**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 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 June 30, 2004**                                                                                                                                     |
|                                                                                                                                                                                      |
| **OR**                                                                                                                                                                                    |
|                                                                                                                                                                                      |
| **o****  TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT  OF 1934**                                                                     |
|                                                                                                                                                                                      |
| **For the transition period from               to              ** |
|                                                                                                                                                                                      |
| **Commission File Number 0-22871**                                                                                                                                                        |
|                                                                                                                                                                                      |
| **OMTOOL, LTD.**                                                                                                                                                                          |
| (Exact  Name of Registrant as Specified in Its Charter)                                                                                                                                   |

 

| **Delaware**                                                     | ** ** | **02-0447481**                            |
|------------------------------------------------------------------|------------|-------------------------------------------|
| (State  or Other Jurisdiction of  Incorporation or Organization) |       | (I.R.S.  Employer  Identification Number) |
|                                                             |       |                                      |
| **8A Industrial Way, Salem, NH**                                 | ** ** | **03079**                                 |
| (Address  of Principal Executive Offices)                        |       | (Zip  Code)                               |
|                                                             |       |                                      |
| **(603) 898-8900**                                               |
| (Registrant’s  Telephone Number Including Area Code)        |

 

Indicate by check markwhether the Registrant has: (1) filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý     No  o

 

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).

 

Yes  o     No  ý

 

There were 3,851,472shares of the Company’s Common Stock, par value $0.01, outstanding onAugust 12, 2004.

 

 

----

 

**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended June 30, 2004

CONTENTS

 
| **Item Number**                                                                                                          |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                     |   |
| PART I: FINANCIAL INFORMATION                                                                                            |   |
|                                                                                                                     |   |
| Item 1.   Consolidated Financial Statements                                                                         |   |
| Consolidated Balance Sheets as of June 30, 2004 and  December 31, 2003 (Unaudited)                             |   |
| Consolidated Statements of Operations for  the three months and six months ended June 30, 2004 and 2003 (Unaudited) |   |
| Consolidated Statements of Cash Flows for  the six months ended June 30, 2004 and 2003 (Unaudited)                  |   |
| Notes to Consolidated Financial Statements                                                                               |   |
|                                                                                                                     |   |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations               |   |
|                                                                                                                     |   |
| Item  3.  Quantitative and Qualitative  Disclosures About Market Risk                                               |   |
|                                                                                                                     |   |
| Item  4.  Controls and Procedures                                                                                   |   |
|                                                                                                                     |   |
| PART  II: OTHER INFORMATION                                                                                              |   |
|                                                                                                                     |   |
| Item 4.   Submission of Matters to a Vote of Security Holders                                                       |   |
|                                                                                                                     |   |
| Item 5.   Other Information                                                                                         |   |
|                                                                                                                     |   |
| Item 6.   Exhibits and Reports on Form 8-K                                                                          |   |
|                                                                                                                     |   |
| Signatures                                                                                                               |   |

 

----

 

**PART I:  FINANCIAL INFORMATION**

Item 1.  Consolidated Financial Statements

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                                | ** ** | **June 30,  2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                                                                |       |                    |       |                       |       |
| Current assets:                                                                                                                                                                                                                                                                                           |       |                    |       |                       |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                 |       | $                       | 10,270,200 |                       | $          | 8,242,067 |   |
| Accounts receivable, less reserves of  $161,000 at June 30, 2004 and $367,000 at December 31, 2003                                                                                                                                                                                              |       | 1,264,473               |       | 1,535,540                  |       |
| Inventories                                                                                                                                                                                                                                                                                               |       | 32,893                  |       | 37,632                     |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                                                 |       | 300,325                 |       | 268,112                    |       |
| Total current assets                                                                                                                                                                                                                                                                                      |       | 11,867,891              |       | 10,083,351                 |       |
| Property and equipment, net                                                                                                                                                                                                                                                                               |       | 290,692                 |       | 394,623                    |       |
| Other assets                                                                                                                                                                                                                                                                                              |       | 11,563                  |       | 13,962                     |       |
| Total assets                                                                                                                                                                                                                                                                                              |       | $                       | 12,170,146 |                       | $          | 10,491,936 |   |
|                                                                                                                                                                                                                                                                                                      |       |                    |       |                       |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                            |       |                    |       |                       |       |
| Current liabilities:                                                                                                                                                                                                                                                                                      |       |                    |       |                       |       |
| Accounts payable                                                                                                                                                                                                                                                                                          |       | $                       | 496,133    |                       | $          | 883,583 |   |
| Accrued liabilities                                                                                                                                                                                                                                                                                       |       | 1,348,813               |       | 1,202,359                  |       |
| Accrued restructuring                                                                                                                                                                                                                                                                                     |       | 158,247                 |       | 443,830                    |       |
| Accrued state sales tax                                                                                                                                                                                                                                                                                   |       | 944,731                 |       | 1,010,496                  |       |
| Deferred revenue, short term                                                                                                                                                                                                                                                                              |       | 3,290,265               |       | 3,306,474                  |       |
| Total current liabilities                                                                                                                                                                                                                                                                                 |       | 6,238,189               |       | 6,846,742                  |       |
| Long term liabilities:                                                                                                                                                                                                                                                                                    |       |                    |       |                       |       |
| Deferred revenue, long-term                                                                                                                                                                                                                                                                               |       | 292,895                 |       | 205,967                    |       |
| Total liabilities                                                                                                                                                                                                                                                                                         |       | 6,531,084               |       | 7,052,709                  |       |
|                                                                                                                                                                                                                                                                                                      |       |                    |       |                       |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                                |       |                    |       |                       |       |
| Preferred Stock, $0.01 par value —  Authorized — 2,000,000 shares; Issued and outstanding — none                                                                                                                                                                                           |       | —                  |       | —                     |       |
| Common Stock, $0.01 par value —  Authorized — 35,000,000 shares; Issued — 4,367,878 shares at June 30,  2004 and 3,716,878 shares at December 31, 2003; Outstanding —  3,847,376 shares at June 30, 2004 and  3,500,500 shares at December 31, 2003, respectively |       | 43,678                  |       | 37,169                     |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                |       | 35,275,049              |       | 31,936,038                 |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                       |       | (26,960,164             | )          | (27,617,599                | )          |
| Treasury stock, at cost (520,502 shares at  June 30, 2004 and 216,378 shares at December 31, 2003)                                                                                                                                                                                              |       | (2,670,770              | )          | (877,934                   | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                                                      |       | (48,731                 | )          | (38,447                    | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                                           |       | 5,639,062               |       | 3,439,227                  |       |
|                                                                                                                                                                                                                                                                                                      |       |                    |       |                       |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                           |       | $                       | 12,170,146 |                       | $          | 10,491,936 |   |

 

The accompanying notes are an integralpart of these consolidated financial statements.

 

----

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

 
| ** **                                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                             |       |                                  |       |                                |       |   |   |   |   |
| Software license                                      |       | $                                     | 1,131,485  |                                | $          | 1,110,787 |   | $ | 2,303,384 |   | $ | 1,988,278 |   |
| Hardware                                              |       | 448,195                               |       | 611,131                             |       | 1,615,746 |   | 1,117,339 |   |
| Service and other                                     |       | 1,787,900                             |       | 1,609,867                           |       | 3,476,529 |   | 3,208,323 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Total revenues                                        |       | 3,367,580                             |       | 3,331,785                           |       | 7,395,659 |   | 6,313,940 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Cost of revenues:                                     |       |                                  |       |                                |       |   |   |   |   |
| Software license                                      |       | 86,649                                |       | 96,780                              |       | 118,174 |   | 150,815 |   |
| Hardware                                              |       | 314,277                               |       | 451,330                             |       | 988,520 |   | 799,520 |   |
| Service and other                                     |       | 644,421                               |       | 805,646                             |       | 1,391,648 |   | 1,597,400 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Total cost of revenues                                |       | 1,045,347                             |       | 1,353,756                           |       | 2,498,342 |   | 2,547,735 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                          |       | 2,322,233                             |       | 1,978,029                           |       | 4,897,317 |   | 3,766,205 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Operating expenses:                                   |       |                                  |       |                                |       |   |   |   |   |
| Sales and marketing                                   |       | 988,494                               |       | 1,336,674                           |       | 2,031,781 |   | 2,668,522 |   |
| Research and development                              |       | 481,990                               |       | 587,516                             |       | 953,165 |   | 1,172,121 |   |
| General and administrative                            |       | 572,296                               |       | 826,418                             |       | 1,271,688 |   | 1,558,218 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Total operating expenses                              |       | 2,042,780                             |       | 2,750,608                           |       | 4,256,634 |   | 5,398,861 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Income (loss) from operations                         |       | 279,453                               |       | (772,579                            | )          | 640,683 |   | (1,632,656 | ) |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Interest and other income, net                        |       | 36,799                                |       | 14,095                              |       | 74,455 |   | 53,363 |   |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Income (loss) before tax provision  (benefit)         |       | 316,252                               |       | (758,484                            | )          | 715,138 |   | (1,579,293 | ) |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Tax provision (benefit)                               |       | 38,572                                |       | —                              |       | 57,703 |   | (155,398 | ) |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss)                                     |       | $                                     | 277,680    |                                | $          | (758,484 | ) | $ | 657,435 |   | $ | (1,423,895 | ) |
| Net income (loss) per share                           |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                 |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.18 |   | $ | (0.41 | ) |
| Diluted                                               |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.17 |   | $ | (0.41 | ) |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| Weighted average number of common shares  outstanding |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                 |       | 3,833,896                             |       | 3,492,226                           |       | 3,677,865 |   | 3,492,086 |   |
| Diluted                                               |       | 4,054,874                             |       | 3,492,226                           |       | 3,862,484 |   | 3,492,086 |   |

 

The accompanying notes are an integral partof these consolidated financial statements*.*

 

2

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**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

 
| ** **                                                                                               | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                               | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Cash Flows from Operating Activities:                                                                    |       |                                |       |   |   |
| Net income (loss)                                                                                        |       | $                                   | 657,435    |   | $ | (1,423,895 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities– |       |                                |       |   |   |
| Depreciation                                                                                             |       | 131,583                             |       | 227,051 |   |
| Accounts receivable reserves                                                                             |       | (207,363                            | )          | (146,746 | ) |
| Changes in assets and liabilities–                                                                  |       |                                |       |   |   |
| Accounts receivable                                                                                      |       | 491,102                             |       | 450,142 |   |
| Prepaid expenses and other current assets                                                                |       | (49,996                             | )          | 193,607 |   |
| Inventory                                                                                                |       | 4,774                               |       | 23,863 |   |
| Accounts payable                                                                                         |       | (392,493                            | )          | 39,250 |   |
| Accrued liabilities                                                                                      |       | 160,084                             |       | (80,498 | ) |
| Accrued state sales tax                                                                                  |       | (65,765                             | )          | (299,463 | ) |
| Accrued restructuring                                                                                    |       | (285,583                            | )          | — |   |
| Other assets                                                                                             |       | 2,399                               |       | — |   |
| Deferred revenue                                                                                         |       | 62,626                              |       | (236,111 | ) |
|                                                                                                     |       |                                |       |   |   |
| Net cash provided by (used in) operating  activities                                                     |       | 508,803                             |       | (1,252,800 | ) |
|                                                                                                     |       |                                |       |   |   |
| Cash Flows from Investing Activities:                                                                    |       |                                |       |   |   |
| Purchases of property and equipment                                                                      |       | (27,405                             | )          | (164,603 | ) |
| Purchases of short-term investments                                                                      |       | —                              |       | (1,999,449 | ) |
| Proceeds from sale of short-term  investments                                                            |       | —                              |       | 3,596,604 |   |
|                                                                                                     |       |                                |       |   |   |
| Net cash (used in) provided by investing  activities                                                     |       | (27,405                             | )          | 1,432,552 |   |
|                                                                                                     |       |                                |       |   |   |
| Cash Flows from Financing Activities:                                                                    |       |                                |       |   |   |
| Net proceeds from issuance of common stock                                                               |       | 3,565,184                           |       | 2,640 |   |
| Purchase of treasury stock                                                                               |       | (2,012,500                          | )          | — |   |
|                                                                                                     |       |                                |       |   |   |
| Net cash provided by financing activities                                                                |       | 1,552,684                           |       | 2,640 |   |
|                                                                                                     |       |                                |       |   |   |
| Exchange rate effect on cash                                                                             |       | (5,949                              | )          | 8,294 |   |
|                                                                                                     |       |                                |       |   |   |
| Net increase in cash and cash equivalents                                                                |       | 2,028,133                           |       | 190,686 |   |
|                                                                                                     |       |                                |       |   |   |
| Cash and cash equivalents, beginning of  period                                                          |       | 8,242,067                           |       | 8,192,523 |   |
|                                                                                                     |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                                                 |       | $                                   | 10,270,200 |   | $ | 8,383,209 |   |

 

The accompanying notes are an integralpart of these consolidated financial statements*.*

 

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMEN****TS**

(Unaudited)

 

**(1)****        ****Basisof Presentation**

 

The accompanying unaudited consolidated financialstatements have been prepared by Omtool, Ltd. (the “Company” or “Omtool”)pursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements and should be read in conjunction with the consolidated financialstatements and notes thereto for the year ended December 31, 2003 as filedwith the SEC on March 23, 2004. The accompanying consolidated financialstatements reflect all adjustments (consisting of normal recurring adjustments)which are, in the opinion of management, necessary for a fair presentation ofresults for the interim periods presented. The results of operations for the three and six month period endedJune 30, 2004 are not necessarily indicative of the results to be expectedfor the full fiscal year.

 

The Company’sfinancial results for the first six months of 2004 improved from the first sixmonths of 2003; the Company generated a net profit of $657,000 in the first sixmonths of 2004 as compared to a net loss of $1.4 million in the first sixmonths of 2003.  The improvement infinancial results was due primarily to an increase of over $1.0 million, or17%, in total revenues and a decrease in operating expenses associated withongoing cost controls.  Managementbelieves that the increase in revenues during this period is due to increaseddemand for enterprise software solutions which has led to an increase ininformation technology spending and resulting sales bookings for theCompany.  Furthermore, managementbelieves that the financial results for the remainder of fiscal year 2004 willexhibit improvement compared to the same period in the prior year.  This belief is based on the Company’s currentexpected level of sales bookings and corresponding revenue growth combined withlower expected operating expenses as a direct result of the Company’s thirdquarter 2003 restructuring.  However,this expectation may change if the current economic environment changes andsoftness in information technology spending returns or if the Company’sproducts do not achieve further market acceptance.  During the six months ended June 30,2004, the Company raised $3.6 million through the sale of 600,000 shares of commonstock, at a price of $6.00 per share, in a private placement to institutionaland other accredited investors. The proceeds of the private placement are beingused for additional working capital and other general corporate purposes.  Also during the six months endedJune 30, 2004, the Company repurchased 350,000 shares of its outstandingcommon stock from ASA International Ltd., an existing shareholder, in a privatetransaction at a price of $5.75 per share. The shares were purchased with theuse of generally available corporate funds and will be held in treasury.  These activities along with cash generatedfrom operations resulted in an increase in cash and cash equivalents ofapproximately $2.0 million for the six months ended June 30, 2004. TheCompany’s cash and cash equivalents at June 30, 2004 were$10.3 million. The Company believes that its existing cash and cashequivalents will be sufficient to meet its working capital and capitalexpenditures for at least the next twelve months.

 

***(2)***         **Net Income (Loss) per Common Share**

* *

The Company reports earnings per share in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 128, *Earnings perShare*.  The dilutive effect ofpotential common shares in 2004, consisting of outstanding stock options and astock warrant, is determined using the treasury stock method, in accordancewith SFAS No. 128.  Diluted weightedaverage shares outstanding for the three months and six months endedJune 30, 2003 exclude 751,160 potential common shares from stock optionsbecause to include them would have been anti-dilutive for the period presentedas the Company reported a net loss during the period.  For the three months and six months endedJune 30, 2004, the dilutive calculation excludes the potential commonshares related to 49,374 and 126,408, respectively, outstanding stock optionswhich have an anti-dilutive effect since their exercise price exceeds themarket value of the Company’s common stock. A reconciliation of basic and diluted common shares outstanding is asfollows:

 

4

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| ** **                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted average number of common shares  outstanding            |       | 3,833,896                             |       | 3,492,226                           |       | 3,677,865 |   | 3,492,086 |   |
| Potential common shares pursuant to stock  options and warrants  |       | 220,978                               |       | —                              |       | 184,619 |   | — |   |
| Diluted weighted average shares                                  |       | 4,054,874                             |       | 3,492,226                           |       | 3,862,484 |   | 3,492,086 |   |
| Basic net income (loss) per common share                         |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.18 |   | $ | (0.41 | ) |
| Diluted net income (loss) per common and  potential common share |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.17 |   | $ | (0.41 | ) |

 

**(3)****        ****IncomeTaxes**

 

SFAS No. 109, *Accounting for IncomeTaxes,* requires a valuation allowance to be recorded againstdeferred tax assets when it is more likely than not that some or all of thedeferred tax assets will not be realized. As a result of cumulative losses in recent years and continued economicuncertainty, the Company has provided a full valuation allowance against all ofits net deferred tax assets and will do so until it returns to an appropriatelevel of sustained taxable income.  Theultimate realization of these deferred tax assets depends upon the Company’sability to generate sufficient future taxable income. If the Company is successfulin generating sufficient future taxable income, the Company will reduce thevaluation allowance through a reduction in income tax expense in the future.

 

During the six months ended June 30, 2004, theCompany recorded a net tax provision of $57,703 for expected tax liability inthe United States and for expected tax liability related to its United Kingdomsubsidiary, Omtool Europe Limited (“OEL”). The provision for the first six months of 2004 is net of a $28,800adjustment related to a fiscal year 2003 transfer pricing adjustment.

 

During the six months ended June 30, 2003, theCompany recorded $155,398 of tax benefit due to a tax refund that OEL receivedduring the first quarter of 2003. OEL had incurred a loss for the year endedDecember 31, 1999 which resulted in the income tax benefit.  The tax benefit was carried back to prioryears’ taxes paid and resulted in a tax refund. Because the subsidiary was undergoing an Inland Revenue audit for the1999 tax year, doubt existed about the realizability of this refund and theCompany did not record the benefit on its books until the audit was cleared andthe cash was received, both of which occurred in the first quarter of 2003.

 

**(4)****        ****Comprehensive Income (Loss)**

 

The components of the Company’scomprehensive income (loss) are as follows:

 
| ** **                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                               | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                        |       | $                                     | 277,680    |                                | $          | (758,484 | ) | $ | 657,435 |   | $ | (1,423,895 | ) |
| Foreign currency translation adjustments |       | (34,294                               | )          | 32,015                              |       | (10,283 | ) | (1,845 | ) |
| Comprehensive income (loss)              |       | $                                     | 243,386    |                                | $          | (726,469 | ) | $ | 647,152 |   | $ | (1,425,740 | ) |

 

**(5)****        ****StockBased Compensation**

 

The Company accounts for stock-based compensation for employees underthe recognition and measurement principles of Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees,*and related interpretations.  Thefollowing table illustrates the effect on net income (loss) and net income(loss) per share if the Company had applied the fair value recognitionprovisions of Financial Accounting Standards Board Statement (“FAS”) No. 123, *Accounting for Stock-Based Compensation,* as amended by FASNo. 148, *Accounting for Stock-Based Compensation –Transition and Disclosure* to stock-based employee compensation

 

5

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| ** **                                                                                                 | ** ** | **Three months Ended  June 30,** | ** ** | **Six months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss), as reported                                                                             |       | $                                     | 277,680    |                                | $          | (758,484 | ) | $ | 657,435 |   | $ | (1,423,895 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value method for all awards |       | (51,065                               | )          | (174,188                            | )          | (122,970 | ) | (440,182 | ) |
| Pro forma net income (loss)                                                                                |       | $                                     | 226,615    |                                | $          | (932,672 | ) | $ | 534,465 |   | $ | (1,864,077 | ) |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss) per share:                                                                               |       |                                  |       |                                |       |   |   |   |   |
| Basic, as reported                                                                                         |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.18 |   | $ | (0.41 | ) |
| Diluted, as reported                                                                                       |       | $                                     | 0.07       |                                | $          | (0.22 | ) | $ | 0.17 |   | $ | (0.41 | ) |
| Basic, pro forma                                                                                           |       | $                                     | 0.06       |                                | $          | (0.27 | ) | $ | 0.15 |   | $ | (0.53 | ) |
| Diluted, pro forma                                                                                         |       | $                                     | 0.06       |                                | $          | (0.27 | ) | $ | 0.14 |   | $ | (0.53 | ) |

 

**(6)****         Accrued Liabilities**

 

Accrued liabilities consist of the following:

 
| ** **                        | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued health insurance expense  |       | $                       | 216,382    |                        | $          | 205,547 |   |
| Accrued salary and salary-related |       | 568,743                 |       | 466,903                     |       |
| Accrued professional fees         |       | 182,479                 |       | 145,962                     |       |
| Other accrued expenses            |       | 381,209                 |       | 383,947                     |       |
|                              |       |                    |       |                        |       |
|                              |       | $                       | 1,348,813  |                        | $          | 1,202,359 |   |

 

**(7)****        ****RestructuringCosts**

 

In the third quarter of 2003, the Company announced a restructuring ofcertain of its operations, and recorded a pre-tax charge of $806,581 inaccordance with SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*.  The charge includes severance-related costsassociated with the workforce reduction in the Company’s domestic operationsand costs associated with closing its Oregon office.  The reduction in workforce consisted of threeemployees in the Company’s sales and marketing department, two employeesperforming general and administrative functions, three employees performingtechnical support and five employees in the Company’s research and developmentdepartment.  The balance of this chargeconsists of costs incurred as a result of closing the Company’s Oregonoffice.  All of the costs associated withclosing the Company’s Oregon office were paid as of December 31, 2003.

 

The following table summarizes the restructuring activity for the sixmonths ended June 30, 2004:

 

| ** **                               | ** ** | **Severance** | ** ** |
|------------------------------------------|------------|---------------|------------|
| Ending balance at December 31, 2003 |       | $             | 443,830    |   |
| Cash payments                            |       | (285,583      | )          |
| Ending balance, June 30, 2004       |       | $             | 158,247    |   |

 

The total cash impact of the restructuring is $806,581, which theCompany anticipates will be paid by the end of the third quarter of 2004.

 

6

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**(8)****         Equity Transactions**

 

On March 30, 2004, the Company raised $3.6 million through thesale of 600,000 shares of common stock, at a price of $6.00 per share in aprivate placement to institutional and other accredited investors.  The fees associated with issuing the sharesin connection with the private placement were approximately $147,000 and wererecorded as a reduction of additional paid-in capital.  Furthermore, Omtool issued 51,000 shares ofcommon stock and a warrant to purchase an additional 51,000 shares of commonstock, exercisable over a five-and-a-half-year period at a price of $6.00 pershare, to its financial advisor or its designees for advisory services relatedto the private placement.

 

On March 30, 2004, Omtool’s Board of Directors approved atwo-for-one stock split of the Company’s Common Stock in the form of a dividendeffective April 27, 2004 for each stockholder of record as ofApril 7, 2004.  All references inthe consolidated financial statements referring to shares, share prices, pershare amounts and stock plans have been adjusted retroactively for the two-for-onestock split.

 

On March 31, 2004, the Company repurchased 350,000 shares of itsoutstanding common stock from ASA International Ltd., an existing shareholder,in a private transaction at a price of $5.75 per share. The 350,000 shares thatwere repurchased have been recorded and are held as treasury stock.

 

**(9)****        ****Segmentand Geographic Information**

 

To date, the Company has viewedits operations and manages its business as principally one segment, softwareand hardware sales and associated services. As a result, the financialinformation disclosed herein represents all of the material financialinformation related to the Company’s principal operating segment in accordancewith SFAS No. 131, *Disclosures About Segmentsof an Enterprise and Related Information*.

 

Total revenues frominternational sources were $691,000 and $2.0 million for the three months andsix months ended June 30, 2004 and $717,000 and $1.2 million for the threemonths and six months ended June 30, 2003, respectively. The Company’s revenuesfrom international sources were primarily generated from customers located inEurope. The following table represents amounts relating to geographiclocations:

 
| ** **              | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **Total  revenues (1)** | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States           |       | $                                     | 2,676,863  |                                | $          | 2,615,274 |   | $ | 5,361,663 |   | $ | 5,156,653 |   |
| United Kingdom          |       | 128,771                               |       | 445,616                             |       | 820,971 |   | 711,425 |   |
| Rest of World           |       | 561,946                               |       | 270,895                             |       | 1,213,025 |   | 445,862 |   |
|                    |       | $                                     | 3,367,580  |                                | $          | 3,331,785 |   | $ | 7,395,659 |   | $ | 6,313,940 |   |

 
| **Long-lived assets (2)** | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** |   |
|---------------------------|------------|-------------------------|------------|-----------------------------|--------|
| United States             |       | $                       | 290,571    |                        | $      | 392,801 |   |
| United Kingdom            |       | 11,684                  |       | 15,784                      |   |
|                      |       | $                       | 302,255    |                        | $      | 408,585 |   |

 

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(1)          Revenuesare attributed to geographic regions based on location of customer.

(2)          Long-livedassets include property and equipment and other assets.

 

7

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Item 2.

 

**MANAGEMENT’SDISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations should be read in conjunction with the accompanying consolidatedfinancial statements for the periods specified and the associated notes.  Further reference should be made to theCompany’s Annual Report on Form 10-K for the year ended December 31, 2003as filed with the SEC on March 23, 2004.

 

# **Overview**

 

Omtool is a leading provider of electronic document delivery andmanagement software that enables efficient, secure, confirmed andcost-efficient document exchange between businesses.  The Company was incorporated inMarch 1991 and shipped its initial facsimile software products in 1991.Omtool’s products provide users with an extensive, flexible feature set thatconverts, transmits, receives, and automatically archives documents inelectronic formats.  Included in theCompany’s products is a suite of utility and control functions that enables theconversion of paper documents to standard electronic formats and integrateswith industry recognized document and records management systems.  Omtool’s products enable the integration ofbusiness processes that include the exchange of hard copy and electronicdocuments such as legal contracts, financial transactions, medical records and purchaseorder processing.  Omtool’s productsminimize risks by preserving the security of high value documents whilefacilitating increased productivity, reducing costs and fulfilling emergingbusiness requirements.  AccuRouteTM,Omtool’s document routing and distribution software, integrates with manydigital scanning and multifunctional devices to allow paper documents to bedigitized, distributed and archived.  Inaddition, Omtool’s AccuRoute software provides capture, distribution andcompliance for movement of electronic documents and information.  GenifaxTM, Omtool’s enterprise fax software,offers a scalable, server-based feature set and shares a common Windowsserver-based architecture with the Genidocs product line.  GenidocsTM, the Company’s secure documentdelivery application, integrates with existing e-mail systems and providesmultiple options for content and attachment encryption, authentication, audittrail and delivery confirmation, and digital signatures.  The Company’s AccuRoute software furtherunifies the codes base and architecture of the Genidocs and Genifax products,coupled with the routing capabilities of AccuRoute’s software platform toprovide a truly unique customer specific product to easily manage documents,both paper and electronic documents, with little or no user trainingrequired.  A significant portion of theCompany’s revenue is derived from licensing the rights to use itsfax software products directly to end-users and indirectly throughresellers.

 

The Company resells, from third-party vendors, certain hardwareproducts, including intelligent fax boards and fax modems, to its customers.Hardware sales are undertaken as a convenience to the Company’s customers; andhardware is not required to be purchased from the Company and can bealternatively obtained from a third-party vendor.  The fax boards and fax modems that are resoldare not functional without the Company’s software and the Company is not in thebusiness of selling fax boards and modems. The Company purchases these hardwareproducts as needed to ship to its customers and the Company maintains a minimalinventory of these hardware products. Management believes that the Company has a good business relationshipwith suppliers of these products and that supply of these products is stable.

 

Service andother revenues have consisted primarily of the sale of support contracts.  The Company generates a smaller portion ofits service and other revenues from consulting, training and installation services.

 

The Company’sfinancial results for the first six months of 2004 improved from the first sixmonths of 2003 as the Company generated a net profit of $657,000 in the firstsix months of 2004 as compared to a net loss of $1.4 million in the first sixmonths of 2003.  The improvement infinancial results was due primarily to an increase of over $1.0 million, or17%, in total revenues and a decrease in operating expenses associated withongoing cost controls.  Managementbelieves that the increase in revenues during this period is due to increaseddemand for enterprise software solutions which has led to an increase ininformation technology spending and resulting sales bookings for theCompany.  Furthermore, managementbelieves that the financial results for the remainder of fiscal year 2004 willexhibit improvement compared to the same period in the prior year.  This belief is based on the Company’s currentexpected level of sales bookings and corresponding revenue growth combined withlower expected operating expenses as a direct result of the Company’s thirdquarter 2003 restructuring.  However,this expectation may change if the current economic environment changes andsoftness in information technology spending returns or if the Company’sproducts do not achieve further market acceptance.  During the six months ended

 

8

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June 30,2004, the Company raised $3.6 million through the sale of 600,000 shares ofcommon stock, at a price of $6.00 per share, in a private placement toinstitutional and other accredited investors. The proceeds of the privateplacement are being used for additional working capital and other generalcorporate purposes.  Also during the sixmonths ended June 30, 2004, the Company repurchased 350,000 shares of itsoutstanding common stock from ASA International Ltd., an existing shareholder,in a private transaction at a price of $5.75 per share. The shares werepurchased with the use of generally available corporate funds and will be heldin treasury.  These activities along withcash generated from operations resulted in an increase in cash and cashequivalents of approximately $2.0 million for the six months endedJune 30, 2004. The Company’s cash and cash equivalents at June 30,2004 were $10.3 million. The Company believes that its existing cash andcash equivalents will be sufficient to meet its working capital and capitalexpenditures for at least the next twelve months

 

Although the Company believes that there has been some recentimprovement in the demand for enterprise software solutions, it cannot predictwhether or when that market will soften. If the market changes, the Company cannot predict whether, and to whatextent, the demand for its products will increase or decrease.  Any decrease in demand for the Company’sproducts would likely result in decreased revenue which would, in turn, have asignificant impact on the Company’s financial results because a significantportion of the Company’s operating costs (such as personnel, rent anddepreciation) are fixed in advance of a particular quarter. As a result,despite savings realized from the Company’s September 2003 restructuring,the Company’s costs for sales and marketing, research and development andgeneral and administrative could continue to increase as a percentage ofrevenues, thereby affecting the Company’s operating results.

 

The Company’s future revenues and operating resultsmay fluctuate from quarter to quarter based on the number and size of salestransactions that the Company enters into with customers, the adequacy ofprovisions for losses, general economic conditions and other factors. Inaddition, revenue from a large order may constitute a significant portion ofthe Company’s total revenues in a particular quarter.

 

The Company has historically derived a substantial portion of its totalrevenues from sales within North America. Sales outside of North America(primarily in Europe) represented 23% and 15% of the Company’s total revenuesfor the six months ended June 30, 2004 and 2003, respectively.  The Company’s gross profit on these salesapproximates the gross profit on sales within North America.  The increase in the percent of sales outsideof North America is a result of the Company’s strategy to expand its internationalpresence (primarily in Europe) by increasing investments in sales and marketingefforts directed toward international markets.

 

The Company’s United Kingdom subsidiary transacts business primarily inits local currency. The Company manages its foreign exchange exposure bymonitoring its net monetary position using natural hedges of its assets andliabilities denominated in local currencies. There can be no assurance thatthis policy will eliminate all currency exposure. If the Company’s businessdenominated in foreign currencies increases, the Company may be required to usederivatives to hedge foreign currency exposure.

 

The Company will continue to leverage its existing distributionchannels where appropriate to broaden its reach to the target vertical marketsand further penetrate its installed base. The Company is pursuing sales opportunities via its solution/resellerchannel as well as focusing sales efforts on specific market segments in orderto facilitate product acceptance.  Salesthrough the Company’s indirect distribution channels represented 20% and 23% ofthe Company’s total revenues for the six months ended June 30, 2004 and2003, respectively.

 

## **CriticalAccounting Policies and Estimates**

 

The Company has identified the policies and estimates below as criticalto its business operations and the understanding of its results of operations.The impact and any associated risks related to these policies on the Company’sbusiness operations is discussed throughout Management’s Discussion andAnalysis of Financial Condition and Results of Operations where such policiesaffect the Company’s reported and expected financial results. Note that theCompany’s preparation of this Quarterly Report on Form 10-Q requires managementto make estimates and assumptions that affect the reported amount of assets andliabilities, disclosure of contingent assets and liabilities at the date of theCompany’s financial statements, and the reported amounts of revenue andexpenses during the reporting period. There can be no assurance that actualresults will not differ from those estimates.

 

*Revenue Recognition and Accounts ReceivableReserves.*  TheCompany derives its revenue from primarily two sources (i) product revenue,which includes software license and hardware revenue and (ii) services andsupport revenue,

 

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which includes software maintenance and support, installation, trainingand consulting revenue. The Company licenses its software products on aperpetual basis.  The Company generatesrevenue from licensing the rights to use its software products and sales ofhardware directly to end-users and indirectly through resellers.  The Company’s resellers order products fromthe Company based on purchase orders received from end-users and do not orderstock.  The Company’s products are soldto resellers and directly to end-users without any specifically stated rightsof return. Occasionally, however, the Company, in its sole discretion, willaccept a product return if the end-user finds that the product does not fit itsneeds. The Company also sells hardware products, which are provided by athird-party, on a pass through basis, plus an additional mark-up, to end-usersand indirectly through resellers. The hardware products that are resold are notfunctional without the Company’s software. To support its software products, the Company sells software maintenanceand support, installation, training and consulting services to end-users andindirectly through resellers.

 

The Company applies the provisions of Statement of Position (“SOP”)97-2, *Software Revenue Recognition*, as amendedby SOP 98-9, Modification of SOP 97-2, *Software RevenueRecognition, With Respect to Certain Transactions*, to alltransactions involving the sale of multiple elements including software,hardware and service revenue.  TheCompany applies the provisions of SFAS No. 48, *RevenueRecognition When Right of Return Exists*, with respect to providingfor potential future product returns.  Asdescribed below, significant management judgments and estimates must be madeand used in connection with the revenue recognized in any accountingperiod.  Material differences may resultin the amount and timing of the Company’s revenue if management made differentjudgments or utilized different estimates.

 

The Company recognizes revenue from the sale of software products andhardware to both end-users and resellers when persuasive evidence of anarrangement exists, the products have been delivered, the fee is fixed ordeterminable, collection of the resulting receivable is reasonably assured andthere are no uncertainties regarding customer acceptance. The Company maintainsa reserve for potential product returns. Software maintenance and supportrevenue is recognized ratably over the term of the related maintenanceperiod.  Typically this is a one-yearperiod, but occasionally the Company sells multiple-year maintenance contracts,in which case the associated revenue is recognized over the multiple-year termof the contract.  Other services revenueis recognized as the services are performed. If an arrangement includes anacceptance provision and acceptance is uncertain then the Company will deferall revenue until the customer accepts the products.  Acceptance in these instances generallyoccurs upon the earlier of receipt of a written customer acceptance orexpiration of the acceptance period.  Ifan arrangement includes an acceptance provision regarding the Company’s productmeeting published specifications and there are no uncertainties with regard tothe customer’s acceptance then the Company will recognize revenue at the timeof sale provided all other revenue recognition criteria previously mentionedhave been met and the acceptance period is of short duration.

 

The Company’s transactions frequently involve the sales of software,hardware and related services under multiple element arrangements.  Revenue under multiple element arrangementsis allocated to each element under the residual method, in accordance with SOP98-9, Modification of SOP 97-2,*Software RevenueRecognition, With Respect to Certain Transactions*. Under thismethod, revenue is allocated first to all undelivered elements, such asservices, based on the fair value of those elements, which is the price chargedwhen these elements are sold separately and unaccompanied by otherelements.  The Company’s services are notessential to the functionality of the software as these services do not alterthe capabilities of the software and do not carry a significant degree of riskto perform. The amount allocated to the delivered elements, such as softwarelicense and hardware revenue, is the difference between the total arrangementvalue and the amount allocated to the undelivered elements. If the delivered elementsinclude both software and hardware, the amount allocated to hardware revenue isbased on the price charged to the Company by the third party vendor plus anadditional mark up, with the remainder allocated to software revenue. To theextent that a discount is offered in the arrangement, the entire discount isallocated to the delivered element or elements. If the delivered elementsinclude hardware and software, the discount is allocated to the hardware andsoftware based on their respective list prices.

 

For all sales, the Company uses a binding purchase order, a signedcontract or a credit card authorization as evidence of an arrangement.  Sales through the Company’s resellers areevidenced by a master agreement governing the relationship, together withbinding purchase orders, on a transaction-by-transaction basis.

 

At the time of the transaction, the Company assesses whether the feeassociated with the transaction is fixed or determinable and whether or notcollection is reasonably assured.  If a significantportion of a fee is due beyond the Company’s normal payment terms, which arethirty to sixty days from invoice date, the Company accounts for the fee as notbeing fixed or determinable.  In thesecases, the Company recognizes revenue as the fees become due. The Companyassesses collection based on a number of factors, including past transactionhistory with the customer and the credit-worthiness of the customer.  The Company reviews D&B credit reports forall of its resellers and adjusts its credit limits with those resellers

 

10

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accordingly.  If the resellerdoes not have a favorable report or the Company does not have enough creditinformation to determine if the reseller is credit-worthy then the Companypredominantly sells to such resellers on C.O.D. terms.  The Company does not request collateral fromits customers.  If the Company determinesthat collection of a fee is not reasonably assured, the fee is deferred andrevenue is recognized at the time collection becomes reasonably assured, whichis generally upon receipt of payment.

 

The Companyreserves for potential product returns and makes adjustments to the reserve asneeded, based on historical product return rates, and considers the impact ofnew product introductions, changes in customer demand and acceptance of theCompany’s products.  Management’scalculation of the estimated return reserve is based upon (1) an accountspecific review of potential returns, where a return probability is known, and(2) a general estimate based upon past historical returns as a percentage ofrevenue.  Significant managementjudgments and estimates must be made and used in connection with establishingthe sales returns reserve in any accounting period. Material differences mayresult in the amount and timing of revenue for any period if management madedifferent judgments or utilized different estimates.  Similarly, management must make estimates ofthe Company’s ability to collect on its accounts receivable.  Management specifically analyzes accountsreceivable and historical bad debts, customer credit-worthiness, currenteconomic trends and changes in customer payment patterns when evaluating theadequacy of the allowance for doubtful accounts.  Management’s calculation of the estimatedaccounts receivable reserve is based upon (1) an account specific review ofpotential uncollectible accounts, where a bad debt probability is known, and(2) a general estimate based upon past historical bad debts as a percentage ofaccounts receivable.

 

The Company’s combined accounts receivable and returns reserve wasapproximately $161,000 and $367,000 at June 30, 2004 and December 31,2003, respectively.  Both components ofcalculating the estimated reserve, specific identification and historicexperience, are material judgments. These judgments are based on historic trends, taking into considerationcurrent business and economic conditions, which could change materially, thuschanging the required reserve level materially. The potential change could be positive, in the event the reserveestimate proves unnecessary, or negative, if the reserve proves inadequate.

 

The Company’s deferred revenue is comprised mainly ofrevenue that is deferred for software maintenance and support contracts.  The other components of deferred revenue arethe amounts from sales transactions****that weredeferred because they did not meet all of the provisions of the Company’srevenue recognition policy.

 

*Software Development Costs*.  Software development costs are considered forcapitalization when technological feasibility is established in accordance withSFAS No. 86, *Accounting for the Costs of ComputerSoftware To Be Sold, Leased or**Otherwise Marketed*.The Company sells software in a market that is subject to rapid technologicalchange, new product introductions and changing customer needs. Accordingly, theCompany has determined that it cannot determine technological feasibility untilthe development state of the product is nearly complete. The time period duringwhich cost could be capitalized from the point of reaching technologicalfeasibility until the time of general product release is very short and,consequently, the amounts that might be capitalized are not material to theCompany’s consolidated financial position or results of operations. Therefore,the Company charges all software development costs to operations in the periodincurred.

 

*Taxes*.  The Company is required to estimate itsincome and state sales taxes. This process involves estimating the Company’sactual current tax obligations together with assessing differences resultingfrom the different treatment of items for tax and accounting purposes whichresult in deferred income tax assets and liabilities and accrued state salestax liabilities. The Company has deferred income tax assets and liabilities andaccrued state sales tax liabilities included within its balance sheet.

 

The Company’s deferred tax assets are assessed for each reportingperiod as to whether it is more likely than not that they will be recoveredfrom future taxable income, including assumptions regarding on going taxplanning strategies. To the extent the Company believes that recovery isuncertain, the Company must establish a valuation allowance for assets not expectedto be recovered. Changes to the valuation allowance are included as an expenseor benefit within the tax provision in the statement of operations.

 

The Company provides a full valuation allowance against all of its netdeferred tax assets and will continue to do so until it returns to anappropriate level of taxable income. The ultimate realization of these deferredtax assets depends upon the Company’s ability to generate sufficient futuretaxable income. If the Company is successful in generating sufficient futuretaxable income, the Company will reduce the valuation allowance through areduction in income tax expense in the future.

 

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Accrued state sales taxes are estimated for each reporting period basedon tax rates in effect for the reporting periods in each of the states wherethe Company has potential nexus and for the time period that the Company hasnexus. The assumptions and estimates used to determine this liability aresubject to change as they are difficult to measure or value.  In the event that actual results differ fromthese estimates, the Company’s state sales taxes expense could be materiallyimpacted.

 

**Results of Operations**

 

The following table setsforth certain financial data for the periods indicated as a percentage of totalrevenues:

 
| ** **                     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                     | ** ** | **2004**                              | ** ** | **2003**                            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                      |       |                                  |       |                                |       |   |   |   |   |
| Software license               |       | 33.6                                  | %          | 33.3                                | %          | 31.2 | % | 31.5 | % |
| Hardware                       |       | 13.3                                  |       | 18.3                                |       | 21.8 |   | 17.7 |   |
| Service and other              |       | 53.1                                  |       | 48.4                                |       | 47.0 |   | 50.8 |   |
| Total revenues                 |       | 100.0                                 |       | 100.0                               |       | 100.0 |   | 100.0 |   |
| Cost of revenues:              |       |                                  |       |                                |       |   |   |   |   |
| Software license               |       | 2.6                                   |       | 2.9                                 |       | 1.6 |   | 2.4 |   |
| Hardware                       |       | 9.3                                   |       | 13.5                                |       | 13.4 |   | 12.7 |   |
| Service and other              |       | 19.1                                  |       | 24.2                                |       | 18.8 |   | 25.3 |   |
| Total cost of revenues         |       | 31.0                                  |       | 40.6                                |       | 33.8 |   | 40.4 |   |
| Gross profit                   |       | 69.0                                  |       | 59.4                                |       | 66.2 |   | 59.6 |   |
| Operating expenses:            |       |                                  |       |                                |       |   |   |   |   |
| Sales and marketing            |       | 29.4                                  |       | 40.2                                |       | 27.4 |   | 42.2 |   |
| Research and development       |       | 14.3                                  |       | 17.6                                |       | 12.9 |   | 18.6 |   |
| General and administrative     |       | 17.0                                  |       | 24.8                                |       | 17.2 |   | 24.7 |   |
| Total operating expenses       |       | 60.7                                  |       | 82.6                                |       | 57.5 |   | 85.5 |   |
| Income (loss) from operations  |       | 8.3                                   |       | (23.2                               | )          | 8.7 |   | (25.9 | ) |
| Interest and other income, net |       | 1.1                                   |       | 0.4                                 |       | 1.0 |   | 0.8 |   |
| Tax provision (benefit)        |       | 1.2                                   |       | —                              |       | 0.8 |   | (2.5 | ) |
|                           |       |                                  |       |                                |       |   |   |   |   |
| Net income (loss)              |       | 8.2                                   | %          | (22.8                               | )%         | 8.9 | % | (22.6 | )% |
|                           |       |                                  |       |                                |       |   |   |   |   |
| Gross profit:                  |       |                                  |       |                                |       |   |   |   |   |
| Software license               |       | 92.3                                  | %          | 91.3                                | %          | 94.9 | % | 92.4 | % |
| Hardware                       |       | 29.9                                  |       | 26.1                                |       | 38.8 |   | 28.4 |   |
| Service and other              |       | 64.0                                  |       | 50.0                                |       | 60.0 |   | 50.2 |   |

 

**Three Months Ended June 30, 2004 and 2003**

 

## ***Revenues***

 

*Total Revenues.*  The Company’s total revenue was$3.4 million and $3.3 million for the three months ended June 30,2004 and 2003, respectively.

 

*Software License.*  Software license revenue was $1.1 million foreach of the three months ended June 30, 2004 and June 30, 2003.  Software license revenue accounted for 34%and 33% of total revenues for each respective period.  Included in software license revenue for thethree months ended June 30, 2004 is a reduction of $30,000 in the salesreturns and allowance reserve relating primarily to specific accounts where theCompany has determined that the risk of a return is no longer present.  Software license revenue for the three monthsended June 30, 2003 was reduced by a $23,000 increase in the sales returnsand allowance reserve based on the Company’s determination of risk of potentialreturns related to specific customer accounts. Software license revenues for the three month period ended June 30,2004 reflected an overall increase in demand for the Company’s AccuRouteproduct while the Company’s legacy fax product line exhibited a declinecompared to the three month

 

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period ended June 30, 2003. Revenues from the Company’s AccuRoute product, which requires nohardware related components, represented 53% and 4% or software sales for thethree month period ended June 30, 2004 and 2003, respectively.  Software revenues from the Company’s legacyfax product line represented 47% and 90% of software sales for the three monthperiod ended June 30, 2004 and 2003, respectively.  The growth of the AccuRoute product line is aresult of greater market acceptance of the product.  Though the Company cannot accurately predictthe exact mix of products that will be sold in the future, it expects thatsoftware license revenue will constitute a larger percentage of its totalrevenue if demand for its newer products which do not require the purchase ofadditional hardware, such as AccuRoute, continue to gain additional marketacceptance.

 

*Hardware.*  Hardware revenue was $448,000 for the threemonths ended June 30, 2004 and $611,000 for the three months endedJune 30, 2003, representing a decrease of 27%.  Hardware revenue accounted for 13% and 18% oftotal revenue for each respective period. The decrease in hardware revenue is primarily driven by the fact thatless of the Company’s legacy fax products were sold in the three months endedJune 30, 2004 than were sold in the three months ended June 30, 2003resulting in a decrease in accompanying hardware sales.  Included in hardware revenue for the threemonths ended June 30, 2004 is a reduction of $8,000 in the sales returnsand allowance reserve relating primarily to specific accounts where the Companyhas determined that the risk of a return is no longer present.  Hardware revenue for the three month periodended June 30, 2003 was reduced by a $7,000 increase in the sales returnsand allowance reserve based on the Company’s determination of risk of potentialreturns related to specific customer accounts. Though the Company cannot accurately predict the exact mix of productsthat will be sold in the future, it expects that hardware revenue willconstitute a smaller percentage of its total revenue if demand for its newerproducts, such as AccuRoute, which does not require the purchase of additionalhardware, continue to gain additional market acceptance.

 

*Service andOther.*  Serviceand other revenue increased by 11% for the three months ended June 30,2004 compared to the three months ended June 30, 2003.  Service and other revenue was $1.8 millionand $1.6 million for the three months ended June 30, 2004 and 2003,respectively.  Service and other revenueaccounted for 53% and 48% of total revenues for each respective period. Theincrease in service and other revenue is primarily due to an increase inmaintenance revenues from a larger installed customer base.  The increase in service and other revenue asa percent of total revenues is due primarily to the combined decrease insoftware license and hardware revenues.

 

*Cost of Revenue*

 

*Software License.*  Cost of software license revenue consistsprimarily of the costs of sublicensing third-party software products, productmedia and product duplication.  Cost ofsoftware license revenue for the three months ended June 30, 2004decreased by 10% or $10,000 during the quarter to $87,000 compared to $97,000during the corresponding period in 2003. The decrease is due primarily to the fact that the Company replacedthird-party software that was imbedded in its products with its owninternally-developed solutions, thus reducing the royalties that it must paywhen a product containing that third-party software is sold.  This decrease is also reflected in softwarelicense gross margin as it improved to 92% from 91%.  The Company has****recentlyadded additional third-party software into its products and expects that itssoftware license cost of revenue as a percent of software license revenue willincrease slightly in the future.

 

*Hardware.*  Cost of hardware revenue consists primarilyof the costs of third-party hardware products. Cost of hardware revenue was$314,000 and $451,000 for the three months ended June 30, 2004 and2003, respectively, representing 70% and 74% of hardware revenues for eachrespective period. The decrease in dollar amount for the cost of hardwarerevenues was due primarily to the decrease of hardware unit sales accompanyingsales of the Company’s software products. The gross margin percentage forhardware sales improved to 30% from 26% for the three month periods endedJune 30, 2004 and 2003 due to a change in the particular mix of hardwareproducts sold.  The Company does notexpect that its per unit cost of hardware products will change significantlyenough through the remainder of 2004 such that it would have a material impacton hardware margins in the future.

 

*Service and Other.*  Cost of service and other revenue consistsprimarily of the costs incurred in providing telephone support as well as othermiscellaneous customer service-related expenses.  Cost of service and other revenues was$644,000 and $806,000 for the three months ended June 30, 2004 and 2003,respectively, representing 36% and 50% of service and other revenues for eachrespective period.  The gross marginpercentage for service and other revenues increased to 64% for the three monthsended June 30, 2004, compared to 50% in the same period in 2003.  The increase in gross margin is due to adecrease in the number of employees and the associated overhead costs resultingfrom the restructuring that occurred in the third quarter of 2003.  The Company does not expect any significantvariances in its service and other gross margins for the remainder of fiscalyear 2004.

 

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*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses consistprimarily of employee salaries, benefits, commissions, and associated overheadcosts, and the cost of marketing programs such as advertisements, directmailings, public relations, trade shows, seminars and related communicationcosts.  Sales and marketing expenses were$988,000 and $1.3 million for the three months ended June 30, 2004and 2003, respectively, or 29% and 40% of total revenues for each respectiveperiod.  The decrease in sales andmarketing expenses is due to decreased wages, commissions, and travel costsresulting from fewer management level personnel in the department as a resultof the restructuring that occurred in the third quarter of 2003. The Companyexpects that its sales and marketing expenses will increase in absolute dollarsas additional sales staff is added during the year.

 

*Research and Development.*Research and development expenses include expenses associated with thedevelopment of new products, enhancements of existing products and qualityassurance activities. These expenses consist primarily of employee salaries,benefits, associated overhead costs, consulting expenses and the cost ofsoftware development tools. Research and development expenses were $482,000 forthe three months ended June 30, 2004 and $588,000 for the three monthsended June 30, 2003, representing 14% and 18% of total revenues for eachrespective period.  The decrease in theexpense and in research and development expenses as a percent of total revenuesis a result of fewer employees in the research and development department andthe associated costs of supporting such personnel due to the restructuring thatoccurred in the third quarter of 2003. Management does not believe that the decrease in the number of employeeswill have a material adverse effect on its ability to develop new products andupdated versions of its existing products. The Company expects research and development expenses to remainconsistent in absolute dollars.

 

*General and Administrative.*  General and administrative expenses consistprimarily of employee salaries, benefits for administrative, executive andfinance personnel and associated corporate general and administrative expenses.General and administrative expenses were $572,000 and $826,000 for the threemonths ended June 30, 2004 and 2003, respectively, or 17% and 25% of totalrevenues for each period. The decrease in dollar amount and percentage of totalrevenues is due to the reduction in general and administrative personnel andoverhead costs associated with supporting such personnel and a decrease inmanagement consulting expenses.  Thedecrease is also due to a $90,000 reduction in the state sales tax accrual forthe three month period ended June 30, 2004 resulting from a refinement inthe Company’s methodology for accrual of sales taxes based on activity in thestate as a basis for determining nexus. The Company expects that it may experience increases to general andadministrative expenses in the form of professional fees and consultingexpenditures in the remaining quarters of 2004 as it continues to prepare forcompliance with Section 404 of the Sarbanes-Oxley Act of 2002.

 

*Interest and other Income.*  Interest and other income consistsprincipally of interest income earned on cash and cash equivalentbalances.  Interest and other income, netwas $37,000 for the three months ended June 30, 2004 and $14,000 for thethree months ended June 30, 2003. This increase is a result of a higher cash balance as well as a higherinterest rate for the three months ended June 30, 2004.  The Company expects that interest and otherincome will be relatively stable quarter over quarter for the remainder of2004.

 

*Provision for Income Taxes.*  During the three months ended June 30,2004, the Company recorded a net tax provision of $38,572 for expected taxliability in the United States and for expected tax liability related to OEL.  The Company did not record a tax provisionduring the three months ended June 30, 2003 as the Company was in a lossposition.

 

**Six Months Ended June 30, 2004 and 2003**

 

## ***Revenues***

 

*Total Revenues.*  The Company’s total revenue was$7.4 million and $6.3 million for the six months ended June 30, 2004and 2003, respectively.

 

*Software License.*  Software license revenue was $2.3 million forthe six months ended June 30, 2004 and $2.0 million for the six monthsended June 30, 2003, representing an increase of 16%.  Software license revenue accounted for 31%and 32% of total revenues for each respective period.  The increase in software license revenue isdue to an improvement in the demand for enterprise software solutions resultingin higher software revenue for the Company. Software license revenue for the six month period ended June 30,2004 reflect an overall increase in demand for the Company’s AccuRoute productwhile the Company’s legacy fax product line exhibited a decline compared to thesix month period ended June 30, 2003. Revenues from the Company’s AccuRoute product represented 36% and 6% ofsoftware license revenue for the six month

 

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period ended June 30, 2004 and 2003, respectively.  Software license revenue from the Company’slegacy fax product line represented 64% and 90% of software license revenue forthe six month period ended June 30, 2004 and 2003, respectively.  The growth of the AccuRoute product line is aresult of greater market acceptance of the product.  Included in software license revenue for thesix months ended June 30, 2004 and 2003 is a net reduction of $140,000 and$60,000, respectively, in the sales returns and allowance reserve relatingprimarily to specific accounts where the Company has determined that the riskof a return is no longer present.  Thoughthe Company cannot accurately predict the exact mix of products that will besold in the future, it expects that software license revenue will constitute alarger percentage of its total revenue in the future if demand for its newerproducts, such as AccuRoute, which does not require the purchase of additionalhardware, continues to gain additional market acceptance.

 

*Hardware.*  Hardware revenue was $1.6 million for the sixmonths ended June 30, 2004 and $1.1 million for the six months endedJune 30, 2003, representing an increase of 45%.  Hardware revenue accounted for 22% and 18% oftotal revenue for each respective period. The increase in hardware revenue is due to an increase in demand fromexisting customers who have upgraded information systems hardware in theirworldwide locations.  Included inhardware revenue for the six months ended June 30, 2004 and 2003 is areduction of $44,000 and $23,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where the Company hasdetermined that the risk of a return is no longer present.  Though the Company cannot accurately predictthe exact mix of products that will be sold in the future, it expects thathardware revenue will constitute a smaller percentage of its total revenue ifdemand for its newer products, such as AccuRoute, which does not require thepurchase of additional hardware, continue to gain additional market acceptance.

 

*Service andOther.*  Serviceand other revenue increased by 8% for the six months ended June 30, 2004compared to the six months ended June 30, 2003.  Service and other revenue was$3.5 million and $3.2 million for the six months ended June 30, 2004and 2003, respectively.  Service andother revenue accounted for 47% and 51% of total revenues for each respectiveperiod.  The increase in service andother revenue is primarily due an increase in maintenance revenues from alarger installed customer base.  Thedecrease in service and other revenue as a percent of total revenues is dueprimarily to the increase in both software license and hardware revenue.

 

*Cost of Revenue*

 

*Software License.*  Cost of software license revenue for the sixmonths ended June 30, 2004 decreased by 22% or $33,000 to $118,000compared to $151,000 during the corresponding period in 2003.  The decrease is due primarily to the factthat the Company replaced third-party software that was imbedded in itsproducts with its own internally-developed solutions, thus reducing theroyalties that it must pay when a product containing that third-party softwareis sold.  This decrease is also reflectedin software license gross margin as it improved to 95% from 92%.  The Company has recently added additionalthird-party software into its products and expects that its software licensecost of sales as a percent of software license revenue will increase slightlyin the future.

 

*Hardware.*  Cost of hardware revenues was $989,000 and$800,000 for the six months ended June 30, 2004 and 2003,respectively, representing 61% and 72% of hardware revenues for each respectiveperiod. The increase in dollar amount for the cost of hardware revenues was dueprimarily to the increase of hardware unit sales accompanying sales of theCompany’s software products. The gross margin percentage for hardware salesimproved to 39% from 28% for the six month periods ended June 30, 2004 and2003 due to a change in the particular mix of hardware products sold.  The Company does not expect that its per unitcost of hardware products will change significantly enough through theremainder of 2004 such that it would have a material impact on hardware marginsin the future.

 

*Service and Other.*  Cost of service and other revenues was $1.4million and $1.6 million for the six months ended June 30, 2004 and 2003,respectively, representing 40% and 50% of service and other revenues for eachrespective period.  The gross marginpercentage for service and other revenues increased to 60% for the six monthsended June 30, 2004, compared to 50% in the same period in 2003.  The increase in gross margin is due to adecrease in the number of employees and the associated overhead costs resultingfrom the restructuring that occurred in the third quarter of 2003.  The Company does not expect any significantvariances in its service and other gross margins for the remainder of fiscalyear 2004.

 

*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses were$2.0 million and $2.7 million for the six months ended June 30,2004 and 2003, respectively, or 27% and 42% of total revenues for eachrespective period.  The decrease in salesand marketing expenses is due to decreased wages, commissions, and travel costsresulting from fewer management level personnel in

 

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the department as a result of the restructuring that occurred in thethird quarter of 2003.  Additionally, theCompany reduced its trade show expenses during the first six months of 2004 ascompared to the first six months of 2003. The Company expects that its sales and marketing expenses will increasein absolute dollars as additional sales staff is hired throughout the year.

 

*Research and Development.*Research and development expenses were $953,000 for the six months endedJune 30, 2004 and $1.2 million for the six months ended June 30,2003, representing 13% and 19% of total revenues for each respectiveperiod.  The decrease in the expense andin research and development expenses as a percent of total revenues is a resultof fewer employees in the research and development department and theassociated costs of supporting such personnel due to the restructuring thatoccurred in the third quarter of 2003. Management does not believe that the decrease in the number of employeeswill have a material adverse effect on its ability to develop new products andupdated versions of its existing products. The Company expects research and development expenses to remainconsistent in absolute dollars.

 

*General and Administrative.*  General and administrative expenses were $1.3million and $1.6 million for the six months ended June 30, 2004 and 2003,respectively, or 17% and 25% of total revenues for each period. The decrease indollar amount and percentage of total revenues is due to the reduction in generaland administrative personnel and overhead costs associated with supporting suchpersonnel and a decrease in management consulting expenses.  The decrease is also due to a $90,000reduction in the state sales tax accrual for the six month period ended June 30,2004 resulting from a refinement in the Company’s methodology for accrual ofsales taxes based on activity in the state as a basis for determiningnexus.  The Company expects that it mayexperience increases to general and administrative expenses in the form ofprofessional fees and consulting expenditures in the remaining quarters of 2004as it continues to prepare for compliance with Section 404 of theSarbanes-Oxley Act of 2002.

 

*Interest and other Income.*  Interest and other income consists principallyof interest income earned on cash and cash equivalent balances.  Interest and other income, net was $74,000for the six months ended June 30, 2004 and $53,000 for the six monthsended June 30, 2003.  Also includedin the six months ended June 30, 2004 interest and other income is otherincome of $5,000 related to the fair value of a warrant to purchase 8,580shares of common stock of Verso Technologies (“Verso”).  The fair value of the warrant is marked tomarket in each financial reporting period resulting in future changes in fairvalue which are recorded in income and other expenses.  The Company’s warrant to purchase 8,580shares of Verso common stock expires in November 2005.  This increase is a result of a higher cashbalance as well as a higher interest rate for the six months endedJune 30, 2004.  The Company expectsthat interest and other income will be relatively stable quarter over quarterfor the remainder of 2004.

 

*Provision for Income Taxes.*  During the six months ended June 30,2004, the Company recorded a net tax provision of $57,703 for expected taxliability in the United States and for expected tax liability related toOEL.  The provision for the first sixmonths of 2004 is net of a $28,800 adjustment related to a fiscal year 2003 transferpricing adjustment.

 

During the six months ended June 30, 2003, the Company recorded$155,398 of tax benefit due to a tax refund that OEL received during the firstquarter of 2003. OEL had incurred a loss for the year ended December 31,1999 which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resultedin a tax refund.  Because the subsidiarywas undergoing an Inland Revenue audit for tax year 1999, doubt existed aboutthe realizability of this refund and the Company did not record the benefit onits books until the audit was cleared and the cash was received, both of whichoccurred in the first quarter of 2003.

 

### **Liquidityand Capital Resources**

 

Since 1996, the Company has financed its operations primarily throughcash flow from operations, the private sales of preferred stock and commonstock and the Company’s initial public offering of Common Stock completed inAugust 1997. At June 30, 2004, the Company had cash and cashequivalents of $10.3 million and working capital of $5.6 million.

 

The Company’s operating activities provided cash of $506,000 for thesix months ended June 30, 2004 and used cash of $1.3 million for the sixmonths ended June 30, 2003. Management restructured the organization in September 2003 toreduce operating expenses and help preserve cash.  Management believes that these reductions,which are anticipated to total approximately $1.6 million annually, along withanticipated revenue for the remainder of fiscal year 2004, will lead tosufficient cash for at least the next twelve months.  Net cash provided during the six months endedJune 30, 2004 consisted primarily of a net profit from operations,depreciation and amortization, an increase in accrued liabilities and adecrease in accounts receivable partially offset by a decrease to the accountsreceivable reserve, a decrease in accrued restructuring and accountspayable.  The decrease in accountsreceivable is due primarily to the continued efforts by management to continueto improve its working capital by expediting the collection of accountsreceivable.  The decrease in the accountsreceivable reserve relates

 

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primarily to specific accounts where the Company has determined thatthe risk of a return is no longer present. The increase to accrued liabilities is the result of an increase inwage-related accruals due to the timing of payroll and an increase in theaccruals for professional services.  Thedecrease in accrued restructuring reflects continued severance paymentsrelating to the September 2003 restructuring.  The decrease to accounts payable is theresult of timing of payments to vendors. Net cash used in operations during the six months ended June 30,2003 resulted from a net loss from operations and decreases in deferredrevenue, accrued sales tax and accounts receivable reserve offset bydepreciation and amortization; and a decrease to accounts receivable, prepaidsand other current assets.

 

Investing activities used cash of $25,000 and provided cash of $1.4million during the six months ended June 30, 2004 and 2003,respectively.  During the six monthsended June 30, 2004, the primary use of cash was for purchases of propertyand equipment. Property and equipment purchases were predominately of computerrelated software and hardware products. During the six months endedJune 30, 2003, the principal uses were purchases of property and equipmentand short-term investments, offset by proceeds from the sale of short-term investments.  The Company does not currently anticipate anysignificant changes to its level and purpose of cash used in investingactivities for the remainder of fiscal year 2004.

 

Financing activities provided cash of $1.6 million and $2,600 for thesix months ended June 30, 2004 and 2003, respectively.  Cash provided for the six months endedJune 30, 2004 was due to the net proceeds from the issuance of commonstock. On March 30, 2004 the Company completed the sale of 600,000 sharesof common stock, at a price of $6.00 per share, in a private placement toinstitutional and other accredited investors. The proceeds of the privateplacement, which totaled $3.6 million, are to be used for additional workingcapital and other general corporate purposes. This was offset by a cash usageof $2.0 million during the six months ended June 30, 2004 as the Companyrepurchased 350,000 shares of its outstanding common stock from ASAInternational, an existing shareholder, in a private transaction at a price of$5.75 per share. The shares were purchased with the use of generally availablecorporate funds and will be held in treasury. Cash provided by financingactivities for the six months ended June 30, 2003 was due primarily to netproceeds from the issuance of common stock related to the Company’s employeestock purchase program.

 

Based on its first two quarters performance and current expectationsfor the remainder of 2004, the Company believes that the current cash and cashequivalents balance as well as the expected cash to be generated fromoperations for the remainder of the year will satisfy its working capitalneeds, capital expenditures and other liquidity requirements associated withits operations through at least the next twelve months.  The Company expects that principal uses ofcash will be for operations, working capital, payment of sales taxes andpurchases of property and equipment. Management currently has no plan to obtain additional financing if theseexpectations are not met. There can be no assurance that any necessaryadditional financing will be available to the Company on commerciallyreasonable terms, or at all.

 

The following table represents the approximate amounts of payments dueunder specified contractual obligations as of June 30, 2004:

 
| **Contractual  Obligations** | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|------------------------------|------------|-----------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------|------------|
|                         |       |      |       |                    |       |                    |       |                     |       |                      |       |
| Operating lease obligations  |       | $         | 512,000    |                    | $          | 396,000                 |       | $                        | 116,000    |                      | —     |   | — |   |
|                              |            |           |            |                         |            |                         |            |                          |            |                           |            |  |  |  |

 

Operating lease requirements consist mainly of lease payments for theCompany’s offices in Salem, NH and London, England, United Kingdom. As ofJune 30, 2004, the Company did not have any long-term debt obligations,material commitments for capital expenditures, capital lease obligations, orother long-term liabilities for which payments are required.

 

**Certain Factors Affecting Future Operating Results**

 

The Company operates in a rapidly changing environment that involves anumber of risks, some of which are beyond the Company’s control. The discussionhighlights some of the risks which may affect future operating results.

 

Information provided by the Company from time to time includingstatements in this Quarterly Report on Form 10-Q which are not historicalfacts are so-called “forward-looking statements” that involve risks anduncertainties, made pursuant to the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. In particular, statements containedin Management’s Discussion and Analysis of Financial Condition and Results ofOperations which are not historical facts (including, but not limited to,statements concerning:  the plans andobjectives of management; expectations for sales and

 

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marketing, research and development and general and administrativeexpenses; developments relating to the Company’s product and service offerings,markets and acquisitions; anticipated trends in the Company’s business; theCompany’s strategic alliances; changes in the regulatory environment; the Company’sexpected liquidity and capital resources and the Company’s critical accountingpolicies) may constitute forward-looking statements. These forward-lookingstatements are neither promises nor guarantees, but are subject to risks anduncertainties that could cause actual results to differ materially from theexpectations set forth in the forward-looking statements. Factors that maycause such differences include, but are not limited to, the factors discussedbelow, and the other risk factors discussed from time to time in the Company’sother filings with the SEC.

 

*Future Operating Results Uncertain.*  The Company incorporated and shipped itsinitial facsimile software products in 1991. In the years ending December 31, 2001, 2002 and 2003, the Company hadoperating losses and decreasing revenues. There can be no assurance that theCompany will be able to increase its level of revenues or maintainprofitability in the future; as the Company’s operating history makes theprediction of future operating results difficult or impossible.  Increases in operating expenses may occurand, together with pricing pressures and a decline in the growth rate of theoverall U.S. economy due to factors beyond the Company’s control, may result ina decrease in operating income and operating margin percentage.  The Company’s ability to improve itsoperating results will depend upon, among other things, its ability to increasesales of the AccuRoute, Genifax and Genidocs software products to new customersas well as increased product penetration into existing customers.  The Company recently commenced its strategicexpansion into document routing and distribution software, and has limitedfinancial and operating data and a limited operating history relevant to thissolution.  Accordingly, it is difficultto evaluate the prospects for the level of acceptance of this solution. Futureoperating results will depend on many other factors, including, withoutlimitation, the degree and rate of growth of the markets in which the Companycompetes, the level of acceptance of the Windows NT, Windows 2000, Windows XPand other operating systems, the level of product and price competition, theability of the Company to establish strategic relationships and develop andmarket new and enhanced products and to control costs, the ability of theCompany to expand its direct sales force and indirect distribution channelsboth domestically and internationally and the ability of the Company to attractand retain key personnel. As a result, it is possible that in the future theCompany’s operating results will be below the expectations of public marketanalysts and investors.  In such event,the price of the Company’s common stock would likely be materially adverselyaffected.

 

*Product Concentration.*  To date, much of the Company’s revenues havebeen attributable to licenses of the Company’s facsimile-based enterprisesolutions and related products and services. The Company expects such productsand related services to continue to account for much of the Company’s futurerevenues. However, recently the amount of revenues attributable to the licensesof such products has declined and there can be no assurances that such declinewill not continue. Furthermore, the Company introduced its secure business-to-businesselectronic document exchange products, Genidocs and Genifax, to the market inthe fourth quarter of 2000.  To date, theCompany has not recognized a significant amount of revenues from its Genidocsproduct. The Company expects that its Genidocs products may account for anincreasing portion of future revenues. However, there can be no assurances thatthe Genidocs products will be financially successful or result in anysignificant revenues. Factors adversely affecting the pricing of or demand forsuch products, such as competition or technological change, could have amaterial adverse effect on the Company’s business, financial condition andresults of operations. The Company’s prospects must be considered in light ofthe risks and difficulties frequently encountered by companies dependent uponoperating revenues from a new product line in an emerging and rapidly evolvingmarket.

 

*New Products and Technological Change.*  The markets for the Company’s products arerelatively new and are characterized by rapid technological change, evolvingindustry standards, changes in end-user requirements and frequent new productintroductions and enhancements. The Company’s future success will depend uponits ability to enhance its current products and to develop and introduce newproducts that keep pace with technological developments and respond to evolvingend-user requirements. There can be no assurance that the Company will besuccessful in developing and marketing new products or product enhancements ona timely basis, or that new products or product enhancements developed by theCompany, such as the Genidocs, Genifax and AccuRoute products will achievecontinuing market acceptance. The introduction of products embodying newtechnologies and the emergence of new industry standards could render theCompany’s existing products obsolete and unmarketable. From time to time, theCompany and its competitors may announce new products, capabilities ortechnologies that have the potential to replace or shorten the life cycle ofthe Company’s existing product offerings. There can be no assurance thatannouncements of new product offerings by the Company or its competitors willnot cause customers to defer or forego the licensing of the Company’s existingor planned products and have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

*The Market Risks for SecureBusiness-to-Business Electronic Document Exchange Solutions.*  The market for Genidocs, the Company’s securebusiness-to-business electronic document exchange solution is new and evolvingrapidly. The

 

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Company’s success will depend upon the adoption and use by current andpotential customers of secure business-to-business electronic document exchangesolutions. The Company’s success will also depend upon acceptance of itstechnology as the standard for providing these solutions. The adoption and useof the Company’s secure business-to-business electronic document exchangesolution will involve changes in the manner in which businesses havetraditionally exchanged information. The Company’s ability to influence usageof its secure business-to-business electronic document exchange solution bycustomers is limited. The Company intends to spend considerable resourceseducating potential customers about the value of secure business-to-businesselectronic document exchange solutions. It is difficult to assess, or topredict with any assurance, the present and future size of the potential marketfor the Company’s secure business-to-business electronic document exchangesolution, or its growth rate, if any. Moreover, the Company cannot predict whether the Company’s securebusiness-to-business electronic document exchange solution will achieve anymarket acceptance. Any future products or future product enhancements that arenot favorably received by customers may not be profitable and, furthermore,could damage the Company’s reputation or brand name.

 

*Dependence on the Genifax and AccuRouteProduct Lines and the Windows 2000/XP environment.*  The Company currently derives a significantportion of its revenues from licenses of the Genifax product and relatedservices and resale of related hardware as well as licenses of the AccuRoute product.Continued market acceptance of the Genifax and AccuRoute products are criticalto the Company’s future success. As a result, any decline in demand for orfailure to maintain broad market acceptance of the Genifax and AccuRouteproduct lines as a result of competition, technological change or otherwise,would have a material adverse effect on the Company’s business, financialcondition and results of operations. The Company’s future financial performancewill depend in large part on new and enhanced versions of the Genifax andAccuRoute products. There can be no assurance that the Company will continue tobe successful in marketing the Genifax and AccuRoute products or any new orenhanced versions of the Genifax and AccuRoute products.  There can be no assurance that the Companywill be successful in developing products for new or enhanced operating systemssuch as Windows 2000 or Windows XP, or that such systems will not obviate theneed for the Company’s products. If any new or enhanced operating system gainswidespread use and the Company fails to develop and provide its products forthis operating system on a timely basis, the Company’s business, financialcondition and results of operations would be materially adversely affected.

 

*Dependence on Client/Server Environment.*  The Company’s enterprise, client/serverfacsimile software products are intended to help organizations efficientlymanage their facsimile communications, utilizing a client/server computingenvironment. The client/server market is relatively new and there can be noassurance that organizations will move away from the use of stand-alone faxmachines or continue to adopt client/server environments, or that customers ofthe Company that have begun the migration to a client/server environment willbroadly implement this model of computing. The Company’s future financialperformance will depend in large part on continued growth in the market forclient/server applications, which in turn will depend in part on the growth inthe number of organizations implementing client/server computing environments.There can be no assurance that these markets will continue to grow or that theCompany will be able to respond effectively to the evolving requirements ofthese markets. If the market for client/server application products andservices does not grow in the future, grows more slowly than the Companyanticipates, or if the Company fails to respond effectively to evolvingrequirements of this market, the Company’s business, financial condition andresults of operations would be materially adversely affected.

 

*Risks Associated with Listing on the NasdaqSmallCap Market*. On November 26, 2002, the Company transferred from the NasdaqNational Market to the Nasdaq SmallCap Market. The Company cannot predict the continuance of its listing status in thefuture including the possibility of delisting from the Nasdaq Small CapMarket.  The delisting of the Company’scommon stock from Nasdaq may materially impair the stockholder’s ability to buyand sell shares of the Company’s common stock and could have an adverse effecton the market price of, and the efficiency of the trading market for, theCompany’s common stock.  Furthermore, thedelisting of the Company’s common stock could significantly impair the Company’sability to raise capital should it desire to do so in the future.  The Company’s listing on the Nasdaq StockMarket is highly important to the Company and the Company intends to takereasonable measures to maintain compliance.

 

*Intense Competition.*  The document routing and distributionsoftware, secure business-to-business electronic document exchange solution andenterprise, client/server facsimile solution markets are intensely competitiveand rapidly changing and the Company expects competition to continue toincrease. The Company believes its ability to compete successfully depends upona number of factors both within and beyond its control, including productperformance; reliability and features; product adoption; ease of use; productscalability; quality of support services; price/performance; timeliness ofenhancements and new product releases by the Company and its competitors; theemergence of new computer-based facsimile and secure business-to-businesselectronic document exchange solutions and standards; name recognition; theestablishment of strategic alliances with industry leaders and industry andgeneral economic trends.

 

The document routing and distribution software market includescompetitive products from vendors such as e-Copy, Notable Solutions, Inc., andElectronics For Imaging, Inc., as well as software products provided byscanning hardware vendors directly, such as Flowport from Xerox and Globalscanfrom Ricoh.  Furthermore, these and additionalhardware vendors may elect to include new functionality in their hardware whichcould have the effect of rendering the Company’s products less attractive toend users or distribution partners.  TheCompany may not be able to compete successfully against these current andfuture vendors of directly competitive products.  Additionally, many other companies in theimage acquisition, workflow, facsimile software, secure messaging software anddocument management markets have products with functionality that overlapswith, and which over time may become increasingly more competitive with, theCompany’s products.

 

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The Company may not be able to compete successfully against current andfuture competitors in the secure business-to-business electronic documentexchange solutions market, and the competitive pressures the Company facescould harm its business and prospects. In the intensely competitive and rapidlychanging business-to-business secure document exchange market, the Companycompetes directly with Authentica, Sigaba, Tumbleweed, and Zixit and a numberof other providers.  There are also othercategories of technology solution that overlap and compete in certain ways withaspects of the Company’s products.  Theseinclude:

 

•                  Documentmanagement solutions from vendors such as Documentum, Hummingbird and iManagewhose electronic collaboration solutions compete with certain aspects of theCompany’s solutions;

•                  Electronicforms and electronic signature solutions from vendors such as Adobe, PureEdge,CreateForm and Silanis that offer the creation of electronic documents withelectronic signatures; and

•                  Securityinfrastructure solutions from vendors such as Verisign and Entrust whosesolutions can be used to build applications that enable secure documentcommunications.

 

The Company expects the competition in the business-to-business securedocument exchange market to increase over time.

 

The Company competes directly with a large number of vendors offacsimile products, including providers of facsimile software products forclient/server networks such as RightFAX (a subsidiary of Captaris), Fenestrae,TopCall International and Biscom. The Company also competes with providersoffering a range of alternative facsimile solutions including outsourcingnetwork facsimile solutions, such as Easylink Services; operating systemscontaining facsimile and document e-mail features; low-end fax modem products;providers of desktop fax software; single-platform facsimile software products;and customized proprietary software solutions. In addition, providers ofoperating systems or business software applications may bundle competitivefacsimile solutions as part of their broader product offerings.

 

Many of the Company’s competitors and potentialcompetitors have longer operating histories and greater financial, technical,sales, marketing and other resources, as well as greater name recognition andmarket acceptance of their products and technologies than the Company. Inaddition, there are relatively low barriers to entry in the markets in whichthe Company operates and intends to operate, and new competition may ariseeither from expansion by established companies or from new emerging companiesor from resellers of the Company’s products. There can be no assurance thatcurrent or potential competitors of the Company will not develop productscomparable or superior—in terms of price and performance features—to thosedeveloped by the Company, adapt more quickly than the Company to new oremerging technologies and changes in market opportunities or customerrequirements, establish alliances with industry leaders, or take advantage ofacquisition opportunities more readily than the Company. In addition, noassurance can be given that the Company will not be required to makesubstantial additional investments in connection with its research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that such required investments willnot have a material adverse effect on operating margins.  Changes in government laws and regulationsmay also affect our ability to maintain competitiveness.  Increased competition may result in reductionin market share, pressure for price reductions and related reductions in grossmargins, any of which could materially adversely affect the Company’s abilityto achieve its financial and business goals. There can be no assurance that inthe future the Company will be able to successfully compete against current andfuture competitors.

 

*Fluctuations in Quarterly Results ofOperations; Seasonality.*  The Company’s quarterly revenues and resultsof operations have fluctuated significantly in the past and will likelyfluctuate significantly in the future. Causes of such fluctuations have includedand may include, among others, the demand for the Company’s products andservices; the size and timing of orders; the number, timing and significance ofnew product announcements by the Company and its competitors; the ability ofthe Company to develop, introduce, market and ship new and enhanced versions ofthe Company’s current and planned products on a timely basis; the level ofproduct and price competition; changes in operating expenses; changes inaverage selling prices and mix of the Company’s products; changes in theCompany’s sales incentive strategy; the mix of direct and indirect sales, andgeneral economic factors, including a decline in the growth rate of the overallU.S. economy. In addition, the sale of the Company’s products often involvesdelays because customers tend to implement the products on a large scale andthey also must establish certain minimum hardware capabilities. The Company’sproducts therefore often have a lengthy sales cycle while the customerevaluates and receives approvals for the purchase of the Company’s products.During such sales cycles, the Company may expend substantial funds andmanagement efforts yet receive no revenues. It is difficult to accuratelypredict the sales cycle of any large order. If one or more large orders fail toclose as forecasted in a fiscal quarter, the Company’s revenues and operatingresults for such quarter could be materially adversely affected. Any one ormore of these or other factors could have a material adverse effect on the Company’sbusiness, financial condition and results of

 

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operations. The potential occurrence of any one or more of thesefactors makes the prediction of revenues and results of operations on aquarterly basis difficult and performance forecasts derived from suchpredictions unreliable.

 

In general, revenues are difficult to forecast because the market forsecure business-to-business electronic document exchange, enterpriseclient/server facsimile solutions software and routing and distributionsoftware is evolving rapidly and the Company’s sales cycle—from the customer’sinitial evaluation through purchase of licenses and the related supportservices—varies substantially from customer to customer. License fee revenuesin any quarter depend on orders received and shipped in that quarter with anincreasing percentage of orders in any quarter being received in the last weeksof the quarter.  License fee revenuesfrom quarter to quarter are difficult to forecast, as no significant orderbacklog exists at the end of any quarter because the Company’s productstypically are shipped upon receipt of customers’ orders.

 

A substantial portion of the Company’s operating expense is related topersonnel, facilities, equipment and marketing programs. The level of spendingfor such expense cannot be adjusted quickly and is therefore fixed in the shortterm. The Company’s expense levels for personnel, facilities, equipment andmarketing programs are based, in significant part, on the Company’sexpectations of future revenues on a quarterly basis. If actual revenue levelson a quarterly basis are below management’s expectations, results of operationsare likely to be adversely affected by a similar amount because a relativelysmall amount of the Company’s expense varies with its revenue in the shortterm.

 

Due to all of the foregoing factors, it is likely that in some futureperiods the Company’s results of operations will be below the expectations ofsecurities analysts and investors. In such event, the price of the Company’scommon stock would likely be materially adversely affected.

 

*Expansion of Indirect Channels; Potential forChannel Conflict; Strategic Alliances.*  The Company markets its products and servicesdirectly through telesales and indirectly through marketing channels such asvalue added resellers (“VARs”), systems integrators, distributors and strategicbusiness partners. Although the Company has historically focused its efforts onmarketing through its sales force, the Company continues to utilize resourcesto develop and expand indirect marketing channels. There can be no assurancethat the Company will be able to attract and retain a sufficient number ofqualified VARs, systems integrators, distributors and strategic businesspartners to successfully market the Company’s products. In addition, there canbe no assurance that the Company’s resellers and strategic business partnerswill not develop, acquire or market computer-based facsimile products that arecompetitive with the Company’s products. The failure to retain its VARs,systems integrators, distributors and strategic partners could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

The distributor agreements generally provide that either party mayterminate the agreement without cause upon 30 days written notice to theother party.  The Company also resellsits products on a purchase order basis through other VARs, systems integratorsand distributors.  Either party mayterminate such relationships, at any time, and therefore there can be noassurance that any VAR, systems integrator or distributor will continue torepresent the Company’s products. Furthermore, the Company’s strategic alliances may be terminated byeither party, at any time; there can be no assurances that such strategicalliances will continue.  The inabilityto retain certain VARs, systems integrators, distributors or strategic businesspartners, or the development or marketing by VARs, systems integrators,distributors or strategic business partners of competitive offerings, couldhave a material adverse effect on the Company’s business, financial conditionand results of operations.

 

Selling through indirect channels may limit the Company’s contacts withits customers.  As a result, theCompany’s ability to accurately forecast sales, evaluate customer satisfactionand recognize emerging customer requirements may be hindered. The Company’sstrategy of marketing its products directly to end-users and indirectly throughVARs, systems integrators and distributors may result in distribution channelconflicts. The Company’s direct sales efforts may compete with those of itsindirect channels and, to the extent different resellers target the same customers,resellers may also come into conflict with each other. As the Company strivesto expand its indirect distribution channels, there can be no assurance thatemerging channel conflicts will not materially adversely affect itsrelationships with existing VARs, systems integrators or distributors oradversely affect its ability to attract new VARs, systems integrators anddistributors.

 

*Ability to obtain Additional Financing.** ***Weexpect our current cash, cash equivalents and investments will meet our normalworking capital and capital expenditure needs for at least the next twelvemonths.  We may need to raise additionalfunding at that time or earlier if we decide to undertake more rapid expansion,including acquisitions of complementary products or technologies, or if weincrease our marketing and/or research and development efforts in order torespond to competitive pressures.  Wecannot be certain that we will be able to obtain additional financing onfavorable terms, if at all.

 

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We may obtain additional financing by issuing shares of our commonstock, which could dilute our existing stockholders.  If we cannot raise needed funds on acceptableterms, or at all, we may not be able to develop or enhance our products orrespond appropriately to competitive pressures, which would seriously harm ourbusiness.

 

*Risks Associated with Acquisitions.*  The Company may augment its internal growthwith acquisitions of businesses, products and technologies that couldcomplement or expand the Company’s business. Certain of these businesses may bemarginally profitable or unprofitable. In order to achieve anticipated benefitsfrom these acquisitions, the Company must successfully integrate the acquiredbusinesses with its existing operations and no assurance can be given that theCompany will be successful in this regard. The Company has limited experiencein integrating acquired companies into its operations, in expanding the scopeof operations of required businesses, in managing geographically dispersedoperations and in operating internationally. In the past the Company hasincurred one-time costs and expenses in connection with acquisitions and it islikely that similar one-time costs and expenses would be incurred in connectionwith future acquisitions.  In addition,attractive acquisitions are difficult to identify and complete for a number ofreasons, including competition among prospective buyers and the possible needto obtain regulatory approval. There can be no assurance that the Company willbe able to complete future acquisitions. In order to finance such acquisitions,it may be necessary for the Company to raise additional funds either throughpublic or private financings, including bank borrowings.  Any financing, if available at all, may be onterms which are not favorable to the Company. The Company may also issue shares of its common stock to acquire suchbusinesses, which may dilute the Company’s existing stockholders.

 

*Ability to Manage Growth.*  The Company may expand its operations andanticipates that expansion may be required in order to address potential marketopportunities. The Company may increase the size of its sales and marketing andresearch and development expenditures as necessary. There can be no assurancethat such expansion would be completed successfully or that it would generatesufficient revenues to cover the Company’s expenses. The Company will need tocontinue to attract and retain highly qualified technical, sales and managerialpersonnel. There can be no assurance that the Company will be able to retain orcontinue to hire such personnel in the future. The inability of the Company toeffectively expand operations and manage growth, if any, could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

*Risks Associated with the Use of Arthur Andersen asIndependent Auditors. *Arthur Andersen LLP (“Andersen”), the Company’sformer independent public accountants that audited the Company’s financialstatements until June 28, 2002, was found guilty by a jury onJune 15, 2002 of federal obstruction of justice in connection with thegovernment’s investigation of Enron Corporation.  Andersen ceased practicing before the SECeffective August 31, 2002.  Althoughthe Company has no reason to believe that those financial statements areincorrect, it is possible that events arising out of the indictment mayadversely affect Andersen’s ability to satisfy any claims arising from itsprovision of auditing and other services to the Company, including claims thatmay arise out of Andersen’s audit of the Company’s financial statements.  The SEC has indicated that it will continueaccepting financial statements audited or reviewed by Andersen provided thatthe Company comply with the applicable rules and orders issued by the SEC inMarch 2002 for such purpose.

* *

*Risks Associated with InternationalExpansion.*  Anelement of the Company’s strategy is to increase its international sales. TheCompany expects to face competition from secure business-to-business electronicdocument exchange solutions and local facsimile product providers in theirnative countries. To successfully maintain international sales, the Companyneeds to recruit and retain additional international resellers anddistributors. There can be no assurance that the Company will be able tomaintain international sales of its products or that the Company’sinternational distribution channels will be able to adequately market, serviceand support the Company’s products. International operations generally aresubject to certain risks, including dependence on independent resellers,fluctuations in foreign currency exchange rates, compliance with foreignregulatory and market requirements, variability of foreign economic conditionsand changing restrictions imposed by United States export laws. Additionalrisks inherent in the Company’s international business activities generallyinclude unexpected changes in regulatory requirements, tariffs and other tradebarriers, costs of localizing products for foreign countries, lack ofacceptance of localized products in foreign countries, longer accountsreceivable payment cycles, difficulties in managing international operations,difficulties in enforcing intellectual property rights and the burdens ofcomplying with a wide variety of foreign laws. The Company has a sales office outside of the United States; suchoperations are subject to certain additional risks, including difficulties instaffing and managing such operations and potentially adverse tax consequencesincluding restrictions on the repatriation of earnings. There can be noassurance that such factors will not have a material adverse effect on theCompany’s future international sales and, consequently, the Company’s business,financial condition and results of operations. To date, a majority of theCompany’s sales have been made in United States dollars and the Company has notengaged in any hedging transactions through the purchase of derivative securitiesor otherwise.

 

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*Dependence on Key Personnel.*  The Company’s future performance depends, insignificant part, upon the continued service of its key technical, sales andsenior management personnel, most of whom are not bound by an employmentagreement or by a noncompetition agreement. The loss of the services of one ormore of the Company’s executive officers or other key employees could have amaterial adverse effect on the Company’s business, financial condition andresults of operations. The Company’s future success also depends on itscontinuing ability to attract and retain highly qualified technical, sales andmanagerial personnel. Competition for such personnel is intense, and theCompany has experienced difficulty in recruiting qualified technical personnel.There can be no assurance that the Company will be able to retain or continueto hire key technical, sales and managerial personnel in the future.

 

Item 3. Quantitativeand Qualitative Disclosures About Market Risk

 

*Derivative Financial Instruments, OtherFinancial Instruments, and Derivative Commodity Instruments.*** **As of June 30,2004, the Company did not participate in any derivative financial instrumentsor other financial and commodity instruments for which fair value disclosurewould be required under SFAS No. 107,*Disclosures about FairValue of Financial Instruments*. All of the Company’s investmentsconsist of money market funds and commercial paper that are carried on theCompany’s books at amortized cost, which approximates fair market value.Accordingly, the Company has no quantitative information concerning the marketrisk of participating in such investments.

 

*Primary Market Risk Exposures***. **The Company’sprimary market risk exposures are in the areas of interest rate risk andforeign currency exchange rate risk. The Company’s investment portfolio of cashequivalents is subject to interest rate fluctuations, but the Company believesthis risk is immaterial due to the short-term nature of these investments. TheCompany’s exposure to currency exchange rate fluctuations has been and isexpected to continue to be modest due to the fact that the operations of itsUnited Kingdom subsidiary are almost exclusively conducted in its local currency.The United Kingdom subsidiary’s operating results are translated into U.S.dollars and consolidated for reporting purposes. The impact of currencyexchange rate movements on intercompany transactions was immaterial for thequarter ended June 30, 2004. Currently, the Company does not engage inforeign currency hedging activities.

 

Item 4. Controls andProcedures

 

As of the end of the fiscal quarter (the“Evaluation Date”), the Company, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and acting Chief Financial Officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures pursuant toRule 13a-15(b) and 15d-15(b) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer andacting Chief Financial Officer concluded that, as of the Evaluation Date, theCompany’s disclosure controls and procedures are effective in ensuring thatinformation relating to the Company (including its consolidated subsidiaries)required to be disclosed by the Company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, including ensuring thatsuch information is accumulated and communicated to the Company’s management,including the Company’s Chief Executive Officer and acting Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

There were no changes in the Company’s internal controls over financialreporting during the Company’s last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II****:  OTHER INFORMATION**

 

Item 4.    Submissionof Matters to a Vote of Security Holders

 

The Annual Meetingof Stockholders of the Company was held on May 24, 2004.  The following nominees were re-elected asClass I Directors of the Company each to serve for a three-year term or untilhis successor is elected and qualified:

 
| **Nominee**       | ** ** | **Total Votes for Nominee** | ** ** | **Total Votes Withheld  for Nominee** | ** ** |
|-------------------|------------|-----------------------------|------------|---------------------------------------|------------|
| ** **        | ** ** | ** **                  | ** ** | ** **                            | ** ** |
| Richard D. Cramer |       | 1,692,319                   |       | 4,240                                 |       |
| Andrew E. Lietz   |       | 1,692,319                   |       | 4,240                                 |       |

 

The term of officeof the following directors continued after the meeting:  Arnold E. Ditri (Class II), William C.Styslinger, III (Class II), Robert L. Voelk (Class III), and Martin A. Schultz(Class III).

 

Item 5.             Other Information

 

There have been nochanges to the procedures by which security holders may recommend nominees tothe Company’s Board of Directors during the time period covered by thisQuarterly Report on Form 10-Q.

 

Item 6.             Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 
| 31.1   |   | Rule  13a-14(a)/15d-14(a) Certification                                                                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |
| 31.2   |   | Rule  13a-14(a)/15d-14(a) Certification                                                                                                                        |
|   |   |                                                                                                                                                           |
| 32.1   |   | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                           |
| 32.2   |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

(b)         Reports on Form 8-K

 

The Companyfiled a Report on Form 8-K, dated March 30, 2004, pursuant to Items 5 and 7thereof, disclosing that it had completed a private placement of an aggregateof 300,000 shares of its common stock, par value $0.01 per share, at a purchaseprice equal to $12.00 per share to institutional and other accredited investorsand that the Company’s Board of Directors had approved a 2-for-1 stock split inthe form of a stock dividend on the Company’s common stock.

 

The Companyfiled a Report on Form 8-K, dated March 31, 2004, pursuant to Items 2 and 7thereof, disclosing that it had agreed to purchased 175,000 shares of itsoutstanding common stock from an existing stockholder, ASA International Ltd.,in a private transaction at a price of $11.50 per share

 

The Company furnisheda Report on Form 8-K, dated April 20, 2004, pursuant to Item 12 thereof,furnishing the results of its operations for the quarter ended March 31, 2004.

 

The Companyfiled a Report on Form 8-K, dated April 27, 2004, pursuant to Item 5 thereof,disclosing that it had effected a two-for-one stock split in the form of astock dividend, which stock split in the form of a dividend was paid tostockholders of record as of April 7, 2004.

 

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OMTOOL, LTD.

 

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 theundersigned thereunto duly authorized.

 
|                 | OMTOOL, LTD. |
|----------------------|--------------|
|                 |         |
|                 |         |
| August 10, 2004 | By:          | /s/ Daniel A. Coccoluto |   |
|                 |         | Daniel A. Coccoluto |
|                 |         | Acting Chief Financial Officer, Secretary and Treasurer |
|                 |         | (Duly authorized officer and principal financial officer) |

 

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**Exhibit Index**

 
| 31.1   |   | Rule  13a-14(a)/15d-14(a) Certification                                                                                                                        |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                           |
| 31.2   |   | Rule  13a-14(a)/15d-14(a) Certification                                                                                                                        |
|   |   |                                                                                                                                                           |
| 32.1   |   | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                           |
| 32.2   |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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