global telecommunications network. The Company's strategy is to collaborate with its partners to help them increase existing business, expand into new markets and accelerate the delivery of new applications and services. The Company sells its products to system vendors, service providers, enterprise customers, original equipment manufacturers ("OEMs"), and value-added resellers ("VARs"), both domestically and internationally, through a direct sales force and a two-tiered distribution system.

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

Prior to February 8, 2001, the Company was organized and reported the results of its operations in three operating segments, Brooktrout Technology, Inc. ("Brooktrout Technology"), Brooktrout Software, Inc. ("Brooktrout Software"), and Interspeed, Inc. ("Interspeed"). On February 8, 2001, the Company's Board of Directors adopted formal plans to discontinue its Brooktrout Software and Interspeed segments. Accordingly, the Company has reclassified the accompanying condensed consolidated financial statements to reflect the discontinuance of these two segments. (See note 1(c) and note 2 to the condensed consolidated financial statements). The following discussion focuses on the Company's results from continuing operations; the historical information presented has been revised to conform to the reclassified condensed consolidated financial statement presentation.

Three Months Ended September 30, 2001 and 2000
(in thousands except share and per share data)

Revenue during the three months ended September 30, 2001 decreased by approximately 56% to $17,213, down from $38,684 for the three months ended September 30, 2000. The decline in revenue resulted primarily from the overall economic slowdown in the United States and international economies and the resulting softening in the telecommunications market. The slowdown the Company is experiencing extends across most product lines and markets, though sales of products for applications in the New Network, specifically those sold to OEM’s for use by large service providers, have declined most significantly. During the three months ended September 30, 2001, sales of products for applications in the New Network accounted for approximately 36% of total revenue, as compared to 64% of total revenue for the same period in 2000.

Revenue from one customer accounted for approximately 16% of total revenue in the current quarter compared to 6% for this same customer in the prior year. The Company expects that revenue from this customer will continue to be significant as a percentage of total revenue for the foreseeable future. A different customer, one typically considered a New Network customer, represented 26% of sales during the three months ended September 30, 2000; however, revenue from this customer represented approximately 1% of total revenue for the three months ended September 30, 2001. For the foreseeable future, the Company expects that revenue from this customer will continue to be significantly less than that of prior comparative periods.

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

Research and development expense was $5,171 or 30% of revenue, compared with $6,045 or 16% of revenue, for the three months ended September 30, 2001 and 2000, respectively. The dollar decrease when compared to the same period in the prior year is primarily attributable to decreased spending on temporary help, contract labor, and to a lesser extent expendable materials and supplies. The Company's continuing development efforts are focused on its switching and access products that allow customers to create the infrastructure to support the New Network; messaging products that allow integration of voice, fax and e-mail into one location; and IP telephony products. The Company intends to continue to commit significant resources to product development.

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

Selling, general and administrative expense was $7,661 or 45% of revenue, compared with $9,358 or 24% of revenue, for the three months ended September 30, 2001 and 2000, respectively. The decline in dollar expense is primarily the result of reduced spending for sales commissions and other incentive compensation, temporary help, discretionary travel, and expendable materials and supplies.

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

The Company's effective tax rate for continuing operations, excluding the effect of non-deductible equity losses in affiliates, was 41% for the quarter ended September 30, 2001, based on the estimated effective rate for the full year.

Nine Months Ended September 30, 2001 and 2000
(in thousands except share and per share data)

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

Revenue from one customer accounted for approximately 12% of total revenue for the nine months ended September 30, 2001, compared to 6% from this same customer for the same period in the prior year. The Company expects that revenue from this customer will continue to be significant as a percent of total revenue for the foreseeable future. A different customer, one typically considered a New Network customer, represented 9% of sales during the nine months ended September 30, 2001, and 21% of revenue for the same period in 2000. For the foreseeable future, the Company expects that revenue from this customer will continue to be significantly less than that of prior comparative periods.

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

Research and development expense was $16,365 or 26% of revenue, compared with $17,442 or 16% of revenue, for the nine months ended September 30, 2001 and 2000, respectively. The dollar decrease when compared to the same period in the prior year is primarily attributable to decreased spending for contract labor, temporary help, and expendable materials and supplies. The Company's continuing development efforts are focused on its switching and access products that allow customers to create the infrastructure to support the New Network; messaging products that allow integration of voice, fax and e-mail into one location; and IP telephony products. The Company intends to continue to commit significant resources to product development.

Selling, general and administrative expense was $25,135 or 40% of revenue, compared with $29,017 or 27% of revenue, for the nine months ended September 30, 2001 and 2000, respectively. The decline in dollar expense is primarily the result of reduced spending for sales commissions and other incentive compensation, professional fees, advertising, temporary help, discretionary travel, and expendable materials and supplies.

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

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

Liquidity and Capital Resources
(in thousands, except share and per share data)

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

During the nine months ended September 30, 2001, the Company purchased approximately $940 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. Certain lease agreements require the Company to pay all of the building's taxes, insurance and maintenance costs.

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

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

The Company anticipates that current cash and marketable securities balances, together with revenues and funds available under the Company's renewed line of credit, will be sufficient to meet the Company's working capital and capital equipment expenditure requirements for the next twelve months.

Risk Factors

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

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

• the Company's ability to develop, manufacture, market and support its products and product enhancements;

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

• cancellation or rescheduling of orders for the Company's products;

• the Company's ability to hire, train and retain key management, sales and marketing and engineering personnel;

• announcements or technological innovations by the Company's competitors or in competing technologies;

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

• conditions in the domestic or global economy generally, and in the telecommunications industry specifically;

• a decrease in the demand for the Company's stock;

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

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

• the mix of products that the Company sells and the mix of distribution channels through which they are sold.

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

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

As a result of recent unfavorable economic conditions affecting most technology sectors and the telecommunications sector in particular, many of our customers are aggressively increasing efficiency in their supply chains and reducing inventory levels. Additionally, we expect the growth of data traffic and the use of the Internet will continue to have a significant impact on traditional voice networks, which is driving the convergence of data and telephony and giving rise to the demand for New Network applications. We cannot be sure what the rate of such convergence will be due to the slowdown in the communications industry and the resulting decrease in spending by our customers. The current economic conditions have adversely impacted the Company’s business and operating results. If the economic conditions worsen or if a wider economic slowdown occurs, the Company may experience a material adverse impact on its business, operating results, and financial condition.

The Company has historically derived the majority of its revenue from a small number of customers.

The Company's failure to generate as much revenue as expected from what has historically been a relatively small number of customers or the failure of these customers to purchase the Company's products could seriously harm the Company's business. For the quarter ended September 30, 2001, one customer accounted for approximately 16% of the Company's revenue. A different customer accounted for 26% of revenue for the quarter ended September 30, 2000; however, this customer represented less than 1% of revenue in the quarter ended September 30, 2001. The decline in expected revenue from this customer, as well as the loss of any one of the Company's other major customers or the delay of significant orders from such customers, even if only temporary, has or could reduce or delay the Company's revenue, could harm the Company's reputation in the industry and could reduce the Company's ability to accurately predict cash flow, and, as a consequence, could seriously harm the Company's business, financial condition and results of operations.

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

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

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

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

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

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

The telecommunications hardware and software market is characterized by:

• rapid technological advances:

• evolving industry standards;

• changes in customer requirements;

• frequent new product introductions;

• intense competition; and

• evolving offerings by telecommunications service providers.

The Company believes that its future success will depend, in part, on its ability to offer products that address the sophisticated and varied needs of its current and prospective customers and to respond to technological advances and evolving industry standards on a timely and cost-effective basis. The Company intends to continue to invest significantly in product and technology development. The development of new or enhanced products is a complex and uncertain process. The Company may experience design, manufacturing, marketing and other difficulties that could delay or prevent its development, introduction or marketing of new products and enhancements. The Company may also not be able to incorporate new technologies on a cost-effective or timely basis. This may result in unexpected expenses. The introduction of new or enhanced products also requires that the Company manage the transition from older products so as to minimize the disruption to customers and ensure that adequate supplies of new products can be delivered to meet anticipated customer demand. The Company's inability to develop on a timely basis new products or enhancements to existing products, or the failure of such new products or enhancements to achieve market acceptance, could have a material adverse effect on the Company's business, financial condition and results of operations.

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

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

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

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

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

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

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

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

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

	•	the right of the Board of Directors, without stockholder approval, to issue shares of preferred stock and to establish the voting rights, preferences, and other terms thereof;

	•	the right of the Board of Directors to elect a director to fill a vacancy created by the expansion of the Board of Directors;

	•	the ability of the Board of Directors to alter the Company's by-laws without prior stockholder approval;

	•	the election of three classes of directors to each serve three-year staggered terms;

	•	the elimination of stockholder voting by consent;

	•	the removal of directors only for cause;

	•	the vesting of exclusive authority in the Board of Directors (except as otherwise required by law) to call special meetings of stockholders; and

	•	certain advance notice requirements for stockholder proposals and nominations for election to the Board of Directors.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Certain of the Company’s investments are minority equity investments in privately held high-technology companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products that they have under development are typically in the early stages and may never materialize. Given the uncertainty of the success of these high-tech companies, in the future the Company could be required to record impairment charges against these investments, though currently no information has come to the Company’s attention that would lead it to believe any such impairment exists.

Readers are referred to the Company’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2000 for additional information.

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

None.

(b) Reports on Form 8-K

None.

SIGNATURES

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

	BROOKTROUT, INC.

Date: November 14, 2001	By:	/s/ ERIC R. GILER
		Eric R. Giler President (Principal Executive Officer)

Date: November 14, 2001	By:	/s/ ROBERT C. LEAHY
		Robert C. Leahy Vice President of Finance and Operations, and Treasurer (Principal Financial and Accounting Officer)