**Table of Contents**

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-Q**

** **

**(Mark One)**

** **

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

** **

**For the quarterly periodended June 30, 2008**

** **

**OR**

** **

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

** **

**For the transition periodfrom               to**

** **

**Commission File Number0-22871**

** **

**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) |
|                                                            |       |                                     |
| **6 Riverside Drive, Andover, MA**                              | ** ** | **01810**                                |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                               |

 

**(978) 327-5700**

(Registrant’s Telephone Number Including Area Code)

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes x  No o

 

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company.  See thedefinitions of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 
| Large accelerated filer o                                                   |   | Accelerated filer o    |
|-----------------------------------------------------------------------------|--------|-----------------------------|
| Non-accelerated filer o (Do not check if a  smaller reporting company) |   | Smaller reporting company x |

 

Indicate by check mark whether the Registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o  No x

 

There were 4,743,241 shares of the Company’s commonstock, par value $0.01, outstanding on August 13, 2008.

 

 

 

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Table of Contents

 

**OMTOOL,LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended June 30, 2008

CONTENTS

 

**Item Number**

 
| PART I:  FINANCIAL INFORMATION |                                                                                                                      |   |
|-------------------------------------|---------------------------------------------------------------------------------------------------------------------------|--------|
|                                |                                                                                                                      |   |   |
| Item 1.                             | Consolidated Financial Statements                                                                                         |   |   |
|                                | Consolidated  Balance Sheets as of June 30, 2008 (Unaudited) and December 31,  2007                             |   |   |
|                                | Consolidated  Statements of Operations for the three months and six months ended  June 30, 2008 and 2007 (Unaudited) |   |   |
|                                | Consolidated  Statements of Cash Flows for the six months ended June 30, 2008 and 2007  (Unaudited)                  |   |   |
|                                | Notes  to Consolidated Financial Statements                                                                               |   |   |
|                                |                                                                                                                      |   |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               |   |   |
|                                |                                                                                                                      |   |   |
| Item 4T.                            | Controls and  Procedures                                                                                                  |   |   |
|                                |                                                                                                                      |   |   |
| PART II:  OTHER INFORMATION    |                                                                                                                      |   |
|                                |                                                                                                                      |   |   |
| Item 1A.                            | Risk Factors                                                                                                              |   |   |
|                                |                                                                                                                      |   |   |
| Item 2.                             | Unregistered  Sales of Equity Securities and Use of Proceeds                                                              |   |   |
|                                |                                                                                                                      |   |   |
| Item 4.                             | Submission  of Matters to a Vote of Security Holders                                                                      |   |   |
|                                |                                                                                                                      |   |   |
| Item 5.                             | Other Information                                                                                                         |   |   |
|                                |                                                                                                                      |   |   |
| Item 6.                             | Exhibits                                                                                                                  |   |   |
|                                |                                                                                                                      |   |   |
| Signatures                          |                                                                                                                      |   |
|                                |                                                                                                                      |   |   |
| Exhibit Index                  |                                                                                                                      |   |
|                                |                                                                                                                      |   |   |
| Exhibits                            |                                                                                                                      |   |   |
|                                     |                                                                                                                           |        |  |  |

 

2

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Table of Contents

 

**PART I:  FINANCIAL INFORMATION**

 

**Item 1.  Consolidated Financial Statements**

 

**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                                                                                                 | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                 | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                 | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                                            |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                  |       | $                       | 2,056,580  |                        | $          | 2,328,033 |   |
| Accounts receivable, net of reserves of  $48,000 at June 30, 2008 and $45,000 at December 31, 2007,  respectively                                                                                                                                |       | 2,117,559               |       | 2,132,950                   |       |
| Unbilled accounts receivable                                                                                                                                                                                                                               |       | 376,705                 |       | 419,843                     |       |
| Inventory                                                                                                                                                                                                                                                  |       | 101,923                 |       | 75,959                      |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                  |       | 410,885                 |       | 368,739                     |       |
| Total current assets                                                                                                                                                                                                                                       |       | 5,063,652               |       | 5,325,524                   |       |
| Property and equipment, net                                                                                                                                                                                                                                |       | 1,187,248               |       | 1,278,297                   |       |
| Goodwill                                                                                                                                                                                                                                                   |       | 1,883,096               |       | 1,883,096                   |       |
| Intangible assets, net                                                                                                                                                                                                                                     |       | 1,088,532               |       | 1,276,656                   |       |
| Unbilled accounts receivable, long-term                                                                                                                                                                                                                    |       | 96,972                  |       | 216,997                     |       |
| Other assets                                                                                                                                                                                                                                               |       | 291,568                 |       | 291,568                     |       |
| Total assets                                                                                                                                                                                                                                               |       | $                       | 9,611,068  |                        | $          | 10,272,138 |   |
|                                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                             | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                           |       | $                       | 805,855    |                        | $          | 949,941 |   |
| Accrued liabilities                                                                                                                                                                                                                                        |       | 1,522,985               |       | 1,571,099                   |       |
| Deferred revenue, current                                                                                                                                                                                                                                  |       | 4,698,677               |       | 4,346,598                   |       |
| Capital lease obligations, current                                                                                                                                                                                                                         |       | 98,213                  |       | 94,624                      |       |
| Note payable, current                                                                                                                                                                                                                                      |       | 561,234                 |       | 561,234                     |       |
| Total current liabilities                                                                                                                                                                                                                                  |       | 7,686,964               |       | 7,523,496                   |       |
| Long term liabilities:                                                                                                                                                                                                                                     |       |                    |       |                        |       |
| Deferred rent                                                                                                                                                                                                                                              |       | 468,099                 |       | 467,660                     |       |
| Deferred revenue, long-term                                                                                                                                                                                                                                |       | 698,832                 |       | 523,877                     |       |
| Capital lease obligations, long-term                                                                                                                                                                                                                       |       | 209,958                 |       | 259,977                     |       |
| Note payable, long-term                                                                                                                                                                                                                                    |       | 420,926                 |       | 701,543                     |       |
| Total liabilities                                                                                                                                                                                                                                          |       | 9,484,779               |       | 9,476,553                   |       |
|                                                                                                                                                                                                                                                       |       |                    |       |                        |       |
| 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 —  4,744,267 shares at June 30, 2008 and 4,743,209 shares at  December 31, 2007; Outstanding — 4,744,267 shares at June 30,  2008 and 4,561,045 shares at December 31, 2007 |       | 47,443                  |       | 47,432                      |       |
| Additional paid-in capital                                                                                                                                                                                                                                 |       | 35,496,623              |       | 36,683,169                  |       |
| Accumulated deficit                                                                                                                                                                                                                                        |       | (35,344,724             | )          | (34,465,277                 | )          |
| Treasury stock, at cost, 182,164 shares at  December 31, 2007                                                                                                                                                                                         |       | —                  |       | (1,399,071                  | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                       |       | (73,053                 | )          | (70,668                     | )          |
| Total stockholders’ equity                                                                                                                                                                                                                            |       | 126,289                 |       | 795,585                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                            |       | $                       | 9,611,068  |                        | $          | 10,272,138 |   |

 

The accompanying notes arean integral part of these unaudited consolidated financial statements.

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Operations**

(Unaudited)

 
| ** **                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue:                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Software license                                         |       | 1,036,674                                       |       | $                                             | 1,281,462  |   | $ | 2,293,688 |   | $ | 2,328,775 |   |
| Hardware and media                                       |       | 360,294                                         |       | 593,685                                       |       | 726,268 |   | 1,055,691 |   |
| Service and other                                        |       | 2,400,988                                       |       | 2,399,955                                     |       | 4,730,034 |   | 4,723,750 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total revenue                                            |       | 3,797,956                                       |       | 4,275,102                                     |       | 7,749,990 |   | 8,108,216 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue:                                         |       |                                            |       |                                          |       |   |   |   |   |
| Software license                                         |       | 106,716                                         |       | 107,270                                       |       | 198,066 |   | 208,545 |   |
| Hardware and media                                       |       | 238,622                                         |       | 400,008                                       |       | 466,785 |   | 694,138 |   |
| Service and other                                        |       | 940,398                                         |       | 943,904                                       |       | 1,891,872 |   | 2,012,279 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total cost of revenue                                    |       | 1,285,736                                       |       | 1,451,182                                     |       | 2,556,723 |   | 2,914,962 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Gross profit                                             |       | 2,512,220                                       |       | 2,823,920                                     |       | 5,193,267 |   | 5,193,254 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Operating expenses:                                      |       |                                            |       |                                          |       |   |   |   |   |
| Sales and marketing                                      |       | 1,469,969                                       |       | 1,870,215                                     |       | 3,146,389 |   | 4,066,944 |   |
| Research and development                                 |       | 693,208                                         |       | 729,681                                       |       | 1,393,956 |   | 1,609,762 |   |
| General and administrative                               |       | 709,879                                         |       | 854,999                                       |       | 1,499,947 |   | 1,851,944 |   |
| Restructuring costs                                      |       | —                                          |       | 130,648                                       |       | — |   | 343,450 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total operating expenses                                 |       | 2,873,056                                       |       | 3,585,543                                     |       | 6,040,292 |   | 7,872,100 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Loss from operations                                     |       | (360,836                                        | )          | (761,623                                      | )          | (847,025 | ) | (2,678,846 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Interest and other income                                |       | 15,607                                          |       | 27,544                                        |       | 33,419 |   | 48,032 |   |
| Interest expense                                         |       | (21,479                                         | )          | (44,498                                       | )          | (47,717 | ) | (95,535 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                                                 |       | $                                               | (366,708   | )                                             | $          | (778,577 | ) | $ | (861,323 | ) | $ | (2,726,349 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net loss per share:                                      |       |                                            |       |                                          |       |   |   |   |   |
| Basic and diluted                                        |       | $                                               | (0.08      | )                                             | $          | (0.17 | ) | $ | (0.18 | ) | $ | (0.60 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average shares used in per share  calculations: |       |                                            |       |                                          |       |   |   |   |   |
| Basic and diluted                                        |       | 4,733,278                                       |       | 4,543,300                                     |       | 4,695,501 |   | 4,512,000 |   |

 

The accompanying notes arean integral part of these unaudited consolidated financial statements*.*

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows**

(Unaudited)

 
| ** **                                                                                 | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2008**                                      | ** ** | **2007** | ** ** |
| Cash Flows from Operating Activities:                                                      |       |                                          |       |   |   |
| Net loss                                                                                   |       | (861,323                                      | )          | $ | (2,726,349 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                                          |       |   |   |
| Depreciation and amortization                                                              |       | 329,930                                       |       | 385,768 |   |
| Accounts receivable reserves                                                               |       | 2,910                                         |       | 14,892 |   |
| Stock-based compensation                                                                   |       | 233,453                                       |       | 170,530 |   |
| Changes in assets and liabilities:                                                         |       |                                          |       |   |   |
| Accounts receivable                                                                        |       | 12,992                                        |       | 185,350 |   |
| Unbilled accounts receivable                                                               |       | 163,163                                       |       | 296,797 |   |
| Prepaid expenses and other current assets                                                  |       | (41,972                                       | )          | 122,398 |   |
| Inventory                                                                                  |       | (25,964                                       | )          | 66,433 |   |
| Other assets                                                                               |       |                                          |       | 11,562 |   |
| Accounts payable                                                                           |       | (144,386                                      | )          | (1,034,061 | ) |
| Accrued liabilities                                                                        |       | (94,387                                       | )          | 56,380 |   |
| Deferred revenue                                                                           |       | 524,020                                       |       | 495,863 |   |
| Deferred rent                                                                              |       | 439                                           |       | (31,128 | ) |
|                                                                                       |       |                                          |       |   |   |
| Net cash provided by (used in) operating  activities                                       |       | 98,875                                        |       | (1,985,565 | ) |
|                                                                                       |       |                                          |       |   |   |
| Cash Flows from Investing Activities:                                                      |       |                                          |       |   |   |
| Additional purchase consideration for prior  period acquisition                            |       | —                                        |       | (669,135 | ) |
| Purchases of property and equipment                                                        |       | (50,696                                       | )          | (23,835 | ) |
|                                                                                       |       |                                          |       |   |   |
| Net cash used in investing activities                                                      |       | (50,696                                       | )          | (692,970 | ) |
|                                                                                       |       |                                          |       |   |   |
| Cash Flows from Financing Activities:                                                      |       |                                          |       |   |   |
| Net proceeds from issuance of common stock                                                 |       | 4,530                                         |       | 14,950 |   |
| Net proceeds from issuance of restricted  common stock                                     |       | 2,048                                         |       | 1,287 |   |
| Forfeiture of restricted common stock                                                      |       | (89                                           | )          | (230 | ) |
| Principal payments for note payable                                                        |       | (280,617                                      | )          | (140,309 | ) |
| Principal payments for capital lease  obligations                                          |       | (46,431                                       | )          | (43,100 | ) |
|                                                                                       |       |                                          |       |   |   |
| Net cash used in financing activities                                                      |       | (320,559                                      | )          | (167,402 | ) |
|                                                                                       |       |                                          |       |   |   |
| Exchange rate effect on cash and cash  equivalents                                         |       | 927                                           |       | (18,201 | ) |
|                                                                                       |       |                                          |       |   |   |
| Net decrease in cash and cash equivalents                                                  |       | (271,453                                      | )          | (2,864,138 | ) |
|                                                                                       |       |                                          |       |   |   |
| Cash and cash equivalents, beginning of  period                                            |       | 2,328,033                                     |       | 5,469,366 |   |
|                                                                                       |       |                                          |       |   |   |
| Cash and cash equivalents, end of period                                                   |       | $                                             | 2,056,580  |   | $ | 2,605,228 |   |
| Supplemental Disclosure of Cash Flow  Information:                                         |       |                                          |       |   |   |
| Cash paid during the period for interest                                                   |       | $                                             | 51,488     |   | $ | 79,664 |   |

 

The accompanying notes arean integral part of these unaudited consolidated financial statements*.*

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements**

(Unaudited)

 

**(1) Basis of Presentation**

 

Omtool, Ltd. (“Omtool”or the “Company”) provides document- and information-handling softwaresolutions that control document-based business communications and integratepaper and electronic documents into enterprise information systems andworkflows. The Company’s software products streamline the capture, conversionand communication of both paper and electronic information, enabling fast,secure and simultaneous distribution to multiple destinations in multipleformats.

 

The accompanyingunaudited consolidated financial statements have been prepared by Omtoolpursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”) regarding interim financialreporting. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements and should be read in conjunction with the consolidatedfinancial statements and notes thereto for the year ended December 31,2007 as filed with the SEC as part of the Company’s Annual Report on Form 10-Kon March 28, 2008. The accompanying unaudited consolidated financialstatements reflect all adjustments (consisting of normal recurring adjustments)that are, in the opinion of management, necessary for a fair presentation ofresults for the interim periods presented. The results of operations for thethree and six month periods ended June 30, 2008 are not necessarilyindicative of the results to be expected for the full fiscal year.

 

**(2) Net Loss Per Share**

 

TheCompany reports net loss per share in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128,**“*Earnings per Share*.”Diluted weighted average shares outstanding for the three and six month periodsended June 30, 2008 and June 30, 2007 exclude 456,683 and 483,660,respectively of potential common shares from stock options and a stock warrantbecause to include them would have been anti-dilutive for the periods presentedas the Company reported a net loss during the periods.

 

**(3) Income Taxes**

 

SFAS No. 109,**“*Accountingfor Income Taxes*,” requires a valuation allowance to be recordedagainst deferred tax assets when it is more likely than not that some or all ofthe deferred tax assets will not be realized. As a result of cumulativelosses in recent years and continued economic uncertainty, the Company hasprovided a full valuation allowance against its net deferred tax assets andwill do so until it returns to an appropriate level of sustained taxableincome. The ultimate realization of these deferred tax assets depends uponthe Company’s ability to generate sufficient future taxable income. If theCompany is successful in generating sufficient future taxable income, theCompany will reduce the valuation allowance through a reduction in income taxexpense in the future.

 

Financial AccountingStandards Board (“FASB”) Interpretation No. 48 “*Accounting for Uncertainty in Income Taxes, aninterpretation of FAS 109*” (“FIN 48”) clarifies the criteriathat an individual tax position must satisfy for some or all of the benefits ofthat position to be recognized in a company’s financial statements. As of June 30,2008 and December 31, 2007, the Company had no unrecognized tax benefits.The Company has not, as yet, conducted a study of its R&D creditcarryforwards. This study may result in an increase or decrease to the Company’sR&D credit carryforwards, however, until a study is completed and anyadjustment is known, no amounts are being presented as an uncertain taxposition under FIN 48. A full valuation allowance has been provided against theCompany’s R&D credits and, if an adjustment is required, this adjustmentwould be offset by an adjustment to the valuation allowance. As a result, therewould be no impact to the consolidated balance sheet, statement of operationsor cash flows if an adjustment were required.

 

During the three and sixmonth periods ended June 30, 2008 and June 30, 2007, the Company didnot record an income tax benefit associated with any pre-tax loss due to theuncertainty regarding future taxable income.

 

**(4) Comprehensive Loss**

 

The components of theCompany’s comprehensive loss are as follows:

 

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** **
| ** **                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss                                 |       | (366,708                                        | )          | $                                             | (778,577   | ) | (861,323 | ) | $ | (2,726,349 | ) |
| Foreign currency translation adjustments |       | (1,581                                          | )          | (13,886                                       | )          | (2,385 | ) | (15,549 | ) |
| Comprehensive loss                       |       | $                                               | (368,289   | )                                             | $          | (792,463 | ) | $ | (863,708 | ) | $ | (2,741,898 | ) |
|                                          |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

 

**(5) Acquisition**

 

On December 29,2006, the Company acquired all of the outstanding shares of Blue ChipTechnologies Ltd. (“BlueChip”) for $562,090 in cash, $1,683,702 in apromissory note issued to BlueChip’s principal shareholder (“Seller”),375,331 shares of the Company’s common stock (valued at $1,478,804), theissuance of vested options to purchase the Company’s common stock insubstitution for outstanding BlueChip stock options (valued at $368,090), anddirect acquisition costs of $563,838, which consisted primarily of financialadvisory, legal and accounting services. The Company acquired BlueChip in orderto strengthen and expand its presence in the healthcare vertical market.

 

The promissory note thatthe Company issued to the Seller of BlueChip is payable in thirty-six equalmonthly installments of approximately $47,000 (See Note 9).

 

Goodwill in theaccompanying consolidated balance sheets as of June 30, 2008 and December 31,2007, represents the excess of the purchase price over the net tangible andidentifiable intangible assets for the acquisition of BlueChip.

 

**(6) Stock-based Compensation**

 

The Company’s 1996 StockOption Plan and 1997 Stock Plan, as amended, provided for the issuance ofcommon stock pursuant to the grant to employees of “incentive stock options”within the meaning of the Internal Revenue Code of 1986, as amended, the grantof nonqualified stock options, stock awards or opportunities to make directpurchases of stock in the Company to employees, consultants, directors andofficers of the Company. In 1997, the Company’s Board of Directors voted thatno further options would be granted or issued under the Company’s 1996 StockOption Plan and on April 14, 2007, the Company’s 1997 Stock Plan expired.The Company’s 2007 Equity Compensation Incentive Plan (“2007 Plan”) wasapproved by the Board of Directors on April 16, 2007 and the Company’sshareholders at the annual meeting of shareholders on May 22, 2007. The2007 Plan provides for the issuance of shares of common stock to employees,consultants, directors and officers of the Company much like the 1997 StockPlan. The aggregate number of shares that can be issued pursuant to the 2007Plan is 500,000 and any shares granted under the 2007 Plan that are canceled orexpired are added back to the 2007 Plan for future issuance. As of June 30,2008, 225,300 shares had been issued under the 2007 Plan. Shares issuedpursuant to this plan are issued from treasury to the extent they areavailable. Stock-based compensation is accounted for in accordance with SFAS No. 123(R),“*Share-Based Payment*”.

 

During the three andsix-month periods ended June 30, 2008 and June 30, 2007, the Companyincurred stock-based compensation expense for restricted common stock (“restrictedstock”) and during the six month period ended June 30, 2008 and thethree and six month periods ended June 30, 2007, the Company also incurredstock-based compensation expense for stock options. The Company also incurredstock-based compensation expense for the employee stock purchase plan (the “ESPP”)during the three-and-six-month periods ended June 30, 2007. The ESPP wasterminated on July 1, 2007.

 
| ** **                                                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                      | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Stock-based compensation expense included  in cost of service and other revenue |       | $                                               | 3,850      |                                          | $          | 2,615 |   | $ | 6,391 |   | $ | 4,727 |   |
| Stock-based compensation expense included  in operating expenses                |       | 119,834                                         |       | 88,630                                        |       | 227,062 |   | 165,803 |   |
| Total stock-based compensation expense                                          |       | $                                               | 123,684    |                                          | $          | 91,245 |   | $ | 233,453 |   | $ | 170,530 |   |

 

***Stock Options***

 

Underthe terms of the Company’s 1996 Stock Option Plan and 1997 Stock Plan, optionsvest and become exercisable as determined by the Board of Directors and expire10 years after the date of grant. Stock option compensation expensecalculated under the fair value approach is recognized ratably over thefour-year vesting period. The fair value for granted options was estimated atthe time of grant using the Black-Scholes option-pricing model. During the sixmonth period ended June 30, 2008 the Company recognized $182 ofstock-based compensation related to stock options and during the three and 

 

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sixmonth periods ended June 30, 2007, the Company recognized $3,338 and$6,691, respectively, of stock-based compensation expense related to stockoptions. As of June 30, 2008, there was no unrecognized stock-basedcompensation expense related to stock options. The Company did not grant anystock options during the six-month periods ended June 30, 2008 and June 30,2007.

 

***Restricted CommonStock***

*** ***

Priorto April 14, 2007, the Company sold shares of restricted stock under theCompany’s 1997 Stock Plan, as amended, to its Board of Directors and certainemployees of the Company at a price per share of $0.01. The Company hascontinued to issue shares of restricted stock in a similar manner under the2007 Plan. The shares of restricted stock vest ratably over a three- orfour-year service period. In the event that a restricted stockholder ceases toprovide services to the Company prior to the vesting of any of the thenunvested shares held by that stockholder, the restricted stockholder isrequired to sell any unvested shares of restricted stock back to the Company atthe original purchase price of $0.01 per share. Restricted stock-basedcompensation expense calculated under the fair value approach is based upon thecurrent stock price and is recognized ratably over the three- or four-yearvesting period. Based upon historical information and management’s estimate offuture voluntary turnover rates, the Company has calculated this expense basedon an annualized estimated forfeiture rate of 10%. The Company trues-upestimated forfeitures to actual forfeitures at the end of each reportingperiod. During the six months ended June 30, 2008, the Company sold204,800 shares of restricted stock to its Board of Directors and certainemployees of the Company at a price of $.01 per share under the Company’s 2007Plan. During the six months ended June 30, 2007, the Company sold 128,675shares of restricted stock, under the Company’s 1997 Stock Plan, as amended, toits Board of Directors and certain employees of the Company at a price pershare of $0.01.

 

Thefollowing is a summary of the Company’s unvested restricted stock awards:

 
| ** **                       | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|----------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|
| Unvested, December 31, 2007 |       | 258,167                    |       | $                                                       | 4.44       |   |
| Granted                          |       | 204,800                    |       | 3.15                                                    |       |
| Vested                           |       | (57,424                    | )          | 5.05                                                    |       |
| Forfeited                        |       | (8,849                     | )          | 4.11                                                    |       |
| Unvested, June 30, 2008     |       | 396,694                    |       | $                                                       | 3.70       |   |

 

** (7) AccruedLiabilities**

 

Accrued liabilitiesconsist of the following:

 
| ** **                        | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued health insurance expense  |       | 300,841                 |       | 300,841                     |       |
| Accrued state sales tax           |       | 385,173                 |       | 344,906                     |       |
| Accrued salary and salary-related |       | 579,975                 |       | 568,339                     |       |
| Accrued professional fees         |       | 119,756                 |       | 145,420                     |       |
| Other accrued expenses            |       | 137,240                 |       | 211,593                     |       |
|                              |       | $                       | 1,522,985  |                        | $          | 1,571,099 |   |
|                                   |            |                         |            |                             |            |  |  |

 

**(8) Capital Lease Obligations**

 

OnMay 1, 2006, the Company entered into a capital lease agreement in theamount of $491,000 to finance the purchase of furniture and equipment for theCompany’s headquarters located in Andover, Massachusetts. The lease has a fiveyear term which expires on May 31, 2011 and is payable in 60 equal monthlyinstallments. The interest rate on the capital lease is 6.2%. Total interestpayments over the life of the lease are estimated to be $99,000.

 

The lease contained aprovision whereby the Company would be required to immediately repay theoutstanding principal balance should the Company’s cash balance ever be lessthan $5,000,000. On August 6, 2007, the Company entered into an amendmentto the aforementioned capital lease which lowered the Company’s requiredminimum cash balance to $2,100,000. In addition, on August 30, 2007, theCompany entered into a pledge and security agreement with the capital 

 

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financing provider that requires a minimum balance ofcash and cash equivalents of no less than $250,000 (“pledged collateral”)and in the event that Company’s cash balance falls below $250,000 the Companywill immediately provide the amount necessary to cover such shortfall to thecapital financing provider. In the event of default in maintaining the requiredamount of pledged collateral or the making of any lease payments, the pledgedcollateral will first be used as payment for costs and expenses incurred toenforce the security and pledge agreement and second for payment in full of theoutstanding principal loan balance. The minimum required cash balance of$2,100,000 includes the pledged collateral. As of June 30, 2008 and December 31,2007, the pledged collateral of $250,000 is restricted cash and has beenclassified as “other assets” in the accompanying balance sheet.

 

**(9) Note Payable**

 

OnDecember 29, 2006, the Company issued a promissory note in the amount of$1,683,702 to the principal shareholder of BlueChip in partial consideration ofall the outstanding shares of BlueChip (See Note 5). The note is payable inthirty-six equal monthly principal installments of approximately $47,000 plusinterest, commencing on March 30, 2007. The promissory note bears intereston the unpaid principal amount at a rate per annum equal to (a) the PrimeRate as set forth in the Wall Street Journal Money Rates column on the lastbusiness day of each month, which rate shall be deemed to be in effect for theentirety of such month; plus (b) one percent. During the six months ended June 30,2008, the Company made total payments of approximately $320,000, consisting ofprincipal payments totaling $281,000 and accumulated interest of $39,000, basedupon an average interest rate of 6.75%.

 

**(10) Restructuring Costs**

 

InMarch 2007, the Company announced a restructuring of certain of itsoperations and reduced its workforce by twelve employees. In addition, tenother positions were eliminated during the first quarter of fiscal year 2007.As a result of these activities, the Company recorded a pre-tax charge duringthe three and six month periods ended June 30, 2007 of $130,648 and $343,450,respectively, in accordance with SFAS No. 146, “*Accounting for Costs Associated with Exit or Disposal Activities.*”**The total restructuring charge for thefirst half of fiscal 2007 included $308,278 of severance-related costs and$35,172 as a result of closing BlueChip’s former headquarters.

 

Thetotal cash impact of the restructuring was $343,450; the remaining balance of$57,540 was paid during the third quarter of fiscal year 2007 and is includedin accrued liabilities in the accompanying consolidated balance sheet as of June 30,2007.

 

**(11) Segment and Geographic Information**

 

To date, the Company hasviewed its operations and manages its business as principally one segment:software, hardware and media sales, and associated services. As a result, thefinancial information disclosed herein represents all of the material financialinformation related to the Company’s principal operating segment in accordancewith SFAS No. 131,**“*Disclosures About Segments of an Enterprise andRelated Information*.”

 

Totalrevenue from international sources was approximately $783,000 and $1,455,000for the three months and six months ended June 30, 2008 and $686,000 and$1,740,000 for the three and six months ended June 30, 2007, respectively.

 

The following tablerepresents amounts relating to geographic locations:

 
| ** **       | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **       | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Total revenue(1) | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States    |       | $                                               | 3,014,904  |                                          | $          | 3,589,516 |   | $ | 6,294,964 |   | $ | 6,367,803 |   |
| United Kingdom   |       | 289,586                                         |       | 132,225                                       |       | 571,257 |   | 717,548 |   |
| Canada           |       | 338,370                                         |       | 248,258                                       |       | 529,178 |   | 390,258 |   |
| South Africa     |       | 62,776                                          |       | 134,175                                       |       | 118,954 |   | 346,928 |   |
| Rest of World    |       | 92,320                                          |       | 170,928                                       |       | 235,637 |   | 285,679 |   |
|             |       | $                                               | 3,797,956  |                                          | $          | 4,275,102 |   | $ | 7,749,990 |   | $ | 8,108,216 |   |

 

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| ** **           | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------|------------|-------------------------|------------|-----------------------------|------------|
| Long-lived assets(2) |       |                    |       |                        |       |
| United States        |       | $                       | 4,534,108  |                        | $          | 4,928,660 |   |
| United Kingdom       |       | 13,308                  |       | 17,954                      |       |
|                 |       | $                       | 4,547,416  |                        | $          | 4,946,614 |   |

 

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

 

(2)             Long-livedassets include net property and equipment, goodwill, net intangible assets,long-term unbilled accounts receivable and other assets.

 

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** **

**Item 2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

Management’s Discussionand Analysis of Financial Condition and Results of Operations for the three andsix month periods ended June 30, 2008 should be read in conjunction withthe accompanying consolidated financial statements for the periods specifiedand the associated notes. Further reference should be made to our Annual Reporton Form 10-K for the year ended December 31, 2007, as filed with theSEC on March 28, 2008.

 

**Overview**

 

We are a provider ofdocument- and information-handling software solutions that controldocument-based business communications and integrate paper and electronicdocuments into enterprise information systems and workflows. Our softwareproducts streamline the capture, conversion and communication of both paper andelectronic information, enabling fast, secure and simultaneous distribution to multipledestinations in multiple formats.

 

*Business*

 

We believe that thecurrent sluggish United States economic conditions had some negative impact onour results during this past quarter as compared to the same quarter in 2007 astotal revenue decreased by 11%. Revenue for the six month period ended June 30,2008 compared to the same period in 2007 decreased by only 4% and was buoyed bya 10% growth in software license revenue and service and other revenue from ourAccuRoute®product which now accounts for almost 60% of our total revenue. While thisgrowth in overall AccuRoute revenue reflects the benefits of the investments wehave made in it since its inception in 2004, we still have challenges toaddress as we seek to expand our business, including expanding our sales in thelegal and professional services, healthcare and financial services verticalmarkets; promoting our products and technologies through reseller and marketingrelationships with leading multi-function device providers; and improving our resultsoutside of the United States. We plan to continue to invest in new andestablished indirect sales channels and strategic business partnerships, and insome cases in advance of significant revenue from these channel partners.Although we achieved profitability for the quarter ended December 31,2007, we have incurred quarterly losses from the quarter ended September 30,2005 to the quarter ended September 30, 2007 as well as the quarters endedMarch 31, 2008 and June 30, 2008, and may continue to incur losses infuture quarters.

 

We experienced thebenefit of cost cutting measures associated with the restructurings weundertook in 2007, as our operating expenses decreased by approximately $1.5million (excluding the $343,450 restructuring charge incurred in the first halfof 2007) in the six months ended June 30, 2008 as compared to the sixmonths ended June 30, 2007. This led to our net loss decreasing from $2.7million in the six months ended June 30, 2007, to $861,000 in the sixmonths ended June 30, 2008.

 

In light of our currentand historical operating results and the continuing challenges we face, and inorder to maximize shareholder value, we are in an ongoing process ofexamining our operations as well as our strategic and financialalternatives. The strategic and financial alternatives we may consider couldinclude a variety of different business arrangements including, but not limitedto: combinations with or a sale to another entity; equity or debt financings;strategic partnerships and joint ventures; the sale or spin off of certainassets; the acquisition of complementary businesses, technologies or productlines; investments in new businesses; reorganization, recapitalization, ordistribution alternatives; deregistering as a public company; or otheralternatives. We have engaged the investment banking firm of America’s GrowthCapital to assist us with the exploration of strategic and financialalternatives. Changes, if any, implemented as a result of the strategic andfinancial alternatives review could affect the basic nature of our Company. Forexample, deregistering our common stock from the public company requirementsunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”)could have an adverse effect on the market price of our common stock and wouldlikely mean that there would be less information about us available toshareholders and potential investors than what is currently contained in theperiodic reports we file pursuant to the Exchange Act.

 

*Products*

 

AccuRoute,our flagship product, provides faster, more efficient document workflows andincreased worker productivity, while reducing cost, complexity and the risk oflosing documents. We also include full enterprise fax capabilities integratedwithin our AccuRoute product. These solutions are used worldwide by businessesin document-

 

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intensive industries andsectors (such as legal, financial services, government and healthcare) thatdemand secure handling, integration and tracking of documents in fullcompliance with a range of regulatory requirements. Companies can deploy oursoftware products on heterogeneous, multi-platform networks, digital scanningdevices and multi-function peripherals and integrate them with both desktop andenterprise software applications. To address customer needs, our products aremodular and scaleable. As a result, customers can add additional communicationcapacity through the addition of system components and connectors to keep pacewith growing demands. In addition, due to this scalable, modular design,customers can add additional Omtool product servers to a configuration toprovide failover redundancy, helping to ensure continuous operation. OurGenifaxTM product is a multi-tiered client/server solution for automating andintegrating fax communication throughout an enterprise. As a component of anenterprise software system, our Genifax product is deployed on heterogeneous,multi-platform networks and integrates with desktop and enterprise softwareapplications.

 

OurGenidocsTM product is a client/server messaging application that enables usersto deliver documents through the Internet with comprehensive security andtracking to external parties. Genidocs offers the security features andfunctionality of traditional, paper-based communications with the speed,efficiency and cost advantages of electronic communications. Fax Sr., ourlegacy network fax product, is a client/server software solution for automatingand integrating fax communication throughout an enterprise. As an integratedcomponent of an enterprise software system, our Fax Sr. product is deployed onheterogeneous, multi-platform networks and integrates with desktop andenterprise software applications. We continue to maintain Genidocs and Fax Sr.and earn recurring maintenance revenue from our installed base, although wehave not sold these products in recent periods. At this time, however, we donot have plans to extend these technologies with new features or new releases.

 

Weresell certain hardware products (such as intelligent fax boards) and mediaproducts (such as admission labels and patient wristbands), which we purchasefrom third-party vendors as a convenience to our customers, who alternativelycan opt to obtain hardware and media directly from third-party vendors. We sellsupport contracts for the software products that we license to our customersand offer certain consulting, training, installation and implementationservices for our products.

 

*OmtoolHealthcare Suite*

 

Our December 2006acquisition of BlueChip brought into our product family document workflowsolutions for the healthcare vertical market, which we combined with ourAccuRoute technology to create the Omtool Healthcare Suite of products.

 

The Omtool Healthcare Suite streamlinesthe registration, inpatient care and post-discharge reimbursement cyclesthrough sophisticated document imaging and workflow for hospital admissions andbilling functions.

 

·                  **ADT eFormsTM** - a production system that provideshospitals with on-demand ADT (admissions, discharge and transfer) electronicforms for registration and patient identification.

 

·                  **eForms StationTM** - an electronic forms library that givesimmediate access to a hospital’s custom library of electronic and printableforms.

 

·                  **Image-InTM Direct Capture(ID-Capture)**- animage capture system that scans images of common non-clinical documents such asinsurance cards, driver’s licenses, referral forms and HIPAA notices anddisplays them on a desktop paneled window.

 

·                  **Image-In Business** - a document and form capture systemthat converts paper-based business documents to electronic records.

 

·                  **Image-In Clinical** - a medical records scan facility thatenables users to capture fully the entire patient file after discharge.

 

·                  **Image-In Queue** - a document viewer that enablesadministrators to manage, view and disseminate electronic documents to theproper departments and/or patient files.

 

·                  **AccuRoute** - a document-handling platform thatsupports distributed document capture for scanning, routing and archivingmedical information throughout the patient service cycle and provides documentdistribution into the document workflow products found in Omtool’s HealthcareSuite.

 

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·                  **ObjectArchiveTM** - an electronic archive that providesthe foundation to securely store information designed, developed and capturedthrough any of the Omtool Healthcare Suite products.

 

*VerticalMarket Focus*

 

While AccuRoute’sfeatures are horizontal in nature, they apply to many different verticalmarkets, including the legal and professional services, healthcare andfinancial services vertical markets. We continue to add extensions to AccuRoutethat provide the greater functionality that is critical to many of ourcustomers. To provide more effective document and information-handlingsolutions, we continue to advance our document processing functionality whileincrementally adding support for electronic information systems such as e-mailsystems, enterprise content management systems, records management systems andarchival systems. We released Omtool Swiftwriter Plug-In for Adobe 3.0, a free,one-click solution that integrates Adobe PDF documents with popular documentmanagement systems such as OpenText/Hummingbird or Interwoven WorkSite.Swiftwriter for Adobe simplifies the opening, closing and check-in/check-outprocesses for users. We offer a set of tailored support options to generaterevenue in this market.

 

We aim to extend ourposition as a provider of enterprise-class document-handling software solutionsand become a leading provider of electronic document exchange solutions thatcapture, process and distribute paper or electronically formatted documents. Toreinforce the Omtool brand in enterprise-class document handling and exchangesolutions, while maintaining our strong position as an enterprise-level faxsoftware provider, we intend to take advantage of our penetration of the legaland professional services vertical market, extend our presence in thehealthcare vertical market and broaden our customer base, industry partnershipsand extensive knowledge of enterprise content management.

 

While we have investedconsiderable resources to penetrate further the financial services verticalmarket and have created and are pursuing opportunities within that verticalmarket, we have found that sales opportunities for our AccuRoute product inthat vertical market, though significant, are longer term opportunities.Therefore, while we will continue to pursue these opportunities, primarilyworking with our large strategic and channel partners, we believe the bestopportunities for replicating our successes in the legal and professionalservices vertical market are in the healthcare vertical market. Similar to ourviews on the legal and professional services vertical market and based on thehigh level of focus by healthcare providers on electronic medical records, wesee a significant opportunity to present AccuRoute as the solution of choice tothe challenge of capturing the paper documents that are endemic in healthcaresystems.

 

*OperatingResults*

 

Our revenue consists primarily of software license revenue, hardwareand media revenue, and service and other revenue, all as further describedbelow. The following table is a presentation of our total revenue for theperiods indicated:

 
| ** **                                   | ** ** | **Total Revenue** | ** ** | **Net Loss** | ** ** | **Software License  Revenue** | ** ** |
|----------------------------------------------|------------|------------------------|------------|-------------------|------------|------------------------------------|------------|
| Three months ended June 30, 2008        |       | $3,797,956             |       | $(366,708)        |       | $1,036,674                         |       |
| Three months ended June 30, 2007        |       | $4,275,102             |       | $(778,577)        |       | $1,281,462                         |       |
| Change over same period of prior fiscal year |       | $(477,146)             |       | $411,869          |       | $(244,788)                         |       |
|                                         |       | or(11.2)%              |       | or  52.9%         |       | or  (19.1)%                        |       |
| ** **                                   | ** ** | ** **             | ** ** | ** **        | ** ** | ** **                         | ** ** |
| Six months ended June 30, 2008          |       | $7,749,990             |       | $(861,323)        |       | $2,293,688                         |       |
| Six months ended June 30, 2007          |       | $8,108,216             |       | $(2,726,349)      |       | $2,328,775                         |       |
| Change over same period of prior fiscal year |       | $(358,226)             |       | $1,865,026        |       | $(35,087)                          |       |
|                                         |       | or  (4.4)%             |       | or  68.4%         |       | or  (1.5)%                         |       |

 

During the three and sixmonth periods ended June 30, 2008 our revenue and net loss decreased ascompared to the same periods in 2007. Much of the reduction in revenue for thethree and six month periods ended June 30, 2008 is due to a $233,000 and$329,000 decrease in hardware and media revenue respectively, each of which weresell from third-party vendors as a convenience to our customers and the saleof which can be dependent upon our customers upgrading their existinginformation technology infrastructure  Inaddition, during the second quarter of 2008 as compared to the second quarterof 2007, we experienced a decrease in software license revenue from our legacyfax products as well as from our AccuRoute product which contributed to theoverall decrease in total revenue during this period. Our operating expensesdecreased by approximately $1.5 million (excluding the $343,450 restructuringcharge incurred in the first half of 2007) in the first six months of 2008 ascompared to the same period in 2007 and by $582,000 (excluding the $130,648restructuring 

 

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charge incurred in the three months ended June 30,2007) for the three months ended June 30, 2008 as a result of therestructuring plan we adopted in March 2007.

 

We continue to experiencegeneral market acceptance of our AccuRoute product as software license revenueand service and other revenue from our AccuRoute product revenue grew byapproximately 10% during the six months ended June 30, 2008 as compared tothe same period in 2007. AccuRoute’s growth comes primarily from the legal andprofessional services vertical market while the overall demand for and ourmarketing of our legacy fax product has continued to decrease. Any decrease indemand for our products would likely result in decreased revenue, which would,in turn, have a significant negative impact on our financial results because asignificant portion of our operating costs such as personnel, rent anddepreciation are fixed in advance of a particular quarter. As a result, ourcosts for sales and marketing, research and development, and general andadministrative could continue to increase as a percentage of revenue, therebynegatively affecting our operating results.

 

In the coming months, ourprimary focus will be to increase our AccuRoute sales opportunities tocustomers in the legal and professional services, healthcare and financialservices vertical markets through investments in direct and indirect sales andmarketing resources. At the same time, we will continue developing ourstrategic relationships in those markets to further our penetration.

 

Sales from our Europeanoperations, which were in a steady decline for several years, increased by 29%during the twelve months ended December 31, 2007 as compared to twelvemonths ended December 31, 2006. Although our European operationsexperienced a 9% decrease in revenue in the first half of 2008 compared to thefirst half of 2007, we remain optimistic that we will continue to seeimprovements outside the United States. For now, we will rely primarily on ourU.S. sales organization for our shorter-term growth. We will continue toleverage our European AccuRoute base and indirect channel relationships tofocus sales resources on the overseas legal and financial services verticalmarkets. However, we expect that, in the short-term, U.S. sales are likely toconstitute a greater percentage of revenue than sales outside the U.S. andthere can be no assurances that we will be able to increase international salesof our products. This failure to increase international sales may have amaterial adverse effect on our business, financial condition and results ofoperations.

 

Our United Kingdomsubsidiary, Omtool Europe Limited, transacts business primarily in its localcurrency. We then translate results generated by that entity into United Statesdollars and consolidate them with our domestic results for reporting purposes.As we make sales to customers in a variety of countries, significant currencyexchange rate fluctuations could have a material impact on our results ofoperations. Foreign currency exposure has not been material to our financialposition or results of operations to date. If the volume of our businessdenominated in foreign currencies increases, we may be required to usederivatives to hedge foreign currency exposure.

 

The following is apresentation of our domestic and international revenue:

 
| ** **                                   | ** ** | **Total Revenue** | ** ** | **United States Revenue** | ** **                              | **Non-United States Revenue** | ** **                             |
|----------------------------------------------|------------|------------------------|------------|-------------------------------------|-----------------------------------------|-----------------------------------------|----------------------------------------|
| Three months ended June 30, 2008        |       | $                      | 3,797,956  |                                | $3,014,904  or 79.4% of Total   Revenue |                                    | $783,052  or 20.6% of Total  Revenue   |   |
|                                         |       |                   |       |                                |                                    |                                    |                                   |
| Three months ended June 30, 2007        |       | $                      | 4,275,102  |                                | $3,589,516  or 84.0% of Total  Revenue  |                                    | $685,586  or 16.0% of Total  Revenue   |   |
|                                         |       |                   |       |                                |                                    |                                    |                                   |
| Change from same period of prior fiscal year |       | $                      | (477,146   | )                                   | $(574,612)                              |                                    | $97,466                                |   |
| ** **                                   | ** ** | ** **             | ** ** | ** **                          | ** **                              | ** **                              | ** **                             |
| Six months ended June 30, 2008          |       | $                      | 7,749,990  |                                | $6,294,964  or 81.2% of Total  Revenue  |                                    | $1,455,026  or 18.8% of Total  Revenue |   |
|                                         |       |                   |       |                                |                                    |                                    |                                   |
| Six months ended June 30, 2007          |       | $                      | 8,108,216  |                                | $6,367,803  or 78.5% of Total  Revenue  |                                    | $1,740,413  or 21.5% of Total  Revenue |   |
|                                         |       |                   |       |                                |                                    |                                    |                                   |
| Change from same period of prior fiscal year |       | $                      | (358,226   | )                                   | $(72,839)                               |                                    | $(285,387)                             |   |

 

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We will continue to leverage our existing distributionchannels, where appropriate, to broaden our reach to our target verticalmarkets and further penetrate our installed customer base. We are pursuing salesopportunities through our solution/reseller channels, as well as focusing salesefforts on specific market segments, in order to facilitate acceptance of ourproducts. In particular, we are focusing considerable attention and resourceson the promotion of sales of our products through our established relationshipswith leading hardware, computer system and software vendors, in advance ofsignificant revenue from  these vendors.However, as shown in the following table, in recent periods, more of our saleshave been derived from direct sales:

 
| ** **                                   | ** ** | **Total Software  License,  Hardware and  Media  Revenue** | ** ** | **Software License,  Hardware and Media  Revenue from  Indirect Distribution  Channel Sales** | ** ** | **Software License,  Hardware and Media  Revenue From  Indirect Distribution  Channel Sales as a  Percentage of Total  Software License,  Hardware and  Media Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $1,396,968                                                           |       | $552,317                                                                                                                    |       | 39.5%                                                                                                                                                                                                                                    |       |
| Three months ended June 30, 2007        |       | $1,875,147                                                           |       | $536,174                                                                                                                    |       | 28.6%                                                                                                                                                                                                                                    |       |
| Change from same period of prior fiscal year |       | $(478,179)                                                           |       | $16,143                                                                                                                     |       | 10.9  percentage                                                                                                                                                                                                                         |       |
|                                         |       | or  (25.5)%                                                          |       | or  3.0%                                                                                                                    |       | points  (“ppt”)                                                                                                                                                                                                                |       |
|                                         |       |                                                                 |       |                                                                                                                        |       |                                                                                                                                                                                                                                     |       |
| Six months ended June 30, 2008          |       | $3,019,956                                                           |       | $922,408                                                                                                                    |       | 30.5%                                                                                                                                                                                                                                    |       |
| Six months ended June 30, 2007          |       | $3,384,466                                                           |       | $966,132                                                                                                                    |       | 28.5%                                                                                                                                                                                                                                    |       |
| Change from same period of prior fiscal year |       | $(364,510)                                                           |       | $(43,724)                                                                                                                   |       | 2.0ppt                                                                                                                                                                                                                                   |       |
|                                         |       | or  (10.8)%                                                          |       | or  (4.5)%                                                                                                                  |       |                                                                                                                                                                                                                                     |       |

 

**Critical Accounting Policies and Estimates**

** **

We have identified thepolicies and estimates below as critical to our business operations and theunderstanding of our results of operations. The impact of and any risksassociated with these policies on our reported and expected financial resultsand business operations are discussed in appropriate sections throughoutManagement’s Discussion and Analysis of Financial Condition and Results ofOperations. Our preparation of this Form 10-Q required us to makeestimates and assumptions that affect the reported amount of assets andliabilities, the disclosure of contingent assets and liabilities as of the dateof the financial statements included herein and the reported amounts of revenueand expenses during the period covered by this report. There can be noassurance that actual results will not differ materially from those estimates.

 

*Revenue Recognition and Accounts Receivable Reserves.***We derive our revenue primarily from twosources: (i) product revenue, which includes software license, hardwareand media revenue, and (ii) service and support revenue, which includessoftware maintenance and support, installation, implementation, training andconsulting revenue. We license our software products on a perpetual basis. Wegenerate revenue from licensing the rights to use our software products andsales of hardware directly to end-users and indirectly through resellers. Ourresellers order products from us based on purchase orders received fromend-users and do not order stock. We generally sell our products to resellersand directly to end-users without any specifically stated rights of return.Occasionally, however, in our sole discretion, we will accept a product returnif the end-user finds that the product does not fit its needs. We sell hardwareand media products, which are provided by a third-party, at cost plus anadditional mark-up, directly to end-users and, in the case of hardware, indirectlythrough resellers as well. The hardware products that we resell are notfunctional without our software. To support our software products, we sellsoftware maintenance and support, installation, implementation, training andconsulting services directly to end-users and indirectly through resellers.

 

We apply the provisionsof Statement of Position (“SOP”) 97-2,**“*Software Revenue Recognition*,”as amended by SOP 98-9, Modification of SOP 97-2,**“*Software RevenueRecognition with Respect to Certain Transactions*” (“SOP 98-9”),to all transactions involving the sale of multiple elements including software,hardware and service revenue. We apply the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 48,**“*Revenue RecognitionWhen Right of Return Exists*,” with respect to providing forpotential future product returns. As described below, we must make and usesignificant judgments and estimates in connection with the revenue recognizedin any accounting period. Material differences may have resulted in the amountand timing of our revenue if we had made different judgments or utilizeddifferent estimates.

 

We recognize revenue fromthe sale of software products, hardware and media to both end-users andresellers when persuasive evidence of an arrangement exists, the products havebeen delivered, the fee is fixed or determinable, collection of 

 

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the resulting receivable is probable and there are nouncertainties regarding customer acceptance. We maintain a reserve forpotential product returns. We sell monthly, annual and multiple-yearmaintenance contracts and the revenue associated therewith is recognized overthe term of the related maintenance period, beginning on the date of delivery.We recognize other service revenue as we perform the associated services. If anarrangement includes an acceptance provision and acceptance is uncertain, thenwe will defer all revenue until the customer accepts the products it purchased.Acceptance in these instances generally occurs upon the earlier of receipt of awritten customer acceptance or expiration of the acceptance period. If anarrangement includes an acceptance provision tied to determination that ourproduct meets published specifications and there are no uncertainties withregard to the customer’s acceptance, then we will recognize revenue at the timeof sale, provided that all of the other previously mentioned revenuerecognition criteria have been met and the acceptance period is of shortduration.

 

Our transactionsfrequently involve the sale of software, hardware and related services undermultiple element arrangements. Revenue under multiple element arrangements isallocated to each element, to the extent vendor specific objective evidence offair value exists, under the residual method, in accordance with SOP 98-9.Under this method, revenue is allocated first to all undelivered elements, suchas services, based on the fair value of those elements, which is calculated tobe the price charged when these elements are sold separately and unaccompaniedby other elements. Our services generally are not essential to thefunctionality of the software, as these services do not alter the capabilitiesof the software and do not carry a significant degree of risk to perform. Theamount allocated to the delivered elements, such as software license andhardware revenue, is the difference between the total arrangement value and theamount allocated to the undelivered elements. If the delivered elements includeboth software and hardware, the amount allocated to hardware revenue is basedon the price charged to us by the third-party vendor plus an additional markup, with the remainder allocated to software revenue. To the extent that adiscount is offered in the arrangement, the entire discount is allocated to thedelivered element or elements. If the delivered elements include hardware andsoftware, the discount is allocated to the hardware and software based on theirrespective list prices. For all sales, we use a binding purchase order, asigned contract, or a credit card authorization as evidence of an arrangement.Sales through our resellers are evidenced by a master agreement governing therelationship between us and the reseller, together with binding purchase orderson a transaction-by-transaction basis.

 

At the time of atransaction, we assess whether the fee associated with the transaction is fixedor determinable and whether or not collection is probable. If a significantportion of a fee is due beyond our normal payment terms, which are thirty toninety days from invoice date, we account for the fee as not being fixed ordeterminable. In these cases, we recognize revenue as the fees become due. Weassess collectability based on a number of factors, including past transactionhistory with the customer and the creditworthiness of the customer. We reviewDunn & Bradstreet credit reports for our resellers and adjust ourcredit limits with those resellers accordingly. If a particular reseller doesnot have a favorable report or if we do not have enough credit information todetermine if the reseller is credit-worthy then we typically sell to thatreseller on cash on delivery terms. We do not request collateral from ourcustomers. If we determine that collection of a fee is not reasonably assured,the fee is deferred and revenue is recognized at the time collection becomesprobable, which is generally upon receipt of payment.

 

We maintain reserves forpotential product returns and make adjustments to these reserves as neededbased on historical product return rates. We also consider the impact of newproduct introductions, changes in customer demand and acceptance of our productson the adequacy of these reserves. Our calculation of the estimated returnreserve is based upon (1) an account specific review of potential returns,where a return probability is known, and (2) an estimate based upon pasthistorical returns as a percentage of revenue. We must make and use significantjudgments and estimates in connection with establishing the product returnsreserve in any accounting period. Material differences may have resulted in theamount and timing of revenue for this or any prior period if we made differentjudgments or utilized different estimates.

 

As with the productreturn reserve, we must make estimates of our ability to collect on ouraccounts receivable. We record trade accounts receivable at the invoiced amountand these accounts do not bear interest. We specifically analyze accountsreceivable, historical bad debts, customer creditworthiness, current economictrends and changes in customer payment patterns when evaluating the adequacy ofour allowance for doubtful accounts. We review our allowance for doubtfulaccounts on a monthly basis. Our calculation of the estimated accountsreceivable reserve is also based upon (1) an account-specific review ofpotential uncollectible accounts, where a bad debt probability is known; and (2) anestimate based upon past historical bad debts as a percentage of accountsreceivable. We do not have any off-balance-sheet credit exposure to ourcustomers.

 

Our combined accountsreceivable and product returns reserve was $48,000 and $45,000 on June 30,2008 and December 31, 2007, respectively. Both components ofcalculating the estimated reserve—specific identification and historicexperience—are material judgments that we make. We base these judgments onhistoric trends, taking into consideration current business and economicconditions, which could change materially, thus changing the required reservelevel 

 

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materially. The potential change to the size of ourrequired reserve could be positive in the event the reserve estimate provesunnecessary, or negative, if the reserve proves inadequate.

 

Our deferred revenue iscomprised mainly of revenue that is deferred for software maintenance andsupport contracts as well as sales of our products targeted to the healthcarevertical market that involve both the sale of software and implementationservices for which the implementation services have not yet been performed. Theother components of deferred revenue are amounts from sales transactions thatwere deferred because they did not meet all of the provisions of our revenuerecognition policy.

 

*Software Development Costs.***Weconsider software development costs for capitalization when technologicalfeasibility is established in accordance with SFAS No. 86,**“*Accountingfor the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed*.”We sell software in a market that is subject to rapid technological change, newproduct introductions and changing customer needs. Accordingly, we havedetermined that we cannot ascertain technological feasibility until thedevelopment 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 ourconsolidated financial position or results of operations. Therefore, we chargeall software development costs to operations in the period incurred.

 

*Goodwilland Intangible Assets.*We account for goodwill in accordancewith SFAS No. 142 “*Goodwill and OtherIntangible Assets*” (“SFAS 142”). Goodwill represents theexcess of purchase price in a business combination over the fair value of nettangible and intangible assets acquired. In accordance with SFAS 142, goodwillamounts are not amortized, but rather are tested for impairment at leastannually. Intangible assets that are not considered to have an indefiniteuseful life are amortized over their useful lives, which range from three toten years.

 

*We account for intangible assets in accordance with SFAS No. 144“*Accounting for the Impairment or Disposal of Long-LivedAsset.” Intangible assets include customercontracts and relationships, purchased technology, trade names and non-competeagreements. The carrying amount of the intangible assets is reviewed wheneverevents or changes in circumstances indicate that the carrying value of an assetmay not be recoverable. Recoverability of these intangible assets is measuredby comparison of the carrying amount of the asset to the future undiscountedcash flows the asset is expected to generate. If the intangible asset isconsidered to be impaired, the amount of any impairment is measured as thedifference between the carrying value and the fair value of the impaired asset.

* *

We account for businesscombinations in accordance with SFAS No. 141, “*Business Combinations*”**(“SFAS 141”), which requiresthe use of the purchase method of accounting for business combinations. Inaccordance with SFAS 141, we determine the recognition of intangibleassets based on the following criteria: (i) the intangible asset arisesfrom contractual or other rights; or (ii) the intangible is separable ordivisible from the acquired entity and capable of being sold, transferred,licensed, returned or exchanged. In accordance with SFAS 141, we allocatethe purchase price of our business combinations to the tangible assets,liabilities and intangible assets acquired, including in-process research anddevelopment, based on their estimated fair values. The excess purchase priceover those fair values is recorded as goodwill.

 

*StockBased Compensation.*We account for stock-based compensationin accordance with SFAS No. 123R, “*Share-BasedPayment*” (“SFAS 123R”), using the modified prospectivemethod. SFAS 123R requires us to measure the cost of employee services inexchange for an award of an equity instrument based on the grant-date fairvalue of the award and to recognize expense over the requisite service period.Compensation expense is recognized for (a) all share-based paymentsgranted after the effective date and (b) all awards granted to employees priorto the effective date that remain unvested on the effective date. We calculatethis expense based upon an annualized estimated forfeiture rate determined byhistorical information and management’s estimate of future voluntary turnoverrates and we true-up estimated forfeitures to actual at the end of eachreporting period.

 

On November 10,2005, the Financial Accounting Standards Board (“FASB”) issued FASBStaff Position FAS 123R-3 “*TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards*.”The Company elected to adopt the alternative transition method provided by theFASB Staff Position for calculating the tax effects (if any) of stock-basedcompensation expense pursuant to SFAS 123R. The alternative transition methodincludes simplified methods to establish the beginning balance of theadditional paid-in capital pool related to the tax effects of employeestock-based compensation and to determine the subsequent impact to theadditional paid-in-capital pool and the consolidated statements of operationsand cash flows of the tax effects of employee stock-based compensation awardsthat are outstanding upon adoption of SFAS 123R.

 

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*Taxes.***Weare required to estimate our income and state sales taxes. This processinvolves estimating our actual current tax obligations, while also assessingdifferences resulting from the different treatment of items for tax andaccounting purposes that result in deferred income tax assets and liabilitiesand accrued state sales tax liabilities. We include deferred income tax assetsand liabilities and accrued state sales tax liabilities in our consolidatedbalance sheet.

 

We assess our deferredtax assets for each reporting period to determine whether it is more likelythan not that we will recover from future taxable income. In making thisassessment, we include assumptions regarding ongoing tax planning strategies.We establish a valuation allowance for assets when their recovery is notcertain. We include changes to the valuation allowance as an expense or benefitwithin the tax provision in our statement of operations.

 

We provide a fullvaluation allowance against all of our net deferred tax assets and willcontinue to do so until we return to an appropriate level of sustained taxableincome. The ultimate realization of these deferred tax assets depends upon ourability to generate sufficient future taxable income. If we are successful ingenerating sufficient future taxable income, we will reduce the valuationallowance through a reduction in income tax expense in the future.

 

FASB Interpretation No. 48“*Accounting for Uncertainty in Income Taxes,an interpretation of FAS 109*” clarifies the criteria that anindividual tax position must satisfy for some or all of the benefits of thatposition to be recognized in a company’s financial statements. As of June 30,2008 and December 31, 2007, the Company had no unrecognized tax benefits.

 

We estimate accrued statesales taxes for each reporting period based on tax rates in effect for thereporting periods in each of the states where we have a potential nexus and forthe time period during which we have that nexus. The assumptions and estimatesused to determine this liability are subject to change as they are difficult tomeasure or value. In the event that actual results differ from these estimates,our state sales taxes expense could be materially impacted.

 

**New Accounting Pronouncements**

** **

In September 2006,the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”),which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements. SFAS No. 157 applies to other existing accountingpronouncements that require or permit fair value measurements. SFAS No. 157does not require any new fair value measurements. However, the application ofthis statement may change the current practice for fair value measurements.SFAS No. 157 is effective for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. However, in February 2008,the FASB issued a final Staff Position to allow filers to defer the effectivedate of SFAS No. 157 for one year for nonfinancial assets and nonfinancialliabilities that are recognized or disclosed at fair value in the financialstatements on a nonrecurring basis. The FASB Staff Position does not deferrecognition and disclosure requirements for financial assets and financialliabilities or for nonfinancial assets and nonfinancial liabilities that areremeasured at least annually. The Company is currently evaluating the impactthis statement will have on its financial position and results of operations.

 

In December 2007,the FASB issued SFAS No. 141R “*BusinessCombinations*”**(“SFAS141R”), which improves the relevance, representational faithfulness andcomparability of the information that a reporting entity provides in itsfinancial reports about a business combination and its effects. SFAS 141Rapplies prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008. We will adopt this statement once it iseffective and applicable. SFAS 141R will not have an impact on our financialposition or results of operations.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“SFAS 160”). SFAS 160 clarifies the classification in a company’sconsolidated balance sheet and the accounting for and disclosure oftransactions between the company and holders of noncontrolling interests. SFAS160 is effective for us as of January 1, 2009. Early adoption is notpermitted. We do not expect the adoption of SFAS 160 to have a material impacton our financial position or results of operations.

 

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**Resultsof Operations**

 

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

 
| ** **                 | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue:                   |       |                                            |       |                                          |       |   |   |   |   |
| Software license           |       | 27.3                                            | %          | 30.0                                          | %          | 29.6 | % | 28.7 | % |
| Hardware and media         |       | 9.5                                             |       | 13.9                                          |       | 9.4 |   | 13.0 |   |
| Service and other          |       | 63.2                                            |       | 56.1                                          |       | 61.0 |   | 58.3 |   |
| Total revenue              |       | 100.0                                           |       | 100.0                                         |       | 100.0 |   | 100.0 |   |
| Cost of revenue:           |       |                                            |       |                                          |       |   |   |   |   |
| Software license           |       | 2.8                                             |       | 2.5                                           |       | 2.6 |   | 2.6 |   |
| Hardware and media         |       | 6.3                                             |       | 9.3                                           |       | 6.0 |   | 8.5 |   |
| Service and other          |       | 24.8                                            |       | 22.1                                          |       | 24.4 |   | 24.8 |   |
| Total cost of revenue      |       | 33.9                                            |       | 33.9                                          |       | 33.0 |   | 35.9 |   |
| Gross profit               |       | 66.1                                            |       | 66.1                                          |       | 67.0 |   | 64.1 |   |
| Operating expenses:        |       |                                            |       |                                          |       |   |   |   |   |
| Sales and marketing        |       | 38.7                                            |       | 43.7                                          |       | 40.6 |   | 50.2 |   |
| Research and development   |       | 18.2                                            |       | 17.1                                          |       | 18.0 |   | 19.9 |   |
| General and administrative |       | 18.7                                            |       | 20.0                                          |       | 19.3 |   | 22.8 |   |
| Restructuring costs        |       | —                                          |       | 3.1                                           |       | — |   | 4.2 |   |
| Total operating expenses   |       | 75.6                                            |       | 83.9                                          |       | 77.9 |   | 97.1 |   |
| Loss from operations       |       | (9.5                                            | )          | (17.8                                         | )          | (10.9 | ) | (33.0 | ) |
| Interest and other income  |       | 0.4                                             |       | 0.6                                           |       | 0.4 |   | 0.6 |   |
| Interest expense           |       | (0.6                                            | )          | (1.0                                          | )          | (0.6 | ) | (1.2 | ) |
|                       |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                   |       | (9.7                                            | )%         | (18.2                                         | )%         | (11.1 | )% | (33.6 | )% |
|                       |       |                                            |       |                                          |       |   |   |   |   |
| Gross profit:              |       |                                            |       |                                          |       |   |   |   |   |
| Software license           |       | 89.7                                            | %          | 91.6                                          | %          | 91.4 | % | 91.0 | % |
| Hardware and media         |       | 33.8                                            |       | 32.6                                          |       | 35.7 |   | 34.2 |   |
| Service and other          |       | 60.8                                            |       | 60.7                                          |       | 60.0 |   | 57.4 |   |

 

**Revenue**

 

*SoftwareLicense. * During the six months ended June 30,2008, we experienced a decrease in our software license revenue of 4% ascompared to the same period in the prior fiscal year due primarily to adecrease in revenue from sales of our legacy fax products. This decrease wasoffset by an increase in our AccuRoute software license revenue during the sametime period. During the three months ended June 30, 2008  as compared to the same period in 2007 weexperienced an 11% decrease in our software license revenue as our Legacy Faxsoftware license revenue declined and, partly as a result of the sluggishUnited States economic conditions, we also experienced a decline in ourAccuRoute software license revenue.

 

During the three monthsand six months ended June 30, 2008, our software license revenue byproduct category, as compared to the same periods in the prior fiscal year, wasas follows:

 
| ** **                                   | ** ** | **Total  Revenue** | ** ** | **Software  License  Revenue** | ** ** | **AccuRoute  Software  License  Revenue** | ** ** | **Legacy Fax  Software  License  Revenue** | ** ** | **Freight and  Allowances  for Returns** | ** ** |
|----------------------------------------------|------------|--------------------|------------|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $3,797,956         |       | $1,036,674                     |       | $839,869                                  |       | $140,239                                        |       | $56,566                                            |       |
| Three months ended June 30, 2007        |       | $4,275,102         |       | $1,281,462                     |       | $1,028,797                                |       | $250,004                                        |       | $2,661                                             |       |
| Change from same period of prior fiscal year |       | $(477,146)         |       | $(244,788)                     |       | $(188,928)                                |       | $(109,765)                                      |       | $53,905                                            |       |
|                                         |       | or  (11.2)%        |       | or  (19.1)%                    |       | or  (18.4)%                               |       | or  (43.9)%                                     |       | or  2,025.7%                                       |       |
|                                         |       |               |       |                           |       |                                      |       |                                            |       |                                               |       |
| Six months ended June 30, 2008          |       | $7,749,990         |       | $2,293,688                     |       | $1,937,467                                |       | $271,268                                        |       | $84,953                                            |       |
| Six months ended June 30, 2007          |       | $8,108,216         |       | $2,328,775                     |       | $1,864,512                                |       | $469,915                                        |       | $(5,652)                                           |       |
| Change from same period of prior fiscal year |       | $(358,226)         |       | $(35,087)                      |       | $72,955                                   |       | $(198,647)                                      |       | $90,605                                            |       |
|                                         |       | or  (4.4)%         |       | or  (1.5)%                     |       | or  3.9%                                  |       | or  (42.3)%                                     |       | or  1,603.1%                                       |       |

 

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During the three monthsended June 30, 2008, our software license revenue represented a decreasedpercentage of our total revenue as compared to the same period in 2007, due toa decrease in software license revenue. During the first half of fiscal 2008,our software license revenue represented a slightly increased percentage of ourtotal revenue as compared to the first half of fiscal 2007 due to a decrease intotal revenue.

 
| ** **                                   | ** ** | **Software License Revenue as a  Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | 27.3%                                                                                             |       |
| Three months ended June 30, 2007        |       | 30.0%                                                                                             |       |
| Change from same period of prior fiscal year |       | (2.7)ppt                                                                                          |       |
| ** **                                   | ** ** | ** **                                                                                        | ** ** |
| Six months ended June 30, 2008          |       | 29.6%                                                                                             |       |
| Six months ended June 30, 2007          |       | 28.7%                                                                                             |       |
| Change from same period of prior fiscal year |       | 0.9ppt                                                                                            |       |

 

The results for the threemonths and six months ended June 30, 2008 and June 30, 2007demonstrate that our software license revenue continues to shift towards ourAccuRoute product. The table below summarizes revenue from each of our majorproduct lines and other components of revenue as a percentage of our totalsoftware license revenue:

 
| ** **                                   | ** ** | **AccuRoute License Revenue as  a Percentage of Software  License Revenue** | ** ** | **Legacy Fax License  Revenue as a Percentage of  Software License Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | 81.0%                                                                                                          |       | 13.5%                                                                                                                |       |
| Three months ended June 30, 2007        |       | 80.3%                                                                                                          |       | 19.5%                                                                                                                |       |
| Change from same period of prior fiscal year |       | 0.7ppt                                                                                                         |       | (6.0)ppt                                                                                                             |       |
| ** **                                   | ** ** | ** **                                                                                                     | ** ** | ** **                                                                                                           | ** ** |
| Six months ended June 30, 2008          |       | 84.5%                                                                                                          |       | 11.8%                                                                                                                |       |
| Six months ended June 30, 2007          |       | 80.1%                                                                                                          |       | 20.2%                                                                                                                |       |
| Change from same period of prior fiscal year |       | 4.4ppt                                                                                                         |       | (8.4)ppt                                                                                                             |       |

 

*Hardwareand Media.*  Hardware and media revenue decreased duringthe three and six month periods ended June 30, 2008 as compared to thesame periods in 2007 due to a decrease in our legacy fax product sales, whichare the main driver for our hardware revenue and also due to the fact thatfewer customers upgraded their information technology infrastructure in 2008than did in 2007.

 
| ** **                                   | ** ** | **Hardware and Media  Revenue** | ** ** | **Hardware and Media  Revenue as a  Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $360,294                                  |       | 9.5%                                                                                                 |       |
| Three months ended June 30, 2007        |       | $593,685                                  |       | 13.9%                                                                                                |       |
| Change from same period of prior fiscal year |       | $(233,391)                                |       | (4.4)ppt                                                                                             |       |
|                                         |       | or  (39.3)%                               |       |                                                                                                 |       |
|                                         |       |                                      |       |                                                                                                 |       |
| Six months ended June 30, 2008          |       | $726,268                                  |       | 9.4%                                                                                                 |       |
| Six months ended June 30, 2007          |       | $1,055,691                                |       | 13.0%                                                                                                |       |
| Change from same period of prior fiscal year |       | $(329,423)                                |       | (3.6)ppt                                                                                             |       |
|                                         |       | or  (31.2)%                               |       |                                                                                                 |       |

 

*Serviceand Other. * Service and other revenue, which consistsprimarily of the sale of support contracts to complement software products soldto customers and, to a lesser extent, consulting, training and installation services,remained relatively flat in the three and six month periods ended June 30,2008 as compared to the same periods in the prior fiscal year. Service andother revenue as a percentage of total revenue increased in both periodscompared to the same periods in 2007 due to the decrease in total revenue.

 

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| ** **                                   | ** ** | **Service and Other Revenue** | ** ** | **Service and Other Revenue as   a Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $2,400,988                                   |       | 63.2%                                                                                                         |       |
| Three months ended June 30, 2007        |       | $2,399,955                                   |       | 56.1%                                                                                                         |       |
| Change from same period of prior fiscal year |       | $1,033                                       |       | 7.1ppt                                                                                                        |       |
|                                         |       | or  0.0%                                     |       |                                                                                                          |       |
| ** **                                   | ** ** | ** **                                   | ** ** | ** **                                                                                                    | ** ** |
| Six months ended June 30, 2008          |       | $4,730,034                                   |       | 61.0%                                                                                                         |       |
| Six months ended June 30, 2007          |       | $4,723,750                                   |       | 58.3%                                                                                                         |       |
| Change from same period of prior fiscal year |       | $6,284                                       |       | 2.7ppt                                                                                                        |       |
|                                         |       | or  0.1                                      |       |                                                                                                          |       |

 

We continue to focus onimproving the renewal rate of software maintenance contracts with our existing customerbase in the United States, Europe and other non-U.S. locations, and ongenerating additional service and other revenue in future quarters.

 

**Costof Revenue**

 

*SoftwareLicense. * Cost of software license revenue consistsprimarily of the costs we incur in sublicensing third-party software products,purchasing product media and contracting for product duplication, as well asthe amortization of purchased technology. Cost of software license revenuefor the three month period ended June 30, 2008 remained essentially flatas compared to the corresponding period in the previous fiscalyear. During the same two time periods, we experienced a decrease in thesoftware license gross margin percentage due to the fact that we sold moresoftware which contained royalty-bearing third-party software. During the sixmonth period ended June 30, 2008 as compared to the six month period endedJune 30, 2007, cost of software license revenue decreased in absolutedollars due to a decrease in royalty fees resulting from lower software sales.To a lesser extent, cost of software license revenue decreased due to areduction in the amortization expense of purchased technology associated withour acquisition of BlueChip, which technology is being amortized over itsestimated future life of five years and is based upon patterns in which theeconomic benefits of such assets are expected to be utilized. As a result ofthis decrease in absolute dollars of the cost of software license revenue weexperienced an increase in the software license gross margin percentage duringthose time periods. We expect the cost of software license revenue to remainconsistent with second quarter levels for the second half of 2008.

 
| ** **                                   | ** ** | **Cost of Software License Revenue** | ** ** | **Software License Gross Margin** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $106,716                                                 |       | 89.7%                                            |       |
| Three months ended June 30, 2007        |       | $107,270                                                 |       | 91.6%                                            |       |
| Change from same period of prior fiscal year |       | $(554)                                                   |       | (1.9)ppt                                         |       |
|                                         |       | or  (0.5)%                                               |       |                                             |       |
| ** **                                   | ** ** | ** **                                               | ** ** | ** **                                       | ** ** |
| Six months ended June 30, 2008          |       | $198,066                                                 |       | 91.4%                                            |       |
| Six months ended June 30, 2007          |       | $208,545                                                 |       | 91.0%                                            |       |
| Change from same period of prior fiscal year |       | $(10,479)                                                |       | 0.4  ppt                                         |       |
|                                         |       | or  (5.0)%                                               |       |                                             |       |

 

*Hardwareand Media. * Cost of hardware and media revenue consistsprimarily of the costs we incur in purchasing third-party hardware and mediaproducts. During the three and six month periods ended June 30, 2008,cost of hardware and media decreased as compared to the same periods in 2007 asa result of a decrease in our hardware unit sales. Our hardware and media grossmargin percentage increased for the three and six month periods ended June 30,2008 as compared to the same periods in 2007 due to a higher concentration ofmedia sales which had a higher gross margin than our hardware. We do not expectsignificant changes in unit prices of hardware or media for the remainder of2008.

 

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| ** **                                   | ** ** | **Cost of Hardware and Media Revenue** | ** ** | **Hardware and Media Gross  Margin** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $238,622                                                        |       | 33.8%                                               |       |
| Three months ended June 30, 2007        |       | $400,008                                                        |       | 32.6%                                               |       |
| Change from same period of prior fiscal year |       | $(161,386)                                                      |       | 1.2ppt                                              |       |
|                                         |       | or  (40.3)%                                                     |       |                                                |       |
| ** **                                   | ** ** | ** **                                                      | ** ** | ** **                                          | ** ** |
| Six months ended June 30, 2008          |       | $466,785                                                        |       | 35.7%                                               |       |
| Six months ended June 30, 2007          |       | $694,138                                                        |       | 34.2%                                               |       |
| Change from same period of prior fiscal year |       | $(227,353)                                                      |       | 1.5ppt                                              |       |
|                                         |       | or  (32.8)%                                                     |       |                                                |       |

 

*Serviceand Other. * Cost of service and other revenue consistsprimarily of the costs we incur in providing telephone support, installationsand other miscellaneous customer service-related expenses. Cost of service andother revenue and the service and other revenue gross margin percentageremained relatively flat during the second quarter of 2008 as compared to the secondquarter of 2007. We experienced a decrease in cost of service and other revenueduring the six month period ended June 30, 2008 as compared to the sameperiod in fiscal year 2007 due to a reduction in travel and consulting expensesresulting from the adoption of our March 2007 restructuring plan. Thisdecrease in absolute dollars of cost of service and other revenue resulted inan increase in our service and other revenue gross margin percentage. We expectcost of service and other revenue to remain relatively consistent during thesecond half of 2008.

 
| ** **                                   | ** ** | **Cost of Service and Other  Revenue** | ** ** | **Gross Margin for Service  and Other Revenue** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $940,398                                                   |       | 60.8%                                                                    |       |
| Three months ended June 30, 2007        |       | $943,904                                                   |       | 60.7%                                                                    |       |
| Change from same period of prior fiscal year |       | $(3,506)                                                   |       | 0.1ppt                                                                   |       |
|                                         |       | or  (0.4)%                                                 |       |                                                                     |       |
| ** **                                   | ** ** | ** **                                                 | ** ** | ** **                                                               | ** ** |
| Six months ended June 30, 2008          |       | $1,891,872                                                 |       | 60.0%                                                                    |       |
| Six months ended June 30, 2007          |       | $2,012,279                                                 |       | 57.4%                                                                    |       |
| Change from same period of prior fiscal year |       | $(120,407)                                                 |       | 2.6ppt                                                                   |       |
|                                         |       | or  (6.0)%                                                 |       |                                                                     |       |

 

**OperatingExpenses**

 

*Salesand Marketing. * Sales and marketing expenses consistprimarily of employee salaries, benefits, commissions, and associated overheadcosts, as well as the cost of marketing programs such as direct mailings,public relations, trade shows, seminars and related communicationcosts. Sales and marketing expenses decreased in absolute dollars and as apercentage of total revenue during the three and six month periods ended June 30,2008 as compared to the same periods in 2007 due to a reduction in headcount asa result of our March 2007 restructuring plan, which resulted in decreasedwages and other costs associated with supporting those employees. In addition,our marketing program expenditures decreased in accordance with this plan.During the second quarter of 2008 as compared to the second quarter of 2007,sales and marketing expenses decreased due to lower commission expenses. Weexpect that our sales and marketing expenses will increase modestly during thesecond half of 2008.

 
| ** **                                   | ** ** | **Sales and Marketing Expenses** | ** ** | **Sales and Marketing Expenses as  a Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $1,469,969                                      |       | 38.7%                                                                                                      |       |
| Three months ended June 30, 2007        |       | $1,870,215                                      |       | 43.7%                                                                                                      |       |
| Change from same period of prior fiscal year |       | $(400,246)                                      |       | (5.0)ppt                                                                                                   |       |
|                                         |       | or  (21.4)%                                     |       |                                                                                                       |       |
|                                         |       |                                            |       |                                                                                                       |       |
| Six months ended June 30, 2008          |       | $3,146,389                                      |       | 40.6%                                                                                                      |       |
| Six months ended June 30, 2007          |       | $4,066,944                                      |       | 50.2%                                                                                                      |       |
| Change from same period of prior fiscal year |       | $(920,555)                                      |       | (9.6)ppt                                                                                                   |       |
|                                         |       | or  (22.6)%                                     |       |                                                                                                       |       |

 

*Researchand Development.*  Research and development expensesinclude expenses associated with the development of new products, enhancementsof existing products and quality assurance activities. These expensesconsist primarily of employee salaries, benefits, associated overhead costs,consulting expenses and the cost of software development tools. For 

 

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the three and six month periods ended June 30,2008, our research and development expenses decreased in absolute dollars ascompared to the same periods in the prior fiscal year. The decrease in researchand development expenses during the second quarter of 2008 as compared to thesecond quarter of 2007 is primarily due to a decrease in overhead expenses.Research and development expenses as a percentage of total revenue increasedduring the second quarter of 2008 as compared to the second quarter of 2007 dueto a decrease in total revenue. The decrease in research and developmentexpenses in absolute dollars and as a percentage of revenue during the sixmonth period ended June 30, 2008 as compared to the same period in 2007 isdue to a reduction in headcount from the March 2007 restructuring planwhich resulted in decreased wages and other costs associated with supportingthose employees as well as a reduction in consulting expenses. We do not expectsignificant changes in our research and development expenses for the remainder of2008.

 
| ** **                                   | ** ** | **Research and Development  Expenses** | ** ** | **Research and Development  Expenses as a Percentage of  Total Revenue** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $693,208                                         |       | 18.3%                                                                                                       |       |
| Three months ended June 30, 2007        |       | $729,681                                         |       | 17.1%                                                                                                       |       |
| Change from same period of prior fiscal year |       | $(36,473)                                        |       | 1.2ppt                                                                                                      |       |
|                                         |       | or  (5.0)%                                       |       |                                                                                                        |       |
| ** **                                   | ** ** | ** **                                       | ** ** | ** **                                                                                                  | ** ** |
| Six months ended June 30, 2008          |       | $1,393,956                                       |       | 18.0%                                                                                                       |       |
| Six months ended June 30, 2007          |       | $1,609,762                                       |       | 19.9%                                                                                                       |       |
| Change from same period of prior fiscal year |       | $(215,806)                                       |       | (1.9)ppt                                                                                                    |       |
|                                         |       | or  (13.4)%                                      |       |                                                                                                        |       |

 

*Generaland Administrative. * General and administrative expensesconsist primarily of employee salaries, benefits for administrative, executiveand finance personnel, and associated corporate, general and administrativeexpenses. During the three and six month periods ended June 30, 2008,our general and administrative expenses decreased in absolute dollars anddecreased as a percentage of total revenue as compared to the same periods inthe prior fiscal year due to a reduction in headcount within our Europeanoperations resulting from our March 2007 restructuring plan, as well as areallocation of resources within the department. To a lesser extent, generaland administrative expenses decreased due to a reduction in accounting andlegal expenses as a result of higher fees in 2007 related to the review of ourexisting commercial and licensing agreements. In addition, the decrease ingeneral and administrative expenses during the six month period ended June 30,2008 is due to a decrease in consulting expenses related primarily to workassociated with public company reporting requirements. We do not expectsignificant changes in our general and administrative expenses during thesecond half of 2008.

 
| ** **                                   | ** ** | **General and Administrative  Expenses** | ** ** | **General and Administrative Expenses  as a Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008        |       | $709,879                                           |       | 18.7%                                                                                                             |       |
| Three months ended June 30, 2007        |       | $854,999                                           |       | 20.0%                                                                                                             |       |
| Change from same period of prior fiscal year |       | $(145,120)                                         |       | (2.3)ppt                                                                                                          |       |
|                                         |       | or  (17.0)%                                        |       |                                                                                                              |       |
|                                         |       |                                               |       |                                                                                                              |       |
| Six months ended June 30, 2008          |       | $1,499,947                                         |       | 19.4%                                                                                                             |       |
| Six months ended June 30, 2007          |       | $1,851,944                                         |       | 22.8%                                                                                                             |       |
| Change from same period of prior fiscal year |       | $(351,997)                                         |       | (3.4)ppt                                                                                                          |       |
|                                         |       | or  (19.0)%                                        |       |                                                                                                              |       |

 

*RestructuringCosts.* In March 2007, we announced a restructuring of certainof our operations and reduced our workforce. As a result of these costreduction activities, we recorded a pre-tax charge of $343,450 for the sixmonths ended June 30, 2007, which charge included $308,278 ofseverance-related costs and $35,172 of costs relating to the closing ofBlueChip’s former headquarters.

 

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| ** **                                    | ** ** | **Restructuring Costs** | ** ** | **Restructuring Costs  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008         |       | $0                           |       | 0.0%                                                                                    |       |
| Three months ended June 30, 2007         |       | $130,648                     |       | 3.1%                                                                                    |       |
| Change from same period of prior fiscal  year |       | $(130,648)                   |       | (3.1)ppt                                                                                |       |
|                                          |       | or (100.0)%                  |       |                                                                                    |       |
| ** **                                    | ** ** | ** **                   | ** ** | ** **                                                                              | ** ** |
| Six months ended June 30, 2008           |       | $0                           |       | 0.0%                                                                                    |       |
| Six months ended June 30, 2007           |       | $343,450                     |       | 4.2%                                                                                    |       |
| Change from same period of prior fiscal  year |       | $(343,450)                   |       | (4.2)ppt                                                                                |       |
|                                          |       | or (100.0)%                  |       |                                                                                    |       |

 

*Interestand other Income and Interest Expense. * Interest andother income consists primarily of interest income earned on cash and cashequivalent balances. The decrease in interest and other income during the threeand six month periods ended June 30, 2008 as compared to the same periodsin 2007 is a result of a lower average investment balance. Interest expenserepresents the interest associated with the capital lease that we entered intoin May 2006 to finance the purchase of furniture and equipment for our newheadquarters, as well as interest expense associated with the promissory noteissued to the Seller of BlueChip. Interest expense decreased during the threeand six month periods ended June 30, 2008 as compared to the same periodsin fiscal 2007 due to a reduction in the variable interest rate on the notepayable and the declining outstanding principal balance.

 

We expect interest andother income to remain relatively stable quarter over quarter for the remainderof 2008 and that interest expense will decrease quarter over quarter for thesecond half of 2008.

 
| ** **                                    | ** ** | **Interest and  Other Income** | ** ** | **Interest  Expense** | ** ** | **Interest and Other  Income  as a Percentage  of Total Revenue** | ** ** | **Interest Expense  as a Percentage  of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|-----------------------|------------|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Three months ended June 30, 2008         |       | $15,607                                  |       | $(21,479)             |       | 0.4%                                                                                            |       | (0.6)%                                                                           |       |
| Three months ended June 30, 2007         |       | $27,544                                  |       | $(44,498)             |       | 0.6%                                                                                            |       | (1.0)%                                                                           |       |
| Change from same period of prior fiscal  year |       | $(11,937)                                |       | $(23,019)             |       | (0.2)ppt                                                                                        |       | (0.4)ppt                                                                         |       |
|                                          |       | or (43.3)%                               |       | or (51.7)%            |       |                                                                                            |       |                                                                             |       |
|                                          |       |                                     |       |                  |       |                                                                                            |       |                                                                             |       |
| Six months ended June 30, 2008           |       | $33,419                                  |       | $(47,717)             |       | 0.4%                                                                                            |       | (0.6)%                                                                           |       |
| Six months ended June 30, 2007           |       | $48,032                                  |       | $(95,535)             |       | 0.6%                                                                                            |       | (1.2)%                                                                           |       |
| Change from same period of prior fiscal  year |       | $(14,613)                                |       | $(47,818)             |       | (0.2)ppt                                                                                        |       | (0.6)ppt                                                                         |       |
|                                          |       | or (30.4)%                               |       | or (50.1)%            |       |                                                                                            |       |                                                                             |       |

 

**Inflation**

 

During the fiscal yearsended December 31, 2005, 2006  and2007 and the six months ended June 30, 2008, neither inflation norchanging prices have had a material impact on our net sales, revenue or incomefrom continuing operations.

 

**Liquidity and Capital Resources**

 

Since 1996, we havefinanced our operations primarily through cash flow from operations and privateand public sales of securities. As of June 30, 2008, we had cash and cashequivalents of $2.1 million and a net working deficit of $2.6 million. Webelieve that our existing cash and cash equivalents will be sufficient to meetour working capital, capital expenditures and other liquidity requirements forat least the next twelve months.

 
| ** **                                    | ** ** | **Cash Used In**    | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **Operating Activities** | ** ** | **Investing Activities** | ** ** | **Financing Activities** | ** ** |
| Six months ended June 30, 2008           |       | $98,875                       |       | $(50,696) |   | $(320,559) |   |
| Six months ended June 30, 2007           |       | $(1,985,565)                  |       | $(692,970) |   | $(167,402) |   |
| Change from same period of prior fiscal  year |       | $2,084,440                    |       | $642,274 |   | $(153,157) |   |
|                                          |       | or 1,049.8%                   |       | or 92.7% |   | or (91.5)% |   |

 

Our operating activitiesprovided cash of $98,875 for the six months ended June 30, 2008 and usedcash of approximately $2.0 million for the six months ended June 30,2007. We believe that the resources we are allocating to improve thesuccess of our AccuRoute product in the legal and professional servicesvertical market and its expansion into 

 

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the healthcare and financial services vertical marketswill continue to put pressure on our earnings and liquidity during theremainder of 2008, but that our existing cash is sufficient for at least thenext twelve months.

 

Net cash provided duringthe six months ended June 30, 2008 consisted primarily of an increase indeferred revenue and the noncash effects of depreciation, amortization andstock-based compensation expense, predominantly for vesting of restricted stockshares, offset in part by a net loss from operations and a decrease in accountspayable. The increase in deferred revenue is due to the timing of supportrenewal contracts and the decrease in accounts payable is due to the timing ofvendor payments.

 

Net cash used during thesix months ended June 30, 2007 consisted primarily of a net loss fromoperations and a decrease in accounts payable, offset in part by an increase indeferred revenue, a decrease in unbilled accounts receivable as well as by thenon-cash effects of depreciation and amortization and stock-based compensation,predominately for vesting of restricted stock shares.

 

Investing activities usedcash of $51,000 and $693,000 during the six months ended June 30, 2008 and2007, respectively. The sole use of cash for the first six months of 2008was for the purchase of various software and computer equipment. The primaryuse of cash for investing activities during the first six months of 2007consisted of the $562,090 cash payment made to the Seller of BlueChip for our December 2006acquisition as well as additional legal and accounting fees related to our December 2006acquisition of BlueChip.

 

Financing activities usedcash of $321,000 and $167,000 during the six months ended June 30, 2008 andJune 30, 2007, respectively. The primary use of cash during these periodswas for principal payments made to the Seller of BlueChip as part of thepurchase consideration for BlueChip and for the repayment of capital leaseobligations.

 

Based on our performancefor the first half of 2008 and current expectations for the remainder of 2008,we believe that our current cash and cash equivalents balance, as well as thecash expected to be generated from operations for the remainder of the year,will satisfy our working capital needs, capital expenditures, and otherliquidity requirements associated with our operations through at least the nexttwelve months. We expect that principal uses of cash will be for operations,repayment of capital lease obligations and notes payable. There can be noassurance that any necessary additional financing will be available to us oncommercially reasonable terms, or at all. The issuance of additional equity orequity-related securities would be dilutive to our stockholders. If we cannotraise funds on acceptable terms, or at all, we may not be able to develop orenhance our products or respond appropriately to competitive pressures, whichwould seriously limit our ability to increase our revenue and grow ourbusiness.

 

Our capital leaseagreement contains a provision, whereby we are required to maintain a minimumcash balance of $2.1 million. In addition, we have entered into a pledge andsecurity agreement with the capital financing provider that requires a minimumbalance of cash and cash equivalents of no less than $250,000 (“pledgedcollateral”) and in the event that our cash balance falls below $250,000 wewill immediately provide the amount necessary to cover such shortfall to thecapital financing provider. In the event of default in maintaining the requiredamount of pledged collateral or the making of any lease payments, the pledgedcollateral will first be used as payment for costs and expenses incurred toenforce the security and pledge agreement and second for payment in full of theoutstanding principal loan balance. The minimum required cash balance of $2.1million includes the pledged collateral. As of June 30, 2008 and December 31,2007, the pledged collateral of $250,000 is restricted cash and has beenclassified as “other assets” in the accompanying balance sheet. In the eventour cash balance falls below the minimum requirement of $2.1 million, we willbe required to pay the outstanding principal balance. As of June 30, 2008,our total outstanding principal balance is approximately $308,000.

 

**Off-Balance Sheet Arrangements**

 

Wedo not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, that would have been established for the purpose offacilitating off-balance sheet arrangements (as that term is defined in Item303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limitedpurposes. As such, we are not exposed to any financing, liquidity, marketor credit risk that could arise if we had engaged in those types ofrelationships.

 

**Item 4T. Controls and Procedures**

 

(a)             Evaluationof disclosure controls and procedures.

 

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As of June 30, 2008(the “Evaluation Date”), the Company, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of the Company’s disclosure controls and procedurespursuant to Rule 13a-15(b) promulgated under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”). Based upon thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, the Company’s disclosure controlsand procedures were effective in ensuring that information relating to theCompany (including its consolidated subsidiaries) required to be disclosed bythe Company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized, and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, includingensuring that this information is accumulated and communicated to the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

(b)            Changesin internal control over financial reporting

 

There were no changes inthe Company’s internal control over financial reporting during the Company’sfiscal quarter ended June 30, 2008 or in other factors that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II:  OTHER INFORMATION**

 

**Item 1A.  RiskFactors**

 

**From time to time we update, revise and supplementthe risk factors described under the title “Risk Factors” in our Annual Reporton Form 10-K for the fiscal year ended December 31, 2007. Thereare no material changes to the risk factors described in the “Risk Factors”section in our Annual Report on Form 10-K for the fiscal year ended December 31,2007 other than as set forth below.**We note that, as a smaller reporting company,we are not required to provide this Item 1A in this Quarterly Report on Form 10-Q.Accordingly, we undertake no duty to update these risk factors on agoing-forward basis.

 

***Given the nature of our business, wemay not be able to obtain sufficient or attractive financing, should thatbecome necessary.***    Weexpect that our current cash, cash equivalents and investments will meet ournormal working capital and capital expenditure needs for at least the nexttwelve months. We may, however, need to raise additional funding at that timeor earlier if we decide to undertake more rapid expansion, includingacquisitions of complementary products or technologies, or if we increase ourmarketing, sales and/or research and development efforts in order to respond tocompetitive pressures. We cannot be certain that we will be able to obtainadditional financing on favorable terms, if at all. We may obtain additionalfinancing by issuing shares of our common stock or other equity securities,which could dilute our existing stockholders. Moreover, our consideration ofstrategic and financial alternatives, including consideration of deregisteringour common stock from the public company requirements under the Exchange Act,could adversely affect our ability to obtain additional financing or the termson which might raise needed financing. If we cannot raise needed funds onacceptable terms, or at all, we may not be able to develop or enhance ourproducts or respond appropriately to competitive pressures, which wouldseriously harm our business.

 

***We have experienced operating lossesand our future operating results are uncertain and difficult to predict.***  We had an operating loss in theyears ended December 31, 2007 and 2006. There can be no assurance that wewill be able to increase our level of revenue or become profitable again in thefuture, as our operating history makes the accurate prediction of futureoperating results difficult or impossible. If we experience any pricingpressures and fail to achieve broader market acceptance of our products andthere is a decline in the growth rate of the overall United States economy orour industry in particular, we may experience continuing operating losses. Wehave reduced our operating expenses and attempted to control our costs. Ourability to further reduce our operating expenses is limited, and anysignificant further reduction would adversely affect our ability to develop,market and sell our products and invest in our indirect sales channels andstrategic business partnerships.

 

OurAccuRoute product represented 82% and 59% of software license revenue for theyears ended December 31, 2007 and 2006, respectively. Our ability toimprove our operating results will depend upon, among other things, our abilityto increase sales of our AccuRoute, Genifax and Healthcare Suite productsto new customers, as well as our ability to increase product penetration intoexisting customers. In addition, we plan to continue investing significantly inthe expansion of our AccuRoute product into new vertical markets, including thehealthcare and financial services vertical markets, in advance of significantrelated revenue from those markets. We also plan to continue to invest in thenew and established indirect sales channels and strategic businesspartnerships, in some cases in advance of significant revenue from thesechannel partners. We 

 

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cannot predict the timing or level of revenueresulting from these investments. Future operating results will depend on manyother factors, including, without limitation, the degree and rate of growth ofthe markets in which we compete; the level of product and price competition;our ability to establish strategic relationships and develop and market new andenhanced products; our ability to control costs; our ability to expand our directand indirect distribution channel sales both domestically and internationally;our ability to integrate our products and cross-sell our solutions acrossvertical markets; and our ability to attract and retain key personnel. As aresult, it is possible that, in the future, our operating results will be belowthe expectations of public market analysts and investors. In that event, theprice of our common stock would likely be materially adversely affected.

 

***In addition todirect sales, we utilize indirect sales and distribution channels and strategicalliances with compatible partners in order to broaden sales of our products.Any failure on our part to form and leverage relationships with these indirectsales and distribution channel partners could have a material adverse affect onour business and results of operations.***  We market our products andservices directly through telesales and prospect visits and indirectly throughmarketing channels such as value added resellers (“VARs”), systems integrators, distributors and strategicbusiness partners. Although we have historically focused our efforts onmarketing through our direct sales force, we continue to utilize resources todevelop and expand our indirect marketing channels. There can be no assurancesthat we will be able to attract and retain a sufficient number of qualifiedVARs, systems integrators, distributors and/or strategic business partners, orthat those third parties will successfully market our products. In addition,there can be no assurances that our resellers and strategic business partnerswill not develop, acquire, or market computer-based electronic documentexchange, document routing and distribution, document exchange and facsimileproducts that are competitive with our products.

 

The distributor agreements governing ourrelationships with third-party distribution chain partners generally do notrequire these parties to purchase minimum volumes from us. Further, theserelationships generally may be terminated by either party. There can be noassurance that any VAR, systems integrator, or distributor will continue torepresent and sell our products.

 

We continue to focus on the marketing and sale ofour products through leading hardware, computer system and software vendors,such as HP, Xerox, Canon and Ricoh. The development of these relationshipsrequires us to make significant executive, marketing and product developmentinvestments in advance of establishing the relationship and making our productsavailable through these partners. While to date we have generated a majority ofour revenues from our direct sales, we are increasingly focusing our futuregrowth strategy on sales through these strategic business partners, andaccordingly investing considerable resources in the promotion of the sale ofour products through these key channels. Once established, these channelsrequire ongoing and considerable investment prior to the achievement ofsignificant sales, and the achievement, amount and timing of any sales throughthese channels is to a large extent outside of our control.In addition, these strategic partners havebroad product portfolios and industry alliances. There can be no assurance thatwe will successfully market and sell our products through these strategicchannels.

 

The inability to retain our VARs, systemsintegrators, distributors, or strategic business partners, or to motivate theseparties to resell our products, or the development or marketing by VARs,systems integrators, distributors, or strategic business partners of competitiveofferings, could have a material adverse effect on our business, financialcondition and results of operations.

 

Selling through indirect channels may limit ourcontacts with our customers, thereby hindering our ability to accuratelyforecast sales, evaluate customer satisfaction and recognize emerging customerrequirements. Our strategy of marketing our products directly to end-users andindirectly through VARs, systems integrators and distributors may result indistribution channel conflicts. Our direct sales efforts may compete with thoseof our indirect channels and, to the extent different resellers target the samecustomers, resellers may also come into conflict with each other. As we striveto expand our indirect distribution channels, there can be no assurance thatemerging channel conflicts will not materially adversely affect ourrelationships with existing VARs, systems integrators, or distributors oradversely affect our ability to attract new VARs, systems integrators anddistributors.

 

***We are in theprocess of identifying and analyzing strategic, financial and operatingalternatives and any such alternatives may not lead to the achievement ofdesired results.***  Inlight of our current and historical operating results and the continuing challengeswe face and in order to maximize shareholder value, we are in an ongoingprocess of examining our operations as well as our strategic and financialalternatives. The strategic and financial options we may consider could includea variety of different business arrangements including, but not limited to:combinations with or a sale to another entity; equity or debt financings;strategic partnerships and joint ventures; the sale or spin off of certainassets; the acquisition of complementary businesses, technologies, or productlines; investments in new businesses; reorganization, recapitalization, ordistribution alternatives; deregistering as a public company; or other alternatives. Changes, if any,implemented as a result of the strategic and financial alternatives reviewcould affect the basic nature of our Company. For example, deregistering our 

 

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common stock from the publiccompany requirements under the Exchange Act could have an adverse effect on themarket price of our common stock and would likely mean that there would be lessinformation about us available to shareholders and potential investors thanwhat is currently contained in the periodic reports we file pursuant to theExchange Act.Theexamination of these strategic and financial alternatives requires significanttime and attention and commitments from our management team and could result inadditional expense. Any strategic and financial options we identify may not beavailable to us or ultimately consummated. Any strategic or financial decisionwill involve risks and uncertainties and present challenges in implementationand integration. As a result, any such business arrangement may not lead toincreased shareholder value. In addition, any strategic or financial decisioncould lead to non-recurring or other charges or be dilutive to our currentshareholders.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

OnApril 25, 2008, the Company sold to each of four employees of the Company10,000 shares of the Company’s Common Stock, par value $0.01 per share. Wecompleted these transactions pursuant to Section 4(2) of the SecuritiesAct of 1933, as amended. These securities were sold for consideration of $0.01per share, for a total aggregate purchase price of $400.00, and were soldpursuant to the Company’s 2007 Equity Compensation Incentive Plan. Thesecurities are subject to vesting restrictions over time and certain otherrestrictions on resale, as outlined in the 2007 Equity Compensation IncentivePlan and in individual Stock Purchase and Restriction Agreements.

 

**Item 4. Submission of Matters to a Vote of Security Holders**

 

Weheld our Annual Meeting of Stockholders on Tuesday, May 20, 2008 at ouroffices at 6 Riverside Drive, Andover, Massachusetts. The matter voted upon wasthe election of each of James P. O’Halloran, Arnold E. Ditri and William J.Drummey as Class II directors of the Company. The terms of office ofRobert L. Voelk, Martin A. Schultz, Richard D. Cramer and William J. Rynkowskicontinued after the meeting.

 

  Thetabulation with respect to each nominee for Class II directors is as setforth below:

 
| **Nominee**              | ** ** | **Number of  Votes For** | ** ** | **Number of Votes  Withheld** | ** ** | **Number of  Abstentions** | ** ** | **Number of  Broker non-  votes** | ** ** |
|--------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| James P. O’Halloran |       | 3,619,910                          |       | 104,498                                 |       | N/A                             |       | 0                                           |       |
| Arnold E. Ditri          |       | 3,619,910                          |       | 104,498                                 |       | N/A                             |       | 0                                           |       |
| William J. Drummey       |       | 3,619,910                          |       | 104,498                                 |       | N/A                             |       | 0                                           |       |

 

**Item 5.  OtherInformation**

 

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**

 

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. |

 

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OMTOOL, LTD.

 

**Signatures**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                      |   |   | OMTOOL, LTD. |
|----------------------|--------|--------|--------------|
|                 |   |   |         |   |
|                 |   |   | By:          | /s/ Daniel A. Coccoluto |
| August 14, 2008 |   |   |         | Daniel A. Coccoluto |
|                 |   |   |         | Chief Financial Officer, Secretary and Treasurer |
|                 |   |   |         | (Duly authorized officer and principal financial  officer) |

 

**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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