<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
-- THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
/_/ 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. 0-20698
BROOKTROUT, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Massachusetts 04-2814792
---------------- ----------------
(State or other (I.R.S. employer
jurisdiction of identification
incorporation or number)
organization)
250 First Avenue, Suite 300
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 _X_ No ___
As of October 31, 2000, 12,333,809 shares of Common Stock, $.01 par value
per share, were outstanding.
Page 1 of 30 pages
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BROOKTROUT, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements 3
Unaudited Condensed Consolidated Balance Sheets as of
September 30, 2000 and December 31, 1999 3
Unaudited Condensed Consolidated Statements of Income (Loss) for
the Three Months Ended September 30, 2000 and
September 30, 1999 and the Nine Months Ended
September 30, 2000 and September 30, 1999 4
Unaudited Condensed Consolidated Statements of Comprehensive
Income (Loss) for the Three Months Ended September 30, 2000
and September 30, 1999 and the Nine Months Ended
September 30, 2000 and September 30, 1999 5
Unaudited Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and
September 30, 1999 6
Notes to Unaudited Condensed Consolidated Financial
Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Three Months Ended September 30, 2000 and 1999 16
Nine Months Ended September 30, 2000 and 1999 17
Liquidity and Capital Resources 19
Risk Factors 20
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 28
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
2
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Brooktrout, Inc.
Unaudited Condensed Consolidated Balance Sheets
(In thousands, except share data)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents .............................................. $ 28,542 $ 48,541
Marketable securities ............................................. 2,487 1,492
Accounts receivable (less allowance for doubtful accounts and sales
returns of $3,184 in 2000 and $2,466 in 1999) ................... 26,544 22,232
Inventory ......................................................... 29,475 14,202
Deferred tax assets ............................................... 5,906 5,121
Prepaid expenses and other current assets.......................... 3,402 1,975
--------- ---------
Total current assets ............................................ 96,356 93,563
Equipment and furniture:
Computer equipment ................................................ 12,085 9,785
Furniture and office equipment .................................... 10,757 8,628
--------- ---------
Total ........................................................... 22,842 18,413
Less accumulated depreciation and amortization .................... (12,671) (9,694)
--------- ---------
Total equipment and furniture - net ............................... 10,171 8,719
Acquired technology and other intangible assets ..................... 13,507 12,973
Investments and other assets ........................................ 3,426 180
--------- ---------
Total assets .................................................... $ 123,460 $ 115,435
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and other accruals ............................... $ 27,943 $ 18,158
Accrued compensation and commissions .............................. 4,431 5,573
Customer deposits ................................................. 496 661
Accrued warranty costs ............................................ 1,986 1,304
Accrued taxes ..................................................... 679 2,736
--------- ---------
Total current liabilities ....................................... 35,535 28,432
--------- ---------
Deferred rent ....................................................... 493 469
Deferred tax liabilities ............................................ 688 479
Minority interest ................................................... 2,007 8,672
Contingencies ....................................................... 0 0
Shareholders' equity:
Common stock, $.01 par value; authorized, 40,000,000
shares; issued and outstanding 12,332,309 shares in
2000 and 11,004,019 in 1999 ..................................... 123 110
Additional paid-in capital ........................................ 62,830 42,991
Loans to officers ................................................. (11,844) --
Accumulated other comprehensive income (loss) ..................... (220) (117)
Retained earnings ................................................. 37,606 37,846
Treasury stock, 255,384 shares in 2000 and 247,582 shares in 1999 . (3,758) (3,447)
--------- ---------
Total shareholders' equity ..................................... 84,737 77,383
--------- ---------
Total liabilities and shareholders' equity ..................... $ 123,460 $ 115,435
========= =========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
3
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Brooktrout, Inc.
Unaudited Condensed Consolidated Statements of Income (Loss)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
----------------------------- -----------------------------
2000 1999 2000 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue ......................................... $ 42,421 $ 34,406 $ 120,191 $ 100,415
Cost and expenses:
Cost of product sold ......................... 19,431 12,846 49,443 39,016
Research and development ..................... 9,127 7,507 26,033 20,821
In-process research and development .......... 2,550 -- 2,550 --
Selling, general and administrative .......... 15,261 11,507 43,058 33,128
Non-cash compensation and warrants ........... 248 401 1,667 2,313
--------- --------- --------- ---------
Total cost and expenses .................... 46,617 32,261 122,751 95,278
Income (loss) from operations ................... (4,196) 2,145 (2,560) 5,137
Other income (expense):
Net gain on investment activity .............. -- 15,485 -- 15,485
Equity in loss of affiliate .................. (594) -- (1,994) --
Interest income, net ......................... 522 69 1,918 264
--------- --------- --------- ---------
Total other income (expense) ............... (72) 15,554 (76) 15,749
--------- --------- --------- ---------
Income (loss) before income tax provision........ (4,268) 17,699 (2,636) 20,886
Income tax provision ............................ 1,646 7,307 5,549 9,019
Minority interest in loss of subsidiary ......... (3,759) (272) (7,945) (272)
--------- --------- --------- ---------
Net income (loss) ............................... $ (2,155) $ 10,664 $ (240) $ 12,139
========= ========= ========= =========
Basic income (loss) per common share ............ $ (0.18) $ 0.97 $ (0.02) $ 1.11
========= ========= ========= =========
Shares for basic ................................ 12,030 10,954 11,742 10,911
========= ========= ========= =========
Diluted income (loss) per common share .......... $ (0.18) $ 0.91 $ (0.02) $ 1.05
========= ========= ========= =========
Shares for diluted .............................. 12,030 11,728 11,742 11,600
========= ========= ========= =========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
4
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Brooktrout, Inc.
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) .......................................... $ (2,155) $ 10,664 $ (240) $ 12,139
Unrealized gains (losses) on marketable securities..... 9 2,272 (5) 3,475
Foreign currency translation adjustment ............... (30) -- (100) (4)
-------- -------- -------- --------
Comprehensive income before income tax provision
(benefit) ......................................... (2,176) 12,936 (345) 15,610
Income tax provision (benefit) related to items of
comprehensive income (loss) ....................... 3 772 (2) 1,181
-------- -------- -------- --------
Comprehensive income (loss) ........................... $ (2,179) $ 12,164 $ (343) $ 14,429
======== ======== ======== ========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
5
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Brooktrout, Inc.
Unaudited Condensed Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ................................................... $ (240) $ 12,139
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Gain on Brooktrout's sale of Interspeed stock .............. -- (15,485)
Depreciation and amortization .............................. 4,646 4,194
Equity in loss of affiliate ................................ 610 --
Non-cash compensation and warrants ......................... 1,766 2,313
Tax benefit of stock options ............................... 1,562 --
Minority interest .......................................... (7,945) (272)
Deferred income taxes and other ............................ (571) 101
Increase (decrease) in cash from:
Accounts receivable ..................................... (4,312) (2,175)
Inventory ............................................... (15,273) (1,829)
Prepaid expenses and other current assets................ (1,427) (376)
Accounts payable and other accruals ..................... 7,645 5,067
-------- --------
Cash provided by (used in) operating activities ....... (13,539) 3,677
-------- --------
Cash flows from investing activities:
Expenditures for equipment and furniture ............................ (4,642) (2,566)
Brooktrout's sale of Interspeed stock, net of related expenses....... -- 16,740
Expenditures for acquired software .................................. (1,982) --
Purchases of marketable securities .................................. (1,000) --
Investment and other assets ......................................... (4,018) (3)
-------- --------
Cash used for investing activities .................... (11,642) 14,171
-------- --------
Cash flows from financing activities:
Proceeds from the sale of common stock .............................. 4,767 770
Interspeed's sale of stock, net of offering expenses ................ -- 20,815
Proceeds from exercise of Interspeed options and warrants ........... 726 217
Purchase of treasury stock .......................................... (311) --
-------- --------
Cash provided by financing activities ................. 5,182 21,802
-------- --------
Increase (decrease) in cash and equivalents ............................. (19,999) 39,650
Cash and equivalents, beginning of period ............................... 48,541 8,518
-------- --------
Cash and equivalents, end of period ..................................... $ 28,542 $ 48,168
======== ========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
6
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation
Brooktrout, Inc. (the "Company") supplies electronic communications
products to system vendors, service providers, and value added resellers
("VARs"), who are developing applications for the new global communications
network. During 1999, the Company reorganized its lines of business and changed
its name from Brooktrout Technology, Inc. to Brooktrout, Inc. The Company is
organized and reports the results of its operations in the following three
business segments: Brooktrout Technology, Inc. ("Brooktrout Technology"),
Brooktrout Software, Inc. ("Brooktrout Software"), and Interspeed, Inc.
("Interspeed"), a publicly traded company in which the Company owns a 55%
interest. These segments are differentiated based upon the products and services
provided to the marketplace, the customers served, and the distribution
channels utilized.
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(TM) - 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 to be distributed using the traditional circuit switched
telephone network.
The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission regarding interim financial reporting. They
should be read in conjunction with the audited consolidated financial statements
included in the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999.
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.
2. Recent Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board released
Statement of Financial Accounting Standards (SFAS) No. 133,"Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133, as amended,
establishes new standards of accounting and reporting for derivative instruments
and hedging activities and will be effective for the Company in 2001. Management
is currently evaluating the effect of adopting SFAS No. 133 on the condensed
consolidated financial statements.
7
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
2. Recent Accounting Pronouncements (Continued)
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." SAB No. 101 summarizes certain of the Securities and Exchange
Commission's views in applying generally accepted accounting principles to
revenue recognition in financial statements and will be effective for the
Company in the fourth quarter of 2000. Management does not believe that SAB No.
101 will have a material impact on the condensed consolidated financial
statements.
3. Income (Loss) Per Share
Basic income (loss) per share is computed using the weighted average number
of common shares outstanding during each period. Diluted income per share
reflects the effect of the Company's outstanding options (using the treasury
stock method), except where such options would be antidilutive. A reconciliation
of weighted average shares used for the basic and diluted computations is as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
------------------------------ ------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average shares for
basic .................. 12,030,000 10,954,000 11,742,000 10,911,000
Dilutive effect of stock
options ................ -- 774,000 -- 689,000
---------- ---------- ---------- ----------
Weighted average shares for
diluted ................ 12,030,000 11,728,000 11,742,000 11,600,000
========== ========== ========== ==========
</TABLE>
8
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
4. Inventory
Inventory is carried at the lower of cost (first-in, first-out basis) or
market and consisted of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
Raw materials ................ $12,590,000 $ 7,254,000
Work in process............... 1,631,000 1,658,000
Finished goods ............... 15,254,000 5,290,000
----------- -----------
Total ................... $29,475,000 $14,202,000
=========== ===========
</TABLE>
Finished goods inventory includes approximately $4,500,000 of Interspeed
product inventory being held under consignment-type arrangements.
5. Cash Flow Information
Cash equivalents include highly liquid securities with remaining maturities
of three months or less at the time of purchase.
Supplemental disclosure of cash flow information:
<TABLE>
<CAPTION>
Nine Months Ended
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Cash paid for interest .................. -- $ 4,000
Cash paid for income taxes............... $8,192,000 $1,998,000
</TABLE>
6. Major Customers
One customer accounted for approximately 24% of revenue for the three
months ended September 30, 2000, however no customer represented greater than
10% of revenues for the three months ended September 30, 1999. Additionally, the
same customer represented 19% and 13% of revenue for the nine months ended
September 30, 2000 and 1999, respectively.
9
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
7. Marketable Securities
Marketable securities are classified as available-for-sale and are carried
at fair market value using current market quotes. Unrealized gains or losses are
included in comprehensive income (loss). Marketable securities consist of U.S.
government notes and bonds, commercial paper, and certificates of deposit.
8. Income Taxes
The Company's tax provision in 2000 is based on the estimated effective tax
rate for the full year. The effective tax rate is greater than the statutory tax
rates due to the non-deductible Interspeed operating loss. Excluding the impact
of the Interspeed operating loss, the Company's effective tax rate would have
been 35% in 2000.
9. International Sales
International sales, principally exports from the United States, accounted
for approximately 18% and 27% of revenue for the three months ended September
30, 2000 and 1999, respectively, and 18% and 25% of revenue for the nine months
ended September 30, 2000 and 1999, respectively.
10. 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 September 30, 2000, approximately 29%
of the Company's accounts receivable were from one customer.
11. Warrants
In consideration for entering into certain long-term reseller agreements,
Interspeed granted to certain customers vested warrants to purchase an aggregate
of 55,000 shares of Interspeed's common stock at the market price of
Interspeed's common stock on the dates the warrants were granted. The value of
the warrants was calculated by applying the Black-Scholes option pricing model
using the fair market value of Interspeed's common stock on the date the
agreements were executed. The value of the warrants has been charged to expense
as a component of non-cash compensation and warrants in the condensed
consolidated statements of income (loss).
Interspeed also granted to certain customers warrants to purchase up to an
aggregate of 150,000 shares of Interspeed's common stock that vest in
installments as the customers attain certain revenue milestones over the terms
of the agreements. The exercise price of the warrants is the fair market value
of Interspeed's common stock on the date that the warrants vest. Interspeed is
accounting for these warrants as a sales discount. As revenue is recognized on
sales to these customers, Interspeed is recording a sales discount based on the
relationship of sales to date to the customer to the specified revenue
milestone. The amount of the discount is being estimated by valuing the warrants
using the Black-Scholes option pricing model. The
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BROOKTROUT, INC. Notes to
Unaudited Condensed Consolidated Financial Statements (Continued)
11. Warrants (Continued)
value of the warrants is being adjusted at the end of each quarter until
the revenue levels are attained and the warrants vest.
12. Loans to Officers
The Board of Directors on March 3, 2000 approved, and the Company
instituted, a loan program. Pursuant to this loan program, the Company loaned
amounts to or on behalf of certain of the Company's executive officers (the
"Loans"), in each case, to finance such executive officer's payment of the
exercise price of one or more stock options to purchase shares of common stock
granted to such officer under the Stock Incentive Plan.
In connection with each of the Loans, the borrower executed a Nonrecourse
Promissory Note and Security Agreement (the "Promissory Note"). The Promissory
Note does not bear interest and becomes due and payable in full no later than
the expiration of the remaining term of the option. The Promissory Note provides
for automatic repayment upon the sale of the common stock that is the subject of
a Loan or within 90 days following the termination of the executive officer's
employment with the Company. Pursuant to the Promissory Note, the shares of the
common stock that are the subject of a Loan serve as collateral (the "Collateral
Stock") for the Promissory Note until such time as the Promissory Note has been
paid in full. Loans made by the Company are non-recourse against the borrower,
and consequently, for satisfaction of the Loans, the Company's recourse is
limited to the Collateral Stock. As a result of this program, Loans to officers
totaling $11,844,000 are reflected in the shareholders' equity section of the
condensed consolidated balance sheets.
13. Deconsolidation of Beacon Networks
During the first quarter of 2000, the Company owned 100% of Beacon Networks
and accounted for its investment under the consolidation method. Through
subsequent issuance of Beacon Networks shares in an equity financing on June 29,
2000, the Company's ownership percentage in Beacon Networks was reduced to below
50%. Accordingly, the Company accounts for its remaining investment under the
equity method of accounting beginning in the second quarter of 2000. The
operating loss of approximately $540,000 generated by Beacon Networks in the
first quarter of 2000 is included in the Company's consolidated operating
results. The Company's share of the Beacon Networks net loss for the second and
third quarters of 2000 has been reported as "Equity in loss of affiliate" in the
condensed consolidated statements of income (loss).
14. Segment Reporting
The Company is organized and reports the results of its operations in the
following three business segments: Brooktrout Technology, Brooktrout Software,
and Interspeed. These segments are differentiated based upon the products and
services provided to the marketplace, the customers served,
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
14. Segment Reporting (Continued)
and the distribution channels utilized. Brooktrout Technology provides enabling
technologies for customers to deliver voice, fax, and data solutions for the
electronic communications market. Brooktrout Software provides specialized
e-Business software and services that enable companies to connect traditional
telephone commerce systems with web-based commerce systems. Interspeed develops
single system, high-speed Internet access solutions for telephone companies and
Internet Service Providers. The Company evaluates performance and allocates
resources based on revenue, gross margin, and income or loss from operations of
the segments.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
-------------------------------- --------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Brooktrout Technology $ 38,682,000 $ 31,520,000 $ 109,177,000 $ 92,772,000
Brooktrout Software 2,590,000 2,249,000 7,845,000 5,729,000
Interspeed 1,149,000 637,000 3,169,000 1,914,000
------------- ------------- ------------- -------------
Consolidated revenue 42,421,000 34,406,000 120,191,000 100,415,000
============= ============= ============= =============
Gross margin:
Brooktrout Technology 24,290,000 20,211,000 68,898,000 57,662,000
Brooktrout Software 1,239,000 1,251,000 4,095,000 3,152,000
Interspeed (2,539,000) 98,000 (2,245,000) 585,000
------------- ------------- ------------- -------------
Consolidated gross margin 22,990,000 21,560,000 70,748,000 61,399,000
============= ============= ============= =============
Income (loss) from operations:
Brooktrout Technology (1) 6,400,000 6,401,000 20,063,000 16,964,000
Brooktrout Software (2,147,000) (857,000) (4,406,000) (2,977,000)
Interspeed (8,449,000) (3,399,000) (18,217,000) (8,850,000)
------------- ------------- ------------- -------------
Consolidated income (loss) from operations (4,196,000) 2,145,000 (2,560,000) 5,137,000
Other income (expense)(2) (72,000) 15,554,000 (76,000) 15,749,000
------------- ------------- ------------- -------------
Consolidated income (loss) before income tax
provision $ (4,268,000) $ 17,699,000 $ (2,636,000) $ 20,886,000
============= ============= ============= =============
</TABLE>
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
14. Segment Reporting (Continued)
(1) Included in the Brooktrout Technology results for the nine months ended
September 30, 2000 is approximately $540,000 of operating losses related
to Beacon Networks. For the second and third quarters ended September 30,
2000, Beacon Networks' results are reflected in other income (expense).
(See Note 13.)
(2) Included in other income (expense) for the three and nine months ended
September 30, 1999 is a gain of $15,485,000 reflecting a gain of
$16,140,000, net of offering related costs, on the sale of 1.5 million
shares of Interspeed common stock by the Company in Interspeed's initial
public offering less $655,000, representing the book value of a separate
investment that was written off during the same period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
------------------------------- ------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Depreciation and amortization expense:
Brooktrout Technology $1,301,000 $1,269,000 $3,733,000 $3,555,000
Brooktrout Software 70,000 119,000 272,000 371,000
Interspeed 168,000 114,000 641,000 268,000
---------- ---------- ---------- ----------
Consolidated depreciation and amortization
expense $1,539,000 $1,502,000 $4,646,000 $4,194,000
========== ========== ========== ==========
</TABLE>
15. Purchase of In-Process Research and Development
On September 29, 2000, the Company acquired rights to certain in-process
technology that, upon completion, is intended to result in a single CompactPCI
(CPCI) circuit board that will provide an STS-1 interface that is capable of
handling 28 T1 links (672 voice channels) and echo cancellation.
The Company recorded a one-time charge of $2,550,000 ($1,658,000 net of tax
benefits) in the third quarter of 2000 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. As of September 30, 2000, the Company estimates the cost to
complete the project is approximately $2,000,000.
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BROOKTROUT, INC.
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
15. Purchase of In-Process Research and Development (Continued)
The valuation of the rights in the acquired in-process technology was based
on an independent third-party appraiser's estimates of the after-tax net cash
flows and gives explicit consideration to the Securities and Exchange
Commission's views on purchased in-process technology, as set forth in its
September 9, 1998 letter to the American Institute of Certified Public
Accountants. Specifically, the valuation gave consideration to the status of the
technology's development as of the transaction date, and only the cash flow
associated with said in-process development for one generation of the
anticipated products.
16. Subsequent Events
On October 9, 2000, the Company announced it would put in place a
$2,500,000 revolving line of credit for Interspeed, a majority owned subsidiary.
Borrowing on this line of credit will bear interest at the Silicon Valley Bank
prime rate per annum. The revolving line of credit will be for a six month
period from the date of closing and will be subject to a first security interest
in all tangible and intangible assets of Interspeed. As of November 13, 2000,
$578,000 has been advanced to Interspeed pursuant to promissory notes, which
will be incorporated into the revolving credit facility, and is outstanding.
In October 2000, several shareholder class action complaints were filed in
the United States District Court for the District of Massachusetts by certain
shareholders of Interspeed and of the Company. The complaints name, among
others, the Company and certain of its current and former officers and directors
as defendants. The lawsuits were filed after Interspeed's October 6, 2000
announcement that it would be restating its unaudited financial results for
certain prior quarters of its fiscal year 2000. The complaints include
allegations that the Company or certain of its officers and directors
participated in and approved the issuance of the financial statements of
Interspeed, that defendants are "controlling persons" of Interspeed, and that
the defendants made false or misleading statements regarding the Company's own
consolidated financial results. The plaintiffs are seeking unspecified damages.
The Company is defending these actions vigorously.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This document contains certain statements that are "forward-looking
statements" as that term is defined under the Private Securities Litigation
Reform Act of 1995 and releases issued by the Securities and Exchange
Commission. The words "believe," "expect," "anticipate," "intend," "estimate,"
and other expressions, which are predictions of or indicate future events and
trends and 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 the Company, which may cause the actual results,
performance or achievements of the Company to differ materially from anticipated
future results, performance or achievements expressed or implied by such
forward-looking statements. These forward-looking statements were based on
information, plans, and estimates at the date of this document and the Company
undertakes no obligation to update any forward-looking statement, whether as a
result of new information, future events or otherwise.
The future operating results and performance trends of the Company may be
affected by a number of factors, including, without limitation, risks related to
the following: (i) market growth, market acceptance of the Company's products
and product demand; (ii) rapid changes in technology; (iii) the impact of
competition; (iv) the uncertainties associated with recently filed shareholder
litigation; and (v) the impact, if any, of Interspeed's financial condition and
prospects on the Company and the price of the Company's common stock. 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.
The following discussion should be read in conjunction with the unaudited
condensed consolidated financial statements as of and for the three and nine
months ended September 30, 2000, included in this quarterly report.
Introduction
On October 6, 2000, Interspeed announced that its revenue for the quarter
ended September 30, 2000 would fall short of analysts' expectations and that
certain revenue may have been recognized incorrectly in prior quarters.
Resulting changes in Interspeed's financial statements are included in amended
quarterly reports to be filed by the Company and are reflected in the financial
statements included in this report. In addition, Interspeed has recorded a
significant inventory provision in the quarter ended September 30, 2000. These
actions have significantly impacted the Company's consolidated financial
statements for the quarter and the nine months ended September 30, 2000. On
October 26, 2000, Interspeed announced that it was exploring strategic
alternatives to maximize shareholder value. If Interspeed is unable to sell
itself, secure additional sources of financing, or achieve positive cash flow
from operations, Interspeed may be required to significantly curtail operations.
As a result of these and related developments, including the shareholder class
action complaints that have been filed against the
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Company and the Company's provision of a line of credit to Interspeed, disclosed
elsewhere in this report, the impact of Interspeed's financial condition and
prospects on the Company's future financial condition and results of operations
is highly uncertain.
Three Months Ended September 30, 2000 and 1999
Revenue during the three months ended September 30, 2000 increased by
approximately 23% to $42,421,000, up from $34,406,000 during the three months
ended September 30, 1999. The majority of the growth was generated by the
Company's Brooktrout Technology segment, in particular by sales of products for
the New Network, including the TrxStream product line and the switching and
access product line. These increases in revenue were partially offset by a
decline in voice mail systems sold for Today's Network use and a reduction in
revenue from enterprise messaging upgrade projects.
Cost of product sold was $19,431,000, or 46% of revenue, during the three
months ended September 30, 2000, compared to $12,846,000, or 37% of revenue, for
the same period in 1999. Gross profit percentage was approximately 54% and 63%
for the three months ended September 30, 2000 and 1999, respectively. The
significant decrease in gross profit percentage was due to an inventory
provision of approximately $3,000,000 recorded by Interspeed in the quarter
ended September 30, 2000.
Research and development expense was $9,127,000, or 22% of revenue,
compared with $7,507,000, or 22% of revenue, for the three months ended
September 30, 2000 and 1999, respectively. The dollar increase is primarily
attributable to increased product development at Brooktrout Technology combined
with further development of the digital subscriber line ("DSL") products at
Interspeed. 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, IP Telephony products and e-Business products.
On September 29, 2000, the Company acquired rights to certain in-process
technology that upon completion is intended to result in a single CompactPCI
(CPCI) circuit board that will provide an STS-1 interface that is capable of
handling 28 T1 links (672 voice channels) and echo cancellation. The Company
recorded a one-time charge of $2,550,000 in the third quarter of 2000 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.
Selling, general and administrative expense was $15,261,000 or 36% of
revenue for the three months ended September 30, 2000, compared with $11,507,000
or 33% or revenue for the same period in 1999. The primary reason for the
increase was expanded selling and marketing initiatives and additional accounts
receivable reserve provisions recorded by Interspeed. To a lesser degree, there
were also increases in staffing and marketing initiatives at the Brooktrout
Technology and Brooktrout Software segments.
For the three months ended September 30, 2000 and 1999, the Company
recorded charges of $248,000 and $401,000, respectively, representing non-cash
expenses of Interspeed as a result of stock option grants to employees.
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\
During the first quarter of 2000, the Company owned 100% of Beacon Networks
and accounted for its investment under the consolidation method. Through a
subsequent issuance of Beacon Networks shares in an equity financing on June 29,
2000, the Company's ownership percentage in Beacon Networks was reduced to below
50%. Accordingly, the Company accounts for its remaining investment under the
equity method of accounting beginning in the second quarter of 2000. The
operating loss of approximately $540,000 generated by Beacon Networks in the
first quarter of 2000 is included in the Company's consolidated operating
results. The Company's share of the Beacon Networks net loss for the second and
third quarters of 2000 has been reported as "Equity in loss of affiliate" in the
condensed consolidated statements of income (loss), which amount was $594,000
for the three months ended September 30, 2000.
For the three months ended September 30, 2000, interest and other income
was $522,000, compared with $69,000 for the same period in 1999, reflecting
higher cash balances available for investment as a result of the sale of
Interspeed common stock in the fourth quarter of 1999.
During the quarter ended September 30, 1999, the Company recorded a gain of
$15,485,000 reflecting a gain of $16,100,000, net of offering related costs, on
the sale of 1.5 million shares of Interspeed common stock by the Company in
Interspeed's initial public offering ("IPO"), less $655,000, representing the
book value of a separate investment that was written off during the same period.
The Company's tax provision in 2000 is based on the estimated effective tax
rate for the full year. Excluding the impact of the Interspeed operating loss,
the Company's effective tax rate would have been 35% in 2000. Excluding the
permanent difference associated with the non-cash compensation charge at
Interspeed, the effective tax rate would have been 34% in 1999.
Minority interest in loss of subsidiary was $3,759,000 for the three months
ended September 30, 2000, compared to $272,000 for the same period in 1999,
which represents the minority shareholders' portion of the losses of Interspeed.
Nine Months Ended September 30, 2000 and 1999
Revenue during the nine months ended September 30, 2000 increased by
approximately 20% to $120,191,000, up from $100,415,000 during the nine months
ended September 30, 1999. The majority of the growth was generated by the
Company's Brooktrout Technology segment, in particular by sales of products for
the New Network, including the TrxStream product line and the switching and
access product line. These increases in revenue were partially offset by a
decline in voice mail systems sold for the Today's Network use, which in the
nine months ended September 30, 2000 only accounted for 1% of total sales
compared to 10% of total sales for the same period in 1999.
Cost of product sold was $49,443,000, or 41% of revenue, during the nine
months ended September 30, 2000, compared to $39,016,000, or 39% of revenue, for
the same period in 1999. Gross profit percentage was approximately 59% and 61%
for the nine months ended September 30, 2000 and 1999, respectively. The
decrease in gross profit percentage was due to a change in the mix of products
sold and an inventory provision of approximately $3,000,000 recorded by
Interspeed in the quarter ended September 30, 2000.
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Research and development expense was $26,033,000, or 22% of revenue,
compared with $20,821,000, or 21% of revenue, for the nine months ended
September 30, 2000 and 1999, respectively. The dollar increase is primarily
attributable to increased product development at Brooktrout Technology combined
with further development of the DSL products at Interspeed. 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, IP Telephony products and e-Business products.
On September 29, 2000, the Company acquired rights to certain in-process
technology that upon completion is intended to result in a single CompactPCI
(CPCI) circuit board that will provide an STS-1 interface that is capable of
handling 28 T1 links (672 voice channels) and echo cancellation. The Company
recorded a one-time charge of $2,550,000 in the third quarter of 2000 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.
Selling, general and administrative expense was $43,058,000, or 36% of
revenue, during the nine months ended September 30, 2000, compared with
$33,128,000, or 33% or revenue, during the same period in 1999. The increases
were generated primarily by increased staffing and marketing initiatives at
Interspeed, and to a lesser extent, increases at the Brooktrout Technology and
Brooktrout Software segments.
For the nine months ended September 30, 2000 and 1999, the Company recorded
charges of $1,667,000 and $2,313,000, respectively, representing non-cash
expenses of Interspeed as a result of stock option grants to employees and
warrant grants to customers.
During the first quarter of 2000, the Company owned 100% of Beacon Networks
and accounted for its investment under the consolidation method. Through
subsequent issuance of Beacon Networks shares in an equity financing on June 29,
2000, the Company's ownership percentage in Beacon Networks was reduced to below
50%. Accordingly, the Company accounts for its remaining investment under the
equity method of accounting beginning in the second quarter of 2000. The
operating loss of approximately $540,000 generated by Beacon Networks in the
first quarter of 2000 is included in the Company's consolidated operating
results. The Company's share of the Beacon Networks net loss for the second and
third quarters of 2000 has been reported as "Equity in loss of affiliate" in the
condensed consolidated statements of income (loss), which amount was $1,994,000
for the nine months ended September 30, 2000.
For the nine months ended September 30, 2000, interest and other income was
$1,918,000, compared with $264,000 for the same period in 1999 reflecting higher
cash balances available for investment as a result of the sale of Interspeed
common stock in the fourth quarter of 1999.
During the quarter ended September 30, 1999, the Company recorded a gain of
$15,485,000 reflecting a gain of $16,100,000, net of offering related costs, on
the sale of 1.5 million shares of Interspeed common stock by the Company in
Interspeed's IPO, less $655,000, representing the book value of a separate
investment that was written off during the same period.
The Company's tax provision in 2000 is based on the estimated effective tax
rate for the full year. Excluding the impact of the Interspeed operating loss,
the Company's effective tax rate would
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have been 35% in 2000. Excluding the permanent difference associated with the
non-cash compensation charge at Interspeed, the effective tax rate would have
been 34% in 1999.
Minority interest in loss of subsidiary was $7,945,000 for the nine months
ended September 30, 2000, compared to $272,000 for the same period in 1999,
which represents the minority shareholders' portion of the losses of Interspeed.
Liquidity and Capital Resources
For the nine months ended September 30, 2000, the Company funded its
Brooktrout Technology and Brooktrout Software operations principally through
operating revenues of these segments. Interspeed's operations were funded
primarily through application of the proceeds of Interspeed's IPO in September
1999. Cash used in operating activities for the nine months ended September 30,
2000 was $13,539,000 and was primarily the result of increases in Brooktrout
Technology inventory and Interspeed's operating losses. Interspeed's cash
balance at September 30, 2000 was approximately $612,000. The Company's working
capital decreased to $60,900,000 at September 30, 2000 from $65,100,000 at
December 31, 1999, primarily due to increases in accounts payable and other
current liabilities.
On June 29, 2000, Beacon Networks completed an equity financing transaction
in which the Company and outside investors purchased Beacon Networks Series A
Preferred Stock. The Company invested approximately $2,500,000 in this financing
and is no longer the controlling shareholder of Beacon Networks.
During the nine months ended September 30, 2000, the Company made no
purchases of its common stock under its stock repurchase program. The Company's
current authorization under its stock repurchase program expired on September
30, 2000.
In August 2000, 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. Any amounts borrowed under the
line would be subject to interest at the lender's prime rate. At September 30,
2000 there were no commitments outstanding on letters of credit and no
borrowings have been made during any period presented.
During the first nine months of 2000, the Company invested approximately
$4,400,000 in capital equipment. A substantial portion of this was related to
the expansion of the Company's facilities. In addition, the Company invested
approximately $2,000,000 in purchased software to support New Network
applications. The Company currently has no material commitments for additional
capital expenditures.
During the first nine months of 2000, the Company generated approximately
$4,767,000 from the sale of common stock as a result of employee stock option
purchases.
The Company anticipates that cash flows from operations from Brooktrout
Technology, together with current cash and marketable securities balances and
funds available under the Company's line of credit, will be sufficient to meet
the Company's working capital and capital equipment expenditure requirements for
the foreseeable future. As discussed in the notes to the unaudited condensed
consolidated
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financial statements, the Company will provide up to $2,500,000 to Interspeed
for use in funding Interspeed's continued operations. Also as discussed in the
notes to the unaudited condensed consolidated financial statements, several
shareholder class action complaints have been filed against the Company. The
Company cannot reasonably estimate the impact that these actions will have on
its liquidity and capital resources.
Recent Accounting Pronouncements
In June of 1998, the Financial Accounting Standards Board released
Statement of Financial Accounting Standards (SFAS) No. 133,"Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133, as amended,
establishes new standards of accounting and reporting for derivative instruments
and hedging activities and will be effective for the Company in 2001. Management
is currently evaluating the effect of adopting SFAS No. 133 on the condensed
consolidated financial statements.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." SAB No. 101 summarizes certain of the Securities and Exchange
Commission's views in applying generally accepted accounting principles to
revenue recognition in financial statements and will be effective for the
Company in the fourth quarter of 2000. Management does not believe that SAB No.
101 will have a material impact on the condensed consolidated financial
statements.
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 amount of, or cancellation or rescheduling of, orders for
the Company's products;
- the Company's ability to hire, train and retain key management, sales and
marketing and engineering personnel;
- announcements or technological innovations by the Company's competitors or
in competing technologies;
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- the Company's ability to obtain sufficient supplies of sole or limited
source components for the Company's products;
- a decrease in the demand for the Company's stock;
- a decrease in the average selling prices of the Company's products;
- changes in costs of components 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, revenues, expenses and results of
operations could vary significantly in the future, and period-to-period
comparisons should not be relied upon as indications of future performance.
THE COMPANY'S MARKETS ARE HIGHLY COMPETITIVE, AND THE COMPANY MAY NOT BE ABLE TO
COMPETE SUCCESSFULLY AGAINST NEW ENTRANTS AND ESTABLISHED COMPANIES WITH GREATER
RESOURCES.
The market for telecommunications equipment is highly competitive. If the
Company is unable to differentiate its products from existing and future
offerings of its competitors, and, thereby, effectively compete in the market
for telecommunications equipment, the Company's results of operations could be
materially adversely affected. Many of the Company's current and potential
competitors have significantly greater selling and marketing, technical,
manufacturing, 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 Original Equipment
Manufacturers ("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.
For example, during 1999, Lucent designed a product that will replace the Merlin
Legend Mail and Partner Mail products manufactured by the Company. As a result,
future sales of these products will be limited to field replacement units and
repairs. The Company cannot assure that its existing customers or potential
customers will do business with the Company, rather than attempting to develop
similar
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technology and products internally or obtaining them through acquisition. The
Company cannot be certain that it will be able to find customers to replace the
revenues lost as a result of customers developing technologies or products
in-house. Any such occurrence could have a material adverse effect on the
Company's business, financial condition or results of operations.
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
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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, 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.
RELIANCE ON A SMALL NUMBER OF CUSTOMERS.
The Company has historically derived the majority of its revenues from a
small number of customers, most of who are significantly larger companies. The
Company's failure to generate as much revenue as expected from these customers
or the failure of these customers to purchase the Company's products would
seriously harm the Company's business. Accordingly, present and future customers
may 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 loss of any one of the Company's major customers or the delay of
significant orders from such customers, even if only temporary, could reduce or
delay the Company's recognition of revenues, harm the Company's reputation in
the industry and 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.
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DEFECTS IN THE COMPANY'S PRODUCTS OR PROBLEMS ARISING FROM THE USE OF ITS
PRODUCTS MAY SERIOUSLY HARM ITS BUSINESS AND REPUTATION.
Products as complex as the Company's may contain known and undetected
errors or performance problems. Defects are frequently found during the period
immediately following introduction and initial implementation of new products or
enhancements to existing products. Although the Company attempts to resolve all
errors that it believes would be considered serious by its customers before
implementation, the Company's products may not be error-free. The Company also
provides warranties against defects in materials and workmanship on its products
that range, depending on the product, generally from twelve months to five
years. However, errors or performance problems could result in lost revenues or
customer relationships and could be detrimental to the Company's business and
reputation generally. Additionally, reduced market acceptance of the Company's
services due to errors or defects in its technology would harm its business by
reducing its revenues and damaging its reputation. In addition, the Company's
customers generally use its products together with their own products and
products from other vendors. As a result, when problems occur, it may be
difficult to identify the source of the problem. These problems may cause the
Company to incur significant warranty and repair costs, divert the attention of
its engineering personnel from the Company's product development efforts and
cause significant customer relations problems. To date, defects in the Company's
products or those of other vendors' products with 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 a material adverse effect will not occur in
the future.
CHANGES TO REGULATIONS AFFECTING THE TELECOMMUNICATIONS OR INTERNET INDUSTRIES
COULD REDUCE DEMAND FOR THE COMPANY'S PRODUCTS OR INCREASE ITS COSTS.
Laws and regulations governing telecommunications, electronic commerce and
the Internet are beginning to emerge, but remain largely unsettled, even in the
areas where there has been some legislative action. 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 CHARTER AND BY-LAWS MAY DISCOURAGE TAKEOVER ATTEMPTS
AND, THUS, DEPRESS THE MARKET PRICE OF THE COMMON STOCK.
Provisions in the Company's Charter may have the effect of delaying or
preventing a change of control or changes in the Company's management or Board
of Directors. These provisions include:
- right of the Board of Directors, without stockholder approval, to issue
shares of preferred stock and to establish the voting rights, preferences,
and other terms thereof;
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- 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.
THE COMPANY'S ABILITY TO ADEQUATELY PROTECT ITS PROPRIETARY RIGHTS MAY PREVENT
IT FROM RETAINING ITS COMPETITIVE ADVANTAGE AND NEGATIVELY IMPACT ITS FUTURE
OPERATING RESULTS.
The Company's success and its ability to compete are dependent, in part,
upon its proprietary technology. Taken as a whole, the Company believes its
intellectual property rights are significant and any failure to adequately
protect the unauthorized use of its proprietary rights could result in the
Company's competitors offering similar products, potentially resulting in loss
of a competitive advantage and decreased revenues. The Company relies upon a
combination of trademark law, trade secret protections, copyright law and
confidentiality agreements with consultants and third parties to protect its
proprietary rights. Notwithstanding its efforts, third parties may infringe or
misappropriate the Company's proprietary rights. In addition, each employee of
the Company has executed a proprietary information agreement designed to protect
the trade secrets of the Company, inventions created in the course of employment
with the Company and other proprietary information of the Company. Moreover,
effective trademark, copyright or trade secret protections may not be available
in every country in which the Company operates or intends to operate to the same
extent as the laws of the United States. Also, it may be possible for
unauthorized third parties to copy or reverse engineer aspects of the Company's
products, develop similar technology independently or otherwise obtain and use
information that it regards as proprietary. Furthermore, detecting unauthorized
use of the Company's proprietary rights is difficult. Litigation may be
necessary in the future to enforce the Company's proprietary rights. Such
litigation could result in the expenditure of significant financial and
managerial resources and could have a material adverse effect on the Company's
future operating results.
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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. In
April 2000, the Company entered into a settlement agreement in connection with
such litigation. Although the Company believes that its proprietary rights do
not infringe on the intellectual property of others, any claims asserting that
the Company's products infringe or may infringe proprietary rights of third
parties, if determined adversely to the Company, could have a material adverse
effect on its business, financial condition or results of operations. Any
claims, with or without merit, could be time-consuming, result in costly
litigation, divert the efforts of the Company's engineering and management
personnel, cause delays in product shipments or require the Company to enter
into royalty or licensing agreements, any of which could have a material adverse
affect upon the Company's operating results. If any legal action claiming patent
infringement is commenced against it, the Company cannot assure you that it
would prevail in such litigation given the complex technical issues and inherent
uncertainties in patent litigation. In addition, the Company may be required to
obtain a license or royalty agreement under the intellectual property rights of
those parties claiming the infringement. In the event a claim against the
Company was successful, and it could not obtain a license on acceptable terms or
license a substitute technology or redesign to avoid infringement, the Company
may be unable to market its affected products. This could have a material
adverse effect on the Company's business, financial condition and results of
operations.
THE COMPANY'S PRODUCTS DEPEND UPON THE CONTINUED AVAILABILITY OF LICENSED
TECHNOLOGY FROM THIRD PARTIES.
The Company currently licenses and will continue to license certain
technology integral to its products and services from third parties. For
example, the Company has obtained licenses from third parties of software for
its voice and fax products. While the Company believes that much of this
technology is available from multiple sources, any difficulties in acquiring
third-party technology licenses, or integrating the related third-party
technology into its products, could result in delays in product development or
upgrade until equivalent technology can be identified, licensed and integrated.
The Company may require new licenses in the future as its business grows and
technology evolves. The Company cannot assure you that these licenses will
continue to be available to it on commercially reasonable terms, if at all,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
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 on a 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.
In addition, in order to grow its business, the Company must increase the number
of engineering, sales, customer support and administrative personnel. There is
intense competition in the
26
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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. If sales forecasted from a specific customer for a
particular quarter are not realized in that quarter, the Company may fail to
achieve its revenue goals.
THE AVERAGE SELLING PRICES OF THE COMPANY'S PRODUCTS MAY DECREASE, WHICH COULD
ADVERSELY AFFECT GROSS MARGINS AND REVENUES.
Competitive pressures and rapid technological change may cause decreases of
the average selling prices of the Company's products and services. In addition,
as many of the Company's target customers are large OEM's with significant
market power, the Company may face pressure from them for steep discounts in its
pricing. Any significant erosion in the Company's average selling prices could
impact its gross margins and have a material adverse effect on the Company's
business, financial condition and results of operations.
THE COMPANY DERIVES A SIGNIFICANT PORTION OF ITS REVENUES FROM INTERNATIONAL
SALES.
The Company believes a material portion of its domestic sales results in
the use of its products outside North America. Risks arising from the Company's
international business include currency fluctuation, political instability in
other countries, the imposition of trade and tariff regulations by foreign
governments and the difficulties in managing operations across disparate
geographic areas. In addition, most countries require technical approvals from
their telecommunications regulatory agencies for products that operate in
conjunction with the telephone system. Obtaining these approvals is
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generally a prerequisite for sales in a given jurisdiction. Obtaining requisite
approvals may require from two months to a year or more depending on the product
and the jurisdiction. The Company cannot assure a shareholder that it will not
encounter delays in obtaining approval in a foreign jurisdiction. These or other
factors may limit the Company's ability to sell its products and services in
other countries, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
INTERSPEED'S FINANCIAL CONDITION AND PROSPECTS MAY HAVE AN ADVERSE IMPACT ON THE
COMPANY'S FINANCIAL CONDITION AND THE PRICE OF THE COMPANY'S COMMON STOCK.
On October 6, 2000, Interspeed announced that its revenue for the quarter
ended September 30, 2000 would fall short of analysts' expectations and that
certain revenue may have been recognized incorrectly in prior quarters. In
addition, Interspeed has recorded a significant inventory provision in the
quarter ended September 30, 2000. These actions have significantly impacted the
Company's consolidated financial statements for the quarter and the nine months
ended September 30, 2000. Additionally, on October 26, 2000, Interspeed
announced that it was exploring strategic alternatives to maximize shareholder
value. If Interspeed is unable to sell itself, secure additional sources of
financing, or achieve positive cash flow from operations, Interspeed may be
required to significantly curtail operations. As a result of these and related
developments, including the shareholder class action complaints that have been
filed against the Company and the Company's provision of a line of credit to
Interspeed, Interspeed's financial condition and prospects could have a material
adverse impact on the Company's future financial condition or results of
operations.
THE OUTCOME OF THE RECENTLY FILED SHAREHOLDER CLASS ACTIONS IS UNCERTAIN AND MAY
BE EXPENSIVE TO DEFEND AND MAY SIGNIFICANTLY DIVERT MANAGEMENT'S TIME AND
ATTENTION.
In October 2000, several shareholder class action complaints were filed by
certain shareholders of Interspeed and the Company naming, among others, the
Company and certain of its current and former officers and directors as
defendants. The lawsuits were filed after Interspeed's October 6, 2000
announcement that it would be restating its unaudited financial results for
certain prior quarters of its fiscal year 2000. The plaintiffs are seeking
unspecified damages. The Company cannot provide any assurances as to the outcome
of this securities litigation. The cost of defending any litigation or other
proceeding, even if resolved in the Company's favor, could be substantial. Such
litigation could also substantially divert management's attention and the
Company's resources in general. Uncertainties resulting from the initiation and
continuation of this litigation or other proceedings could harm the Company's
ability to compete in the marketplace and could contribute to the volatility of
the Company's stock price. Any conclusion of this litigation in a manner adverse
to the Company may 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
Market risk is the potential change in a financial instrument's value
caused by fluctuations in interest and currency exchange rates and equity and
commodity prices. Our operating activities expose us to many risks that are
continually monitored, evaluated, and managed. Proper management of these risks
helps reduce the likelihood of earnings volatility. The Company's exposure to
market risk from changes in foreign currency, exchange rates, interest rates,
and equity prices has not changed materially from its exposure at December 31,
1999.
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Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 $286,000 Principal Amount Promissory Note of Interspeed,
Inc., dated October 26, 2000.
10.2 $292,000 Principal Amount Promissory Note of Interspeed,
Inc., dated November 10, 2000.
27 Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarterly period
ended September 30, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BROOKTROUT, INC.
Date: November 14, 2000 By: /s/ Eric R. Giler
-----------------------------
Eric R. Giler
President
(Principal Executive Officer)
Date: November 14, 2000 By: /s/ Robert C. Leahy
-----------------------------
Robert C. Leahy
Vice President of Finance and
Operations and Treasurer
(Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<S> <C>
10.1 $286,000 Principal Amount Promissory Note of Interspeed, Inc., dated October 26, 2000.
10.2 $292,000 Principal Amount Promissory Note of Interspeed, Inc., dated November 10, 2000.
27 Financial Data Schedule.
</TABLE>
31
