**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

**FORM 10-Q**

**(MarkOne)**
| **x****QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------------------------|
| ** **                                                                                          |
| **For the  quarterly period ended March 31, 2007**                                                  |
| ** **                                                                                          |
| **OR**                                                                                              |
| ** **                                                                                          |
| **o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |

 

**Forthe transition periodfrom           to         **

**Commission File Number 0-22871**

**OMTOOL, LTD.**

(Exact Name ofRegistrant as Specified in Its Charter)
| **Delaware**                                              | ** ** | **02-0447481**          |
|-----------------------------------------------------------|------------|-------------------------|
| (State or Other  Jurisdiction of                          |       | (I.R.S. Employer        |
| Incorporation or  Organization)                           |       | 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 markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes  x   No   o

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition ofaccelerated filer and large accelerated filer in Rule 12b-2 of the ExchangeAct.

Large acceleratedfiler  o                   Accelerated filer  o                             Non-acceleratedfiler  x

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes  o   No  x

There were 4,539,706shares of the Company’s common stock, par value $0.01, outstanding on May 11,2007.

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

FORM 10-Q

For the Quarter EndedMarch 31, 2007

CONTENTS
| Item Number                    | ** ** | ** **                                                                                             |
|--------------------------------|------------|--------------------------------------------------------------------------------------------------------|
|                           |       |                                                                                                   |
| PART  I: FINANCIAL INFORMATION |
|                           |       |                                                                                                   |
| Item 1.                        |       | Consolidated  Financial Statements                                                                     |
|                           |       | Consolidated  Balance Sheets as of March 31, 2007 (Unaudited) and December 31, 2006                    |
|                           |       | Consolidated  Statements of Operations for the three months ended March 31, 2007 and 2006  (Unaudited) |
|                           |       | Consolidated Statements of Cash Flows for the three  months ended March 31, 2007 and 2006 (Unaudited)  |
|                           |       | Notes to Consolidated Financial Statements                                                             |
|                           |       |                                                                                                   |
| Item 2.                        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations            |
|                           |       |                                                                                                   |
| Item 3.                        |       | Quantitative  and Qualitative Disclosures About Market Risk                                            |
|                           |       |                                                                                                   |
| Item 4.                        |       | Controls and  Procedures                                                                               |
|                           |       |                                                                                                   |
| PART  II: OTHER INFORMATION    |
|                           |       |                                                                                                   |
| Item 1.                        |       | Legal Proceedings                                                                                      |
|                           |       |                                                                                                   |
| Item  1A.                      |       | Risk  Factors                                                                                          |
|                           |       |                                                                                                   |
| Item 5.                        |       | Other Information                                                                                      |
|                           |       |                                                                                                   |
| Item  6.                       |       | Exhibits                                                                                               |
|                           |       |                                                                                                   |
| Signatures                     |       |                                                                                                   |
|                           |       |                                                                                                   |
| Exhibit Index                  |       |                                                                                                   |
|                           |       |                                                                                                   |
| Exhibits                       |       |                                                                                                   |

 

2

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**PARTI:  FINANCIAL INFORMATION**

**Item1.  Consolidated Financial Statements**

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**
| ** **                                                                                                                                                                                                                              | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                              | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                         |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                              |       | $                        | 4,109,908  |                        | $          | 5,469,366 |   |
| Accounts receivable,  net of reserves of $28,000 at March 31, 2007 and $14,000 at December 31,  2006, respectively                                                                                                                      |       | 2,107,013                |       | 2,100,266                   |       |
| Unbilled accounts  receivable                                                                                                                                                                                                           |       | 500,510                  |       | 677,624                     |       |
| Inventory                                                                                                                                                                                                                               |       | 180,289                  |       | 111,389                     |       |
| Prepaid expenses and  other current assets                                                                                                                                                                                              |       | 432,448                  |       | 491,483                     |       |
| Total current assets                                                                                                                                                                                                                    |       | 7,330,168                |       | 8,850,128                   |       |
| Property and equipment,  net                                                                                                                                                                                                            |       | 1,472,694                |       | 1,525,028                   |       |
| Goodwill                                                                                                                                                                                                                                |       | 1,883,096                |       | 1,776,051                   |       |
| Intangible assets, net                                                                                                                                                                                                                  |       | 1,657,914                |       | 1,785,000                   |       |
| Unbilled accounts  receivable, long-term                                                                                                                                                                                                |       | 404,879                  |       | 424,469                     |       |
| Other assets                                                                                                                                                                                                                            |       | 55,168                   |       | 66,730                      |       |
| Total assets                                                                                                                                                                                                                            |       | $                        | 12,803,919 |                        | $          | 14,427,406 |   |
|                                                                                                                                                                                                                                    |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                          | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                    |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                        |       | $                        | 1,874,655  |                        | $          | 2,069,727 |   |
| Accrued liabilities                                                                                                                                                                                                                     |       | 1,844,571                |       | 1,521,644                   |       |
| Deferred revenue,  current                                                                                                                                                                                                              |       | 4,581,292                |       | 4,026,773                   |       |
| Capital lease  obligations                                                                                                                                                                                                              |       | 421,088                  |       | 442,438                     |       |
| Amount due to seller                                                                                                                                                                                                                    |       | —                   |       | 562,090                     |       |
| Note payable, current                                                                                                                                                                                                                   |       | 608,004                  |       | 467,695                     |       |
| Total current  liabilities                                                                                                                                                                                                              |       | 9,329,610                |       | 9,090,367                   |       |
| Long term liabilities:                                                                                                                                                                                                                  |       |                     |       |                        |       |
| Deferred rent                                                                                                                                                                                                                           |       | 467,000                  |       | 498,348                     |       |
| Deferred revenue,  long-term                                                                                                                                                                                                            |       | 606,943                  |       | 436,086                     |       |
| Note payable, long-term                                                                                                                                                                                                                 |       | 1,075,698                |       | 1,216,007                   |       |
| Total liabilities                                                                                                                                                                                                                       |       | 11,479,251               |       | 11,240,808                  |       |
|                                                                                                                                                                                                                                    |       |                     |       |                        |       |
| 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 — 4,743,209 shares at March 31, 2007 and  December 31, 2006; Outstanding — 4,545,561 shares at March 31, 2007  and 4,432,101 shares at December 31, 2006, respectively |       | 47,432                   |       | 47,432                      |       |
| Additional paid-in  capital                                                                                                                                                                                                             |       | 36,673,744               |       | 36,668,927                  |       |
| Accumulated deficit                                                                                                                                                                                                                     |       | (33,560,443              | )          | (31,608,373                 | )          |
| Treasury stock, at  cost, 197,648 shares at March 31, 2007 and 311,108 shares at December 31,  2006                                                                                                                                     |       | (1,771,449               | )          | (1,858,435                  | )          |
| Accumulated other  comprehensive loss                                                                                                                                                                                                   |       | (64,616                  | )          | (62,953                     | )          |
| Total stockholders’  equity                                                                                                                                                                                                        |       | 1,324,668                |       | 3,186,598                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                         |       | $                        | 12,803,919 |                        | $          | 14,427,406 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements.

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

(Unaudited)
| ** **                                               | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Revenue:                                                 |       |                                             |       |   |   |
| Software license                                         |       | $                                                | 1,047,313  |   | $ | 1,031,819 |   |
| Hardware and  media                                      |       | 462,006                                          |       | 557,400 |   |
| Service and  other                                       |       | 2,323,795                                        |       | 1,747,285 |   |
|                                                     |       |                                             |       |   |   |
| Total revenue                                            |       | 3,833,114                                        |       | 3,336,504 |   |
|                                                     |       |                                             |       |   |   |
| Cost of revenue:                                         |       |                                             |       |   |   |
| Software license                                         |       | 101,275                                          |       | 31,441 |   |
| Hardware and  media                                      |       | 294,130                                          |       | 345,078 |   |
| Service and  other                                       |       | 1,068,375                                        |       | 713,099 |   |
|                                                     |       |                                             |       |   |   |
| Total cost of  revenue                                   |       | 1,463,780                                        |       | 1,089,618 |   |
|                                                     |       |                                             |       |   |   |
| Gross profit                                             |       | 2,369,334                                        |       | 2,246,886 |   |
|                                                     |       |                                             |       |   |   |
| Operating  expenses:                                     |       |                                             |       |   |   |
| Sales and  marketing                                     |       | 2,196,729                                        |       | 2,052,207 |   |
| Research and  development                                |       | 880,081                                          |       | 707,252 |   |
| General and  administrative                              |       | 996,945                                          |       | 899,942 |   |
| Restructuring  costs                                     |       | 212,802                                          |       | — |   |
|                                                     |       |                                             |       |   |   |
| Total operating  expenses                                |       | 4,286,557                                        |       | 3,659,401 |   |
|                                                     |       |                                             |       |   |   |
| Loss from  operations                                    |       | (1,917,223                                       | )          | (1,412,515 | ) |
|                                                     |       |                                             |       |   |   |
| Interest income                                          |       | 20,488                                           |       | 44,573 |   |
| Interest expense                                         |       | (51,037                                          | )          | (60 | ) |
|                                                     |       |                                             |       |   |   |
| Net loss                                                 |       | $                                                | (1,947,772 | ) | $ | (1,368,002 | ) |
|                                                     |       |                                             |       |   |   |
| Net loss per  share:                                     |       |                                             |       |   |   |
| Basic and  diluted                                       |       | $                                                | (0.43      | ) | $ | (0.34 | ) |
|                                                     |       |                                             |       |   |   |
| Weighted average  shares used in per share calculations: |       |                                             |       |   |   |
| Basic and diluted                                        |       | 4,478,066                                        |       | 4,020,573 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements*.*

4

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

(Unaudited)
| ** **                                                                   | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Cash Flows from  Operating Activities:                                       |       |                                             |       |   |   |
| Net loss                                                                     |       | $                                                | (1,947,772 | ) | $ | (1,368,002 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                               |       | 200,015                                          |       | 32,391 |   |
| Accounts  receivable reserves                                                |       | 14,846                                           |       | (2,863 | ) |
| Stock-based  compensation                                                    |       | 79,285                                           |       | 77,265 |   |
| Changes in  assets and liabilities:                                          |       |                                             |       |   |   |
| Accounts  receivable                                                         |       | (5,338                                           | )          | (22,174 | ) |
| Unbilled  accounts receivable                                                |       | 196,704                                          |       | — |   |
| Prepaid expenses  and other current assets                                   |       | 59,405                                           |       | 4,945 |   |
| Inventory                                                                    |       | (68,900                                          | )          | 31,287 |   |
| Other assets                                                                 |       | 11,562                                           |       | (10,000 | ) |
| Accounts payable                                                             |       | (196,365                                         | )          | 296,675 |   |
| Accrued  liabilities                                                         |       | 321,845                                          |       | (68,467 | ) |
| Deferred revenue                                                             |       | 723,612                                          |       | 63,119 |   |
| Deferred rent                                                                |       | (31,348                                          | )          | — |   |
|                                                                         |       |                                             |       |   |   |
| Net cash used in  operating activities                                       |       | (642,449                                         | )          | (965,824 | ) |
|                                                                         |       |                                             |       |   |   |
| Cash Flows from  Investing Activities:                                       |       |                                             |       |   |   |
| Additional  purchase consideration for prior period acquisition              |       | (107,045                                         | )          | — |   |
| Purchases of  property and equipment                                         |       | (20,451                                          | )          | (374,461 | ) |
|                                                                         |       |                                             |       |   |   |
| Net cash used in  investing activities                                       |       | (127,496                                         | )          | (374,461 | ) |
|                                                                         |       |                                             |       |   |   |
| Cash Flows from  Financing Activities:                                       |       |                                             |       |   |   |
| Net proceeds  from issuance of common stock                                  |       | 7,105                                            |       | 9,792 |   |
| Net proceeds  from issuance of restricted common stock                       |       | 1,287                                            |       | 622 |   |
| Forfeiture of  restricted common stock                                       |       | (171                                             | )          | — |   |
| Payment for  amount due to seller                                            |       | (562,090                                         | )          | (15,517 | ) |
| Principal  payments for capital lease obligations                            |       | (21,350                                          | )          | — |   |
|                                                                         |       |                                             |       |   |   |
| Net cash used in  financing activities                                       |       | (575,219                                         | )          | (5,103 | ) |
|                                                                         |       |                                             |       |   |   |
| Exchange rate  effect on cash and cash equivalents                           |       | (14,294                                          | )          | 11,104 |   |
|                                                                         |       |                                             |       |   |   |
| Net decrease in  cash and cash equivalents                                   |       | (1,359,458                                       | )          | (1,334,284 | ) |
|                                                                         |       |                                             |       |   |   |
|  Cash and  cash equivalents, beginning of period                        |       | 5,469,366                                        |       | 10,471,272 |   |
|                                                                         |       |                                             |       |   |   |
| Cash and cash  equivalents, end of period                                    |       | $                                                | 4,109,908  |   | $ | 9,136,988 |   |
| Supplemental  Disclosure of Cash Flow Information:                           |       |                                             |       |   |   |
| Cash paid during the  period for interest                                    |       | $                                                | 8,128      |   | $ | 60 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements*.*

5

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

**(1) Basisof Presentation**

Omtool, Ltd. (“Omtool”or the “Company”) provides document and information handling solutionsthat control document lifecycles and simplify the integration of paper andelectronic documents in enterprise information systems.  Through the Company’s acquisition of BlueChipTechnologies (“BlueChip”) in December 2006, the Company now provideselectronic forms automation, document imaging and object archiving solutionsfor the healthcare vertical market.

The accompanyingunaudited consolidated financial statements have been prepared by Omtoolpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) regarding interim financial reporting.  Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements and should beread in conjunction with the consolidated financial statements and notesthereto for the year ended December 31, 2006 as filed with the SEC as part ofthe Company’s Annual Report on Form 10-K on March 26, 2007.  The accompanying unaudited consolidatedfinancial statements reflect all adjustments (consisting of normal recurringadjustments) that are, in the opinion of management, necessary for a fairpresentation of results for the interim periods presented.  The results ofoperations for the three month period ended March 31, 2007 are not necessarilyindicative of the results to be expected for the full fiscal year.

**(2)** **Net Loss Per Share**

The Companyreports net loss per share in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 128,**“*Earningsper Share*.”  Dilutedweighted average shares outstanding for the fiscal quarter ended March 31, 2007and March 31, 2006 exclude 447,055 and 363,142, respectively of potentialcommon shares from stock options and 51,000 shares for a stock warrant becauseto include them would have been anti-dilutive for the periods presented as theCompany reported a net loss during the periods.

**(3) IncomeTaxes**

SFAS No. 109,**“*Accounting for Income Taxes*,”requires a valuation allowance to be recorded against deferred tax assets whenit is more likely than not that some or all of the deferred tax assets will notbe realized.  As a result of cumulative losses in recent years andcontinued economic uncertainty, the Company has provided a full valuationallowance against its net deferred tax assets and will do so until it returns toan appropriate level of sustained taxable income.  The ultimaterealization of these deferred tax assets depends upon the Company’s ability togenerate sufficient future taxable income. If the Company is successful in generating sufficient future taxableincome, the Company will reduce the valuation allowance through a reduction inincome tax expense in the future.

As of January 1, 2007 theCompany adopted the provisions of Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *“Accounting for Uncertaintyin Income Taxes, an Interpretation of FASB Statement No. 109”* (“FIN48”).  The adoption of FIN 48, didnot have a material impact on the Company’s financial position or results ofoperations for the three months ended March 31, 2007.

During the three monthsended March 31, 2007 and March 31, 2006, the Company did not record an incometax benefit associated with any pre-tax loss due to the uncertainty regardingfuture taxable income.

**(4) ComprehensiveLoss**

The components of theCompany’s comprehensive loss are as follows:
|                                           | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Net loss                                  |       | $                                                | (1,947,772 | ) | $ | (1,368,002 | ) |
| Foreign currency  translation adjustments |       | (1,663                                           | )          | 7,185 |   |
| Comprehensive  loss                       |       | $                                                | (1,949,435 | ) | $ | (1,360,817 | ) |

 

**(5) Acquisition**

On December 29, 2006, theCompany acquired all of the outstanding shares of BlueChip for $562,090 incash, $1,683,702 in a promissory note issued to BlueChip’s principalshareholder (“Seller”), 375,331 shares of the Company’s common stock(valued at $1,478,804), the issuance of vested options to purchase the Company’scommon stock in substitution for outstanding BlueChip stock options (valued at$368,090), and direct acquisition costs of $563,838, which consisted primarilyof financial advisory, legal and

6

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accounting services.  The Company acquired BlueChip in order tostrengthen and expand its presence in the healthcare vertical market.

As of December 31, 2006,the $562,090 owed to the Seller of BlueChip was classified in the accompanyingconsolidated balance sheet as “Amount due to seller.”  This amount was paid in January 2007.

The promissory note thatthe Company issued to the Seller of BlueChip is payable in thirty-six equalmonthly installments of approximately $47,000. The Company made the first principal and interest payment in April 2007.

Goodwill in theaccompanying consolidated balance sheets as of March 31, 2007 and December 31,2006, represents the excess of the purchase price over the net tangible andidentifiable intangible assets for the acquisition of BlueChip.

The changes in thecarrying amount of goodwill were as follows:
|                                                 | ** ** | **Three Month  Period Ending  March 31,  2007** | ** ** | **Twelve Month  Period Ending  December 31,  2006** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Beginning of the  period                        |       | $                                                              | 1,776,051  |                                                               | $          | — |   |
| Acquisition of  BlueChip                        |       | —                                                         |       | 1,776,051                                                          |       |
| Additional  purchase consideration for BlueChip |       | 107,045                                                        |       | —                                                             |       |
| End of the period                               |       | $                                                              | 1,883,096  |                                                               | $          | 1,776,051 |   |

 

Additional purchaseconsideration for BlueChip for the three month period ending March 31, 2007represents direct acquisition costs consisting of legal and accountingservices.

Gross carrying amountsand accumulated amortization for each intangible asset class was as follows:
|                                       | ** ** | **March 31, 2007**    | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Balances** | ** ** |
| Purchased  technology                 |       | $                               | 774,000    |   | $ | 46,914 |   | $ | 727,086 |   |
| Customer  contracts and relationships |       | 850,000                         |       | 70,301 |   | 779,699 |   |
| Trade names                           |       | 110,000                         |       | 5,621 |   | 104,379 |   |
| Non-compete  agreements               |       | 51,000                          |       | 4,250 |   | 46,750 |   |
|                                  |       | $                               | 1,785,000  |   | $ | 127,086 |   | $ | 1,657,914 |   |

 
|                                       | ** ** | **December 31, 2006** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Balances** | ** ** |
| Purchased  technology                 |       | $                               | 774,000    |   | $ | — |   | $ | 774,000 |   |
| Customer  contracts and relationships |       | 850,000                         |       | — |   | 850,000 |   |
| Trade names                           |       | 110,000                         |       | — |   | 110,000 |   |
| Non-compete  agreements               |       | 51,000                          |       | — |   | 51,000 |   |
|                                  |       | $                               | 1,785,000  |   | $ | — |   | $ | 1,785,000 |   |

 

The range of amortizationperiod for identifiable intangible assets is from three to ten years.

7

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Theestimated future amortization expense of intangible assets for the nine monthsended December 31, 2007 and each of the next five years, thereafter was asfollows:

| Year ending December 31, | ** ** | ** ** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 381,258    |   |
| 2008                     |       | 376,249    |       |
| 2009                     |       | 307,265    |       |
| 2010                     |       | 237,778    |       |
| 2011                     |       | 196,694    |       |
| 2012                     |       | 61,176     |       |
| Thereafter               |       | 97,494     |       |
| Total                    |       | $          | 1,657,914  |   |

 

**(6) Stock-basedCompensation**

The Company’s 1996 StockOption Plan and 1997 Stock Plan, as amended, provide for the issuance of commonstock pursuant to the grant to employees of “incentive stock options” withinthe meaning of the Internal Revenue Code and the grant of nonqualified stockoptions, stock awards or opportunities to make direct purchases of stock in theCompany to employees, consultants, directors, and officers of the Company.  The aggregate number of shares of commonstock that may be issued pursuant to the 1997 Stock Plan is 1,228,570.  Shares issued pursuant to these plans areissued from treasury to the extent they are available.  Stock-based compensation is accounted for inaccordance with SFAS No. 123(R), “*Share-Based Payment*”**(“SFAS 123R”).

The Company incurredstock-based compensation expense for restricted common stock, stock options,and the employee stock purchase plan as follows:
|                                                                                 | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Stock-based  compensation expense included in cost of service and other revenue |       | $                                                | 2,112      |   | $ | 3,824 |   |
| Stock-based  compensation expense included in operating expenses                |       | 77,173                                           |       | 73,441 |   |
| Total  stock-based compensation expense                                         |       | $                                                | 79,285     |   | $ | 77,265 |   |

 

The Board of Directors of the Company recently approved the Company’s2007 Equity Compensation Incentive Plan (the “2007 Plan”), which planhas been submitted for shareholder approval at the annual meeting of theCompany’s shareholders to be held on May 22, 2007.  If approved, the 2007 Plan will provide forthe issuance of common stock to employees, consultants, directors and officersof the Company much like the 1997 Plan. The term of the 1997 Plan expired on April 14, 2007 so, if the 2007 Planis not approved by the Company’s shareholders, the Company generally will nolonger have the ability to issue common stock to its employees, consultants,directors, and officers under stock-based compensation plans, other than uponexercise of outstanding options.  Ifapproved, the aggregate number of shares that could be issued pursuant to the2007 Plan is 500,000.

***Stock Options***

Under the terms ofthe Company’s 1996 Stock Option Plan and 1997 Stock Plan, options vest andbecome exercisable as determined by the Board of Directors and expire10 years after the date of grant. In 1997, the Company’s Board of Directors voted that no further optionswould be granted or issued under the Company’s 1996 Stock Option Plan.  In accordance with the 1997 Stock Plan, stockoptions that are canceled or expired are added back to the potential optionsavailable for future issuance.  Stock option compensation expense calculatedunder the fair value approach is recognized ratably over the four year vestingperiod.  The fair value for granted optionswas estimated at the time of grant using the Black-Scholes option-pricingmodel.  Based upon historical informationand management’s estimate of future voluntary turnover rates, theCompany has calculated this expense based on an annualized estimated forfeiture rate of 5%.  The Company trues-up estimated forfeitures toactual at the end of each reporting period. The Company did not grant any stock options during the three monthsended March 31, 2007 or March 31, 2006.

***Employee Stock Purchase Plan***

The 1997 EmployeeStock Purchase Plan provides for the issuance of a maximum of 57,142 shares ofcommon stock pursuant to the exercise of nontransferable options granted toparticipating employees.  The exerciseprice for the option for each six-month purchase period is 85% of the lesser ofthe market price of the common stock on the first or last business day of thesix-month purchase period.  Employee stock purchase plan compensationexpense calculated under the fair value approach is recognized ratably over thesix-month purchase period.  The weightedaverage fair value of the shares subject to purchase under the employee stockpurchase plan was $1.30 for the three months ended March 31, 2007, based uponthe following assumptions:

8

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|                          | ** ** | **Three Months  Ended  March 31, 2007** | ** ** |
|--------------------------|------------|--------------------------------------------------------|------------|
| Risk-free  interest rate |       | 5.1                                                    | %          |
| Volatility               |       | 57.0                                                   | %          |
| Expected  dividend yield |       | 0.0                                                    |       |
| Expected life            |       | 0.5 Years                                              |       |

 

We relied on historical information about the Company to determine theexpected volatility assumptions.  Theexpected life is equal to the six-month purchase period.

***Restricted Common Stock***

The Company sellsshares of restricted common stock (“restricted stock”) under the Company’s1997 Stock Plan, as amended, to its Board of Directors and certain employees ofthe Company at a price per share of $0.01, and it intends to continue to sellshares of restricted stock in a similar manner under the 2007 Plan, if the 2007Plan is approved by the Company’s shareholders. If the 2007 Plan is not approved by the Company’s shareholders, theCompany will no longer have the ability to sell shares of restricted stock toits Board of Directors or employees under the stock-based compensation plansbecause the term of the 1997 Stock Plan expired on April 14, 2007.  The shares of restricted stock vest ratablyover a four year service period.  In theevent that a restricted stockholder ceases to provide services to the Companyprior to the vesting of any of the then unvested shares held by thatstockholder, the restricted stockholder is required to sell any unvested sharesof restricted stock back to the Company at the original purchase price of $0.01per share.  Restricted stock-basedcompensation expense calculated under the fair value approach is based upon thecurrent stock price and is recognized ratably over the four-year vestingperiod.  Based upon historicalinformation and management’s estimate of future voluntary turnover rates, theCompany has calculated this expense based on an annualized estimated forfeiturerate of 10%.  The Company trues-upestimated forfeitures to actual forfeitures at the end of each reportingperiod.  During the three months endedMarch 31, 2007 and March 31, 2006, the Company sold 128,675 and 62,196 sharesof restricted stock, respectively, under the Company’s 1997 Stock Plan, asamended, to its Board of Directors and certain employees of the Company at aprice per share of $0.01.

**(7) AccruedLiabilities**

Accrued liabilitiesconsist of the following:
|                                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Accrued health  insurance expense  |       | $                        | 258,083    |                        | $          | 258,083 |   |
| Accrued state  sales tax           |       | 283,295                  |       | 343,212                     |       |
| Accrued salary  and salary-related |       | 639,861                  |       | 538,224                     |       |
| Accrued  professional fees         |       | 145,806                  |       | 154,306                     |       |
| Accrued  restructuring costs       |       | 148,913                  |       | —                      |       |
| Other accrued  expenses            |       | 368,613                  |       | 227,819                     |       |
|                               |       | $                        | 1,844,571  |                        | $          | 1,521,644 |   |

 

**(8)** **Capital Lease Obligations**

On May 1, 2006,the Company entered into a capital lease agreement in the amount of $491,000 tofinance the purchase of furniture and equipment for the Company’s headquarterslocated in Andover, Massachusetts.  Thelease has a five year term which expires on May 31, 2011 and is payable in 60equal monthly installments.  The interestrate on the capital lease is 6.2%.  Totalinterest payments over the life of the lease are estimated to be $99,000.  The lease contains a provision whereby theCompany would be required to repay the outstanding principal balance should theCompany’s cash balance ever be less than $5,000,000.  In January 2007, the Company’s cash balancefell below $5,000,000 and therefore as of March 31, 2007 and December 31, 2006,the entire principal balance of $421,088 and $442,438, respectively, may berequired to be paid in full and has been classified as a current liability inthe accompanying consolidated balance sheets.

**(9) NotePayable**

On December 29,2006, the Company issued a promissory note in the amount of $1,683,702 to theprincipal shareholder of BlueChip in partial consideration of all theoutstanding shares of BlueChip (See Note 5). The note is payable in thirty-six equal monthly principal installmentsof approximately $47,000 plus interest, commencing on March 30, 2007.  The promissory note bears interest on theunpaid principal amount at a rate per annum equal to (a) the Prime Rate as setforth in the Wall Street Journal Money Rates column on the last business day ofeach month, which rate shall be deemed to be in effect for the entirety of suchmonth; plus

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(b) one percent.  The Company made a payment of approximately$86,000 in April 2007, consisting of a principal payment of $47,000 andaccumulated interest for the three month period ended March 31, 2007, of$39,000.

**(10) RestructuringCosts**

In March 2007, theCompany announced a restructuring of certain of its operations and reduced itsworkforce by twelve persons.  Inaddition, ten other positions were eliminated during the first quarter.  As a result of these activities, the Companyrecorded a pre-tax charge of $212,802 in accordance with SFAS No. 146, “*Accounting for Costs Associated with Exit or Disposal Activities.*”** The charge included$177,630 of severance-related costs associated with a total workforce reductionof approximately twenty-two positions and $35,172 as a result of closingBlueChip’s former headquarters located in Danvers, Massachusetts.

The total cashimpact of the restructuring was $212,802; the remaining balance of $148,913 isexpected to be paid during the second quarter of fiscal 2007 and has beenincluded in accrued liabilities in the accompanying consolidated balance sheetas of March 31, 2007.

**(11) Segmentand 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, the financial informationdisclosed herein represents all of the material financial information relatedto the Company’s principal operating segment in accordance with SFAS No. 131,**“*Disclosures About Segments of an Enterprise andRelated Information*.”

Total revenue frominternational sources was approximately $1,055,000 and $438,000 for the threemonths ended March 31, 2007 and 2006, respectively.

The following tablerepresents amounts relating to geographic locations:
|               | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|
| ** **         | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Total revenue  (1) |       |                                             |       |   |   |
| United States      |       | $                                                | 2,778,287  |   | $ | 2,898,667 |   |
| United Kingdom     |       | 585,323                                          |       | 171,614 |   |
| Canada             |       | 142,000                                          |       | 175,268 |   |
| South Africa       |       | 212,753                                          |       | 30,653 |   |
| Rest of World      |       | 114,751                                          |       | 60,302 |   |
|               |       | $                                                | 3,833,114  |   | $ | 3,336,504 |   |

 
|                        | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Long-lived  assets (2) |       |                     |       |                        |       |
| United States          |       | $                        | 5,447,560  |                        | $          | 5,549,313 |   |
| United Kingdom         |       | 26,191                   |       | 27,965                      |       |
|                   |       | $                        | 5,473,751  |                        | $          | 5,577,278 |   |

 

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(1) Revenue is attributed to geographic regions based on location ofcustomer.

(2) Long-lived assetsinclude net property and equipment, goodwill, net intangible assets, long-termunbilled accounts receivable and other assets.

**(12) Legal Proceedings**

On or aboutSeptember 15, 2006, J. PatrickMansfield, a former employee of BlueChip, predecessor-in-interest toOmtool Healthcare, LLC, a wholly-owned subsidiary of the Company, filed acomplaint against BlueChip and William J. Rynkowski, Jr., BlueChip’sthen-current chief executive officer and a current employee and director of theCompany (together with BlueChip, the “Defendants”), with theMassachusetts Superior Court for Essex County (Civil Action No. 6-1756), asserting among other thingsbreach of contract, violations of the Massachusetts Weekly Payment of WagesAct, breach of fiduciary duty, intentional misrepresentation, and breach ofcovenant of good faith and fair dealing for the alleged failure of Defendantsto pay wages allegedly owed to Mr. Mansfield, the alleged failure of Defendantsto acknowledge Mr. Mansfield’s alleged ownership interest in BlueChip, and thealleged improper termination of Mr. Mansfield’s employment.

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While managementcurrently believes that resolving the aforementioned legal matter will not havea material adverse impact on the Company’s financial position, the litigationnoted above is subject to inherent uncertainties, including the risk of anunfavorable outcome, and management’s view of these matters may change in thefuture.  An unfavorable outcome couldinclude monetary damages or, in cases where injunctive relief is sought, aninjunction prohibiting certain activities. Were an unfavorable final outcome to occur, there exists the possibilityof a material adverse impact on the Company’s financial position, cash flowsand results of operations for the period in which the effect becomes reasonablyestimable.

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**Item2.**

**MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

Management’sDiscussion and Analysis of Financial Condition and Results of Operations forthe three months ended March 31, 2007 should be read in conjunction with theaccompanying consolidated financial statements for the periods specified andthe associated notes.  Further reference should be made to our AnnualReport on Form 10-K for the year ended December 31, 2006, as filed with the SECon March 26, 2007.

**Overview**

We are a providerof document and information-handling solutions that control document lifecyclesand simplify the integration of paper and electronic documents in enterpriseinformation systems. Our enterprise document-handling platform streamlines thecapture, conversion, and communication of any combination of paper andelectronic information, enabling fast, secure, and simultaneous distribution tomultiple destinations in multiple formats.

*Business*

In March 2007, weannounced a restructuring of certain of our operations and reduced ourworkforce by approximately twelve positions. Since then, employee attrition and the elimination of additionalpositions, when combined with the March restructuring and the other operatingexpense reductions we have made, has resulted in a total decrease ofapproximately thirty positions and, we believe, an annual savings ofapproximately $3.6 million.  Our threegoals in undertaking these cost reduction measures are: one, to achievefinancial results that will enable us to be at or near cash flow break even bythe end of fiscal year 2007; two, to enable our sales force to focus on sellingour products to customers in the legal and healthcare vertical markets directlyand also in partnership with indirect sales channels, while allowing ourpartners to focus on selling our products to customers in the financialservices and other vertical markets; and three, to support our integration ofthe BlueChip business.

As a result ofthese cost reduction activities, we recorded a pre-tax charge of $212,802,which charge included $177,630 of severance-related costs and $35,172 of costsrelating to the closing of BlueChip’s former headquarters.  The total cash impact of the restructuringwas $212,802; $63,889 was paid during the quarter ended March 31, 2007 andthe remaining balance of $148,913 is expected to be paid during the secondquarter of fiscal year 2007 and has been included in accrued liabilities in ourconsolidated balance sheet as of March 31, 2007.

We have incurredquarterly losses since the quarter ended September 30, 2005******andmay continue to incur similar losses during the remainder of fiscal year 2007.

We have remainingchallenges to address as we seek to expand our business including: increasingour software license revenue from AccuRoute® sales to help offset declines inour legacy fax business (including the hardware revenue associated with suchsales);  expanding our sales in targetedvertical markets, such as legal, healthcare and financial services; promotingour products and technologies through reseller and marketing relationships withleading multi-function device providers; and improving our results outside ofthe Americas.  As indicated by our recentoperating results, we have invested in direct and indirect sales efforts, aswell as marketing efforts, ahead of revenue attributed to these expenses.

In light of ourcurrent and historical operating results and the continuing challenges we face,and in order to maximize shareholder value, we are in an ongoing process ofexamining our operations as well as our strategic and financialalternatives.  The strategic andfinancial options we may consider could include a variety of different businessarrangements including, but not limited to: combinations with or a sale toanother entity; equity or debt financings; strategic partnerships and jointventures; the sale or spin off of certain assets; the acquisition ofcomplementary businesses, technologies or product lines; investments in newbusinesses; reorganization, recapitalization, or distribution alternatives; orother alternatives.  Changes, if any,implemented as a result of the strategic and financial alternatives reviewcould affect the basic nature of our Company.

*Products*

AccuRoute, ourflagship product, provides faster, more efficient document workflows, whilereducing cost, complexity, and risk of losing documents.  We also include full enterprise faxcapabilities integrated within our AccuRoute product.  These solutions are used worldwide bybusinesses in document-intensive industries and sectors such as legal,financial services, government, and healthcare that demand secure handling,integration, and tracking of documents in full compliance with a range ofregulatory requirements.

Companies candeploy our software products on heterogeneous, multi-platform networks, digitalscanning devices, and multi-function peripherals and integrate them with bothdesktop and enterprise software applications. To address customer needs, ourproducts are modular and scaleable.  As aresult, customers can add additional communication capacity through theaddition of system 

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components andconnectors to keep pace with growing demands. In addition, due to this scalable, modular design, customers can addadditional Omtool product servers to a configuration to provide failoverredundancy, helping to ensure continuous operation.

OurGenifax product is a multi-tiered client/server solution for automatingand integrating fax communication throughout an enterprise.  As a component of an enterprise softwaresystem, our Genifax product is deployed on heterogeneous, multi-platformnetworks and integrates with desktop and enterprise software applications.

Our Genidocsproduct is a client/server messaging application that enables users to deliverdocuments – with comprehensive security and tracking – through theInternet to external parties.  Genidocsoffers the security features and functionality of traditional, paper-basedcommunications with the speed, efficiency, and cost advantages of electroniccommunications.

Fax Sr., ourlegacy network fax product, is a client/server software solution for automatingand integrating fax communication throughout an enterprise.  As an integrated component of an enterprisesoftware system, our Fax Sr. product is deployed on heterogeneous, multi-platformnetworks and integrates with desktop and enterprise software applications.

We continue tomaintain Genidocs and Fax Sr. and earn recurring maintenance revenue from ourinstalled base.  At this time, however, wedo not have plans to extend these technologies with new features or newreleases.

We resell certainhardware products (such as intelligent fax boards) and media products (such asadmission labels and patient wristbands), which we purchase from third-partyvendors as a convenience to our customers, who alternatively can opt to obtainhardware and media directly from third-party vendors. We sell support contractsfor the software products that we license to our customers and offer certainconsulting, training, installation and implementation services for ourproducts.

***Products stemming from ouracquisition of BlueChip***

Our December 2006acquisition of BlueChip brought us document workflow solutions for thehealthcare vertical market, as well as forms processing and document archivingtechnologies for other vertical markets. BlueChip also brings deep domain expertise and longstanding customerrelationships in the healthcare vertical market that will help to accelerate ourpenetration in that market.  We intend toincorporate BlueChip’s forms automation and document archiving functionalitiesinto our AccuRoute product line.

This acquisitionwill enable us to extend our AccuRoute product line to include the BlueChipsolutions for document imaging and workflow systems for hospital admissions andbilling functions, as well as BlueChip’s document archive product.  The end result will be a robust suite ofproducts that are well-suited to handle the workflows of healthcaredocuments.  Omtool’s Healthcare Suite ofproducts includes:

·                  **ADT eFormsTM**-****a productionsystem****that provides hospitals with on-demandADT (admissions, discharge, and transfer) electronic forms for registration andpatient identification.

·                  **eForms StationTM** - an electronic forms library****that gives immediate access to a hospital’s custom libraryof electronic and printable forms.

·                  **Image-InTM Point of Service**-****animage capture system that scans****images ofcommon non-clinical documents such as insurance cards, driver’s licenses,referral forms, and Health Insurance Portability and Accountability Actnotices, and displays them on a desktop paneled window.

·                  **Image-In Business**- a document and form capture system thatconverts 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****thatenables administrators to manage, view, and disseminate electronic documents tothe proper departments and/or patient files.

·                  **AccuRoute** - a document-handling platform that supportsdistributed document capture for scanning, routing, and archiving medicalinformation throughout the patient service cycle and provides documentdistribution into the document workflow products found in Omtool’s HealthcareSuite.

·                  **ObjectArchiveTM**-an electronic archive that provides the foundation to securely storeinformation designed, developed, and captured through any of the OmtoolHealthcare Suite products.

*VerticalMarket Focus*

Two years ago, weintroduced AccuRoute 2.0, our innovative document handling platform forenterprise document routing and managing the distributed capture, processing,distribution, and archiving of both paper and electronic documents.  AccuRoute’s features are horizontal in natureand apply to many different markets, including the legal, healthcare, andfinancial services vertical markets.  Werecently issued an extension to AccuRoute that provides greater functionalityin support of the e-filing requirements that are critical to many of our legalcustomers.  Earlier this year, weannounced expanded support for additional litigation and document supportsystems as we continue to focus on improving the quality of and customersatisfaction with our products.

Our position indocument handling in the legal vertical market will continue to be an area ofprimary focus for us, but in order to 

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grow our business, wewill expand on this focus.  Based on oursuccess in the legal vertical market, the industry accolades about AccuRoutethat we continue to receive from third parties (including industry experts),and the fact that AccuRoute sales presently represent approximately 80****percent of our software license revenue, we see a largemarket opportunity for AccuRoute in other vertical market segments.

While we have investedconsiderable resources to penetrate further the financial services verticalmarket and we have created and are pursuing opportunities within that verticalmarket, we have found that sales opportunities for our AccuRoute product in thefinancial services vertical market, though significant, are longer termopportunities.  Therefore, while we willcontinue to pursue these opportunities, primarily working with our largestrategic and channel partners, we believe the best opportunities forreplicating our continued success in the legal vertical market is in thehealthcare vertical market.  Similar toour views on the legal vertical market, and based on the high level of focus byhealthcare providers on electronic medical records, we see a significant opportunityto present AccuRoute as the solution of choice to the challenge of capturingthe paper documents that are endemic in healthcare systems.

We anticipate thatthe structure and buying patterns in the healthcare vertical market willpresent us with more near-term opportunities than the financial servicesvertical market.  Based on this view, inDecember 2006, we acquired BlueChip, a privately held provider ofelectronic forms automation, document imaging, and object archiving solutionsfor the healthcare vertical market. BlueChip provides complementary value to us through verticalmarket-specific document workflow solutions for healthcare providers, as wellas forms processing and document archiving technologies for other markets.  Moreover, BlueChip brings deep domainexpertise and longstanding customer relationships in the healthcare verticalmarket that will help to accelerate our penetration in that market.  We intend to incorporate BlueChip formsautomation and document archiving functionalities into our AccuRoute productline.

*OperatingResults*

Our revenue consistsprimarily of software license revenue, hardware and media revenue, and serviceand other revenue, all as further described below.  The following table is a presentation of ourtotal revenue for the periods indicated:
|                                               | ** ** | **Total Revenue** | ** ** | **Net Loss** | ** ** | **Software License  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-------------------|------------|------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                      | 3,833,114  |              | $          | (1,947,772                         | )          | $ | 1,047,313 |   |
| Three months  ended March 31, 2006            |       | $                      | 3,336,504  |              | $          | (1,368,002                         | )          | $ | 1,031,819 |   |
| Change over same period of  prior fiscal year |       | $                      | 496,610    |              | $          | (579,770)                          |       | $ | 15,494 |   |
|                                               |       | or 14.9%               |       | or (42.4)%        |       | or 1.5%                            |       |

 

During the firstthree months of 2007 as compared to the first three months of 2006 our revenueincreased by approximately $500,000 but our loss increased from approximately$1.4 million to approximately $1.9 million. Our gross profit for the quarter ended March 31, 2007 increased byapproximately $122,000 as compared to the same period in the prior fiscal yeardue to an increase in service and other revenue from our customers in thehealthcare vertical market.   Ouroperating expenses increased by approximately $500,000 in the first quarter of2007 as compared to the same quarter in 2006 due to an increase in personnelassociated with our acquisition of BlueChip, as well as a restructuring chargeof approximately $213,000 resulting from the March 2007 restructuring.

The increase in totalrevenue of approximately $500,000 during the quarter ended March 31, 2007 ascompared to the same period of 2006 was due to the revenue associated with thenew customers we gained as a result of our acquisition of BlueChip in December2006.  The revenue from these customersaccounted for approximately $590,000 of our total revenue during the firstquarter of fiscal year 2007 and does not include any software licenserevenue.  The contractual practices thatwe inherited from BlueChip result in a delay in revenue recognition related tothose contracts because they are written in such a way that, when combined withtheir selling practices, they lack vendor-specific objective evidence (“VSOE”)for all elements in the customers’ orders. Thus we do not recognize software license revenue until the products wesell to these customers are actually installed and operating at the customersite.  As a result, our order backlogwhich consists of invoiced and uninvoiced orders received but for which couldnot recognize revenue, increased by approximately $500,000 from the priorquarter.  We are working towardsmodifying those practices so that we can take this revenue in a more timelyfashion in future quarters.

We experienced a 60%increase in AccuRoute software license revenue due to increased sales in thelegal vertical market and a 56% decrease in our legacy fax product line for thequarter ended March 31, 2007 as compared to the same period in the prior fiscalyear.  We continue to experience generalmarket acceptance of our AccuRoute product in the legal vertical market whilethe demand for and marketing of our legacy fax product has continued todecrease. We experienced an increase in service and other revenue for thequarter ended March 31, 2007 as compared to the same period in the prior fiscalyear due primarily to the service and other revenue associated with the newcustomers that we gained as a result of our acquisition of BlueChip and a 51%increase in support revenue for our AccuRoute product.

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Any decrease in demandfor our products would likely result in decreased revenue, which would, inturn, 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, our costs for sales andmarketing, research and development, and general and administrative couldcontinue to increase as a percentage of revenue, thereby negatively affectingour operating results.

In the coming months, ourprimary focus will be to penetrate further vertical and geographic marketsthrough sales and marketing investments, primarily in the healthcare and legalvertical markets.  At the same time, wewill continue developing our strategic relationships in those markets, thefinancial services vertical market, and other vertical markets.  We will continue these efforts through directsales and our strategic and channel partners, all with the goal of increasingAccuRoute sales opportunities in other vertical markets.

Sales from our Europeanoperations, which were in a steady decline for several years, have beenrelatively flat for the past four quarters. We remain optimistic that we will see improvements outside the Americas,but for now, we will rely primarily on our U.S. sales organization for ourshorter-term growth.  While total revenuefrom our legacy fax business continues to decline, we expect that themaintenance component of that business will remain stable over time.  The recent stabilization of the maintenancecomponent of our legacy fax business and the continued growth of our AccuRoutebusiness gives us confidence that our planned investments are warranted, as webelieve they will produce significant improvements in our financial resultsover time when combined with our cost savings plan described herein.

The following is apresentation of our domestic and international revenue:
| ** **                                    | ** ** | **Total Revenue** | ** ** | **United States Revenue**   | ** **                             | **Non-United States Revenue** | ** **                             |
|-----------------------------------------------|------------|------------------------|------------|---------------------------------------|----------------------------------------|-----------------------------------------|----------------------------------------|
| Three months  ended March 31, 2007            |       | $                      | 3,833,114  |                                  | $2,778,287  or 72.5% of Total  Revenue |                                    | $1,054,827  or 27.5% of Total  Revenue |   |
| Three months  ended March 31, 2006            |       | 3,336,504              |       | 2,898,667  or 86.9% of Total  Revenue |                                   | 437,837  or 13.1% of Total  Revenue     |                                   |
| Change from same period  of prior fiscal year |       | $                      | 496,610    |                                  | $(120,380)                             |                                    | $616,990                               |   |

 

We have historicallyderived a majority of our total revenue from sales within the UnitedStates.  Revenue from outside of theUnited States increased by approximately $617,000 during the three months endedMarch 31, 2007 as compared to the same period in 2006.  This increase is due primarily to the receiptof one software license, service and other order from a customer located in theUnited Kingdom.  We will continue to leverageour AccuRoute base in Europe, as well as our indirect channel relationships inEurope, to focus sales resources on the legal and financial services verticalmarkets.  However, we expect that, in theshort-term, US sales are likely to constitute a greater percentage of revenuethan sales outside the US and there can be no assurance that we will be able toincrease international sales of our products and the failure to do so may havea material 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 resultsgenerated by that entity into United States dollars and consolidate them withour domestic results for reporting purposes. As we sell our products to customers in a variety of countries,significant currency exchange rate fluctuations could have a material impact onour results of operations.  We manage ourforeign currency exchange exposure by monitoring our net monetary positionusing natural hedges of our assets and liabilities denominated in localcurrencies.  There can be no assurancethat this policy will eliminate all foreign currency exchange exposure.  Foreign currency exposure has not been materialto our financial position or results of operations to date.  If the volume of our business denominated inforeign currencies increases, we may be required to use derivatives to hedgeforeign currency exposure.

We will continue toleverage our existing distribution channels, where appropriate, to broaden ourreach to our target vertical markets and further penetrate our installedcustomer 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.  However, as shown in thefollowing table, in recent periods, more of our sales resources have beenfocused on the direct model and we have consequently derived a significantportion of our revenue from direct sales:

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|                                               | ** ** | **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 March 31,  2007            |       | $                                                                    | 1,509,319  |                                                                                                                        | $          | 429,958                                                                                                                                                                                                                                              |       | 28.5 | % |
| Three months  ended March 31, 2006       |       | $                                                                    | 1,589,219  |                                                                                                                        | $          | 571,281                                                                                                                                                                                                                                              |       | 35.9 | % |
| Change from same period of  prior fiscal year |       | $                                                                    | (79,900)   |                                                                                                                        | $          | (141,323)                                                                                                                                                                                                                                            |       | (7.4 | )% |
|                                               |       | or (5.0)%                                                            |       | or (24.7)%                                                                                                                  |       |                                                                                                                                                                                                                                                 |       |

 

**CriticalAccounting 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 and any associated risks related to these policies on ourreported and expected financial results and business operations are discussedin appropriate sections throughout Management’s Discussion and Analysis ofFinancial Condition and Results of Operations. 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 no assurance that actual resultswill not differ materially from those estimates.

*Revenue Recognition andAccounts Receivable Reserves.**  *We derive our revenue primarilyfrom two sources: (i) product revenue, which includes software license,hardware, and media revenue, and (ii) service and support revenue, whichincludes software maintenance and support, installation, implementation, training,and consulting revenue.  We license oursoftware products on a perpetual basis. We generate revenue from licensing the rights to use our softwareproducts and sales of hardware directly to end-users and indirectly throughresellers.  Our resellers order productsfrom us based on purchase orders received from end-users and do not orderstock.  We generally sell our products toresellers and directly to end-users without any specifically stated rights ofreturn.  Occasionally, however, in oursole discretion, we will accept a product return if the end-user finds that theproduct does not fit its needs.  We sellhardware and media products, which are provided by a third-party, at cost plusan additional mark-up, directly to end-users and, in the case of hardware,indirectly through resellers as well. The hardware products that we resell are not functional without oursoftware.  To support our softwareproducts, we sell software maintenance and support, installation,implementation, training, and consulting services directly to end-users andindirectly through resellers.

We apply the provisionsof Statement of Position (“SOP”) 97-2,**“*Software Revenue Recognition*,” asamended by SOP 98-9, Modification of SOP 97-2,**“*Software Revenue Recognition with Respect to CertainTransactions*” (“SOP 98-9”), to all transactionsinvolving the sale of multiple elements including software, hardware andservice revenue.  We apply the provisionsof Statement of Financial Accounting Standards (“SFAS”) No. 48,**“*Revenue Recognition When Right of Return Exists*,”with respect to providing for potential future product returns.  As described below, we must make and usesignificant judgments and estimates in connection with the revenue recognizedin any accounting period.  Material differencesmay have resulted in the amount and timing of our revenue if we had madedifferent judgments or utilized different 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 the resultingreceivable is probable, and there are no uncertainties regarding customeracceptance.  We maintain a reserve forpotential product returns.  We sellmonthly, annual, and multiple-year maintenance contracts and the associatedrevenue is recognized over the term of the related maintenance period,beginning on the date of delivery.  Werecognize other service revenue as we perform the associated services.  If an arrangement includes an acceptanceprovision and acceptance is uncertain, then we will defer all revenue until thecustomer accepts the products purchased. Acceptance in these instances generally occurs upon the earlier ofreceipt of a written customer acceptance or expiration of the acceptanceperiod.  If an arrangement includes anacceptance provision tied to determination that our product meets publishedspecifications and there are no uncertainties with regard to the customer’sacceptance, then we will recognize revenue at the time of sale, provided thatall of the other previously mentioned revenue recognition criteria have beenmet and the acceptance period is of short duration.

Our transactionsfrequently involve the sale of software, hardware, and related services undermultiple element arrangements.  Revenueunder multiple element arrangements is allocated to each element, to the extentVSOE of fair value exists, under the residual method, in accordance with SOP 98-9.  Under this method, revenue is allocated firstto all undelivered elements, such as services, based on the fair value of thoseelements, which is calculated to be the price charged when these elements aresold separately and unaccompanied by other elements.  Our services generally are not essential tothe functionality of the software, as these services do not alter thecapabilities of the software and do not carry a significant degree of risk toperform.  The amount allocated to thedelivered elements, such as software license and hardware revenue, is thedifference between the total arrangement value and the amount allocated to theundelivered elements.  If the deliveredelements include both software and hardware, the amount allocated to hardware 

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revenue is based on theprice charged to us by the third party vendor plus an additional mark up, withthe remainder allocated to software revenue. To the extent that a discount is offered in the arrangement, the entirediscount is allocated to the delivered element or elements.  If the delivered elements include hardwareand software, the discount is allocated to the hardware and software based ontheir respective list prices.

For our newly acquiredsuite of products for the healthcare vertical market, we have established VSOEof fair value for our support services but not for the software license orimplementation services provided to our customers.  Whenever the software license, implementationservices, and support services are sold together, we first allocate revenue tothe support services based upon the respective fair value.  The remaining revenue is then allocated tothe software license and implementation services.  Recognition of revenue from software licensessold with implementation services is recognized once the software license hasbeen delivered and the implementation services have been completed and acceptedby the customer.

For all sales, we use abinding purchase order, a signed contract, or a credit card authorization asevidence of an arrangement.  Salesthrough 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 significant portion of a fee is duebeyond our normal payment terms, which are thirty to sixty days from invoicedate, we account for the fee as not being fixed or determinable.  In these cases, we recognize revenue as thefees become due. We assess collectability based on a number of factors,including past transaction history with the customer and the creditworthinessof the customer.  We reviewDunn & Bradstreet credit reports for all of our resellers and adjustour credit limits with those resellers accordingly.  If a particular reseller does not have afavorable report or if we do not have enough credit information to determinewhether the reseller is creditworthy then we would typically sell to thatreseller on cash on delivery terms.  Wedo not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, thefee 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 new product introductions, changes incustomer demand, and acceptance of our products on the adequacy of thesereserves.  Our calculation of theestimated return reserve is based upon (1) an account-specific review ofpotential returns, where a return probability is known, and (2) anestimate based upon past historical returns as a percentage of revenue.  We must make and use significant judgmentsand estimates in connection with establishing the product returns reserve inany accounting period.  Materialdifferences may have resulted in the amount and timing of revenue for this orany prior period if we made different judgments or utilized differentestimates.

As with the productreturn reserve, we must make estimates of our ability to collect on ouraccounts receivable.  We record tradeaccounts receivable at the invoiced amount and these accounts do not bearinterest.  We specifically analyzeaccounts receivable, historical bad debts, customer creditworthiness, currenteconomic trends, and changes in customer payment patterns when evaluating theadequacy of our allowance for doubtful accounts.  We review our allowance for doubtful accountson a monthly basis.  Our calculation ofthe estimated accounts receivable reserve is also based upon (1) an account-specificreview of potential uncollectible accounts, where a bad debt probability isknown, and (2) an estimate based upon past historical bad debts as apercentage of accounts receivable.  We donot have any off-balance-sheet credit exposure to our customers.

Our combined accountsreceivable and product returns reserve was $28,000 and $14,000 at March 31,2007 and December 31, 2006, respectively.  Both components of calculating the estimatedreserve – specific identification and historic experience — arematerial judgments that we make.  We basethese judgments on historic trends, taking into consideration current businessand economic conditions, which could change materially, thus changing therequired reserve level materially.  Thepotential change to the size of our required reserve could be positive, in theevent the reserve estimate proves unnecessary, or negative, if the reserveproves inadequate.

Our deferred revenue iscomprised mainly of revenue that is deferred for software maintenance and supportcontracts as well as sales of our products targeted to the healthcare verticalmarket that involve both the sale of software and implementation services forwhich the implementation services have not yet been performed and accepted bythe customer.  The other components ofdeferred revenue are amounts from sales transactions that were deferred becausethey did not meet all of the provisions of our revenue recognition policy.

*Software DevelopmentCosts.** *Weconsider software development costs for capitalization when technologicalfeasibility is established in accordance with SFAS No. 86,**“*Accounting for the Costs of Computer Software To BeSold, Leased or Otherwise Marketed*.”  We sell software in a market that is subjectto rapid technological change, new product introductions, and changing customerneeds.  Accordingly, we have determinedthat we cannot ascertain technological feasibility until the development stateof the product is nearly complete.  Thetime period during which cost could be capitalized from the point of reachingtechnological feasibility until the time of general product release is veryshort and, consequently, the amounts that might be capitalized are not materialto our consolidated financial position or results of operations.  Therefore, we charge all software developmentcosts to operations in the period incurred.

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*Goodwilland Intangible Assets. *Weaccount for goodwill in accordance with SFAS No. 142 “*Goodwill andOther Intangible Assets*” (“SFAS 142”).  Goodwill represents the excess of purchaseprice in a business combination over the fair value of net tangible andintangible assets acquired.  Inaccordance with SFAS 142, goodwill amounts are not amortized, but rather aretested for impairment at least annually. Intangible assets that are not considered to have an indefinite usefullife are amortized over their useful lives, which range from three to tenyears.

*We account for intangible assets inaccordance with SFAS No. 144 “*Accounting for the Impairmentor Disposal of Long-Lived Assets.”  Intangible assets include customer contractsand relationships, purchased technology, trade names, and non-competeagreements.  The carrying amount of theintangible assets is reviewed whenever events or changes in circumstancesindicate that the carrying value of an asset may not be recoverable.  Recoverability of these intangible assets ismeasured by comparison of the carrying amount of the asset to the futureundiscounted cash flows the asset is expected to generate.  If the intangible asset is considered to beimpaired, the amount of any impairment is measured as the difference betweenthe carrying value and the fair value of the impaired asset.

We account for businesscombinations in accordance with SFAS No. 141, “*Business Combinations*”**(“SFAS 141”), whichrequires the use of the purchase method of accounting for businesscombinations.  In accordance withSFAS 141, we determine the recognition of intangible assets based on thefollowing criteria: (i) the intangible asset arises from contractual orother rights; or (ii) the intangible asset is separable or divisible fromthe acquired entity and capable of being sold, transferred, licensed, returned,or exchanged.  In accordance withSFAS 141, we allocate the purchase price of our business combinations tothe tangible assets, liabilities, and intangible assets acquired, includingin-process research and development, based on their estimated fair values.  The excess purchase price over those fairvalues is recorded as goodwill.

*StockBased Compensation. *EffectiveJanuary 1, 2006, we adopted the provisions of SFAS 123R, using the modifiedprospective method.  SFAS 123R requiresus to measure the cost of employee services in exchange for an award of anequity instrument based on the grant-date fair value of the award and torecognize expense over the requisite service period.  Under the modified prospective method,financial statements for periods prior to the date of adoption are not adjustedfor the change in accounting, thus, prior period financial statements have notbeen restated.  However, compensationexpense is recognized for (a) all share-based payments granted after theeffective date and (b) all awards granted to employees prior to the effectivedate that remain unvested on the effective date.  Based upon historical information andmanagement’s estimate of future voluntary turnover rates, we have calculatedour stock-based compensation expense using an annualized estimated forfeiturerate of 10% for restricted stock and 5% for stock options.  Estimated forfeitures are trued-up to actualforfeitures at the end of each reporting period.

On November 10, 2005,FASB issued FASB Staff Position FAS 123R-3 “*Transition ElectionRelated to Accounting for Tax Effects of Share-Based Payment Awards.*”  The Company has elected to adopt thealternative transition method provided the FASB Staff Position for calculatingthe tax effects (if any) of stock-based compensation expense pursuant to SFAS123R.  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.

*Taxes.**  *Weare required to estimate our income and state sales taxes.  This process involves estimating our actualcurrent tax obligations, while also assessing differences resulting from thedifferent treatment of items for tax and accounting purposes that result indeferred income tax assets and liabilities and accrued state sales taxliabilities.  We include deferred incometax assets and liabilities and accrued state sales tax liabilities in ourconsolidated balance 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 this assessment, we includeassumptions regarding ongoing tax planning strategies.  We establish a valuation allowance for assetswhen their recovery is not certain.  Weinclude changes to the valuation allowance as an expense or benefit within thetax 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 ofthese deferred tax assets depends upon our ability to generate sufficientfuture taxable income.  If we aresuccessful in generating sufficient future taxable income, we will reduce thevaluation allowance through a reduction in income tax expense in the future.

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 estimates used todetermine this liability are subject to change as they are difficult to measureor value.  In the event that actualresults differ from these estimates, our state sales taxes expense could bematerially impacted.

**NewAccounting Pronouncements**

In September 2006, theFASB issued Statement No. 157 “*Fair Value Measurements*”**(“SFAS 157”), which establishes a framework formeasuring fair value in generally accepted accounting principles and expandsdisclosures about fair value financial 

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instruments.  SFAS 157 becomes effective for fiscal yearsbeginning after November 15, 2007.  Wewill adopt this statement prospectively once it is effective and applicable tous.  We do not expect SFAS 157 to have amaterial impact on our financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159 “*The FairValue Option for Financial Assets and Financial Liabilities*”**(“SFAS 159”), which permits entities to choose tomeasure many financial instruments and certain other items at fair value.  SFAS 159 becomes effective for fiscal yearsbeginning after November 15, 2007.  Wewill adopt this statement prospectively once it is effective and applicable tous.  We do not expect the adoption of SFAS 159 to have a material impact onour financial position or results of operations.

**Resultsof Operations**

 Thefollowing table sets forth certain financial data for the periods indicated asa percentage of total revenue:
|                             | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Revenue:                    |       |                                             |       |   |   |
| Software license            |       | 27.3                                             | %          | 30.9 | % |
| Hardware and  media         |       | 12.1                                             |       | 16.7 |   |
| Service and  other          |       | 60.6                                             |       | 52.4 |   |
| Total revenue               |       | 100.0                                            |       | 100.0 |   |
| Cost of revenue:            |       |                                             |       |   |   |
| Software license            |       | 2.6                                              |       | 0.9 |   |
| Hardware and  media         |       | 7.7                                              |       | 10.3 |   |
| Service and  other          |       | 27.9                                             |       | 21.4 |   |
| Total cost of  revenue      |       | 38.2                                             |       | 32.6 |   |
| Gross profit                |       | 61.8                                             |       | 67.4 |   |
| Operating  expenses:        |       |                                             |       |   |   |
| Sales and  marketing        |       | 57.3                                             |       | 61.5 |   |
| Research and  development   |       | 23.0                                             |       | 21.2 |   |
| General and  administrative |       | 26.0                                             |       | 27.0 |   |
| Restructuring  costs        |       | 5.5                                              |       | — |   |
| Total operating  expenses   |       | 111.8                                            |       | 109.7 |   |
| Loss from  operations       |       | (50.0                                            | )          | (42.3 | ) |
| Interest income             |       | 0.5                                              |       | 1.3 |   |
| Interest expense            |       | (1.3                                             | )          | 0.0 |   |
| Income tax  benefit         |       | 0.0                                              |       | 0.0 |   |
|                        |       |                                             |       |   |   |
| Net loss                    |       | (50.8                                            | )%         | (41.0 | )% |
|                        |       |                                             |       |   |   |
| Gross margin:               |       |                                             |       |   |   |
| Software license            |       | 90.3                                             | %          | 97.0 | % |
| Hardware and  media         |       | 36.3                                             |       | 38.1 |   |
| Service and other           |       | 54.0                                             |       | 59.2 |   |

 

**Revenue**

*SoftwareLicense. * During the three months ended March 31, 2007,we experienced a slight increase in our software license revenue as compared tothe same period in the prior fiscal year, due to a 60% increase in revenue fromsales of our AccuRoute product, which was offset in part by a 56% decrease inrevenue from sales of our legacy fax products. We continue to experience general market acceptance of our AccuRouteproduct in the legal vertical market while the demand for and our marketing ofour legacy fax product has continued to decrease.

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During the three monthsended March 31, 2007, our software license revenue by product category, ascompared to the same period in the prior fiscal year was as follows:
|                                               | ** ** | **Total  Revenue** | ** ** | **Software License  Revenue** | ** ** | **AccuRoute  License  Revenue** | ** ** | **Legacy Fax  License  Revenue** | ** ** | **Freight and  Allowances for  Returns** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|------------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|----------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                  | 3,833,114  |                               | $          | 1,047,313                       |       | $                                     | 835,715    |                                               | $          | 219,911 |   | $ | (8,313 | ) |
| Three months  ended March 31, 2006            |       | $                  | 3,336,504  |                               | $          | 1,031,819                       |       | $                                     | 521,889    |                                               | $          | 498,980 |   | $ | 10,950 |   |
| Change from same period of  prior fiscal year |       | $                  | 496,610    |                               | $          | 15,494                          |       | $                                     | 313,826    |                                               | $          | (279,069) |   | $ | (19,263) |   |
|                                               |       | or 14.9%           |       | or 1.5%                            |       | or 60.1%                        |       | or (55.9)%                            |       | or (175.9)%                                        |       |

 

During the three monthsended March 31, 2007, our software license revenue represented a decreasedpercentage of our total revenue as compared to the same period in 2006 becausewe could not currently recognize any software license revenue for the productswe sell to the customers we gained as a results of the BlueChip acquisition,and we had an increase in service and other revenue as discussed further below.
|                                               | ** ** | **Software License Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| Three months  ended March 31, 2007            |       | 27.3%                                                                                             |       |
| Three months  ended March 31, 2006            |       | 30.9%                                                                                             |       |
| Change from same period  of prior fiscal year |       | (3.6)%                                                                                            |       |

 

The results for the threemonths ended March 31, 2007 and 2006 demonstrate that our software licenserevenue continues to shift towards our AccuRoute product, as displayed in thetable below, which summarizes revenue from each of our major product lines andother components of revenue as a percentage of our total software licenserevenue:
|                                               | ** ** | **AccuRoute License Revenue as  a Percentage of Software  License Revenue** | ** ** | **Legacy Fax License  Revenue as a Percentage of  Software License Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended March 31, 2007            |       | 79.8%                                                                                                          |       | 21.0%                                                                                                                |       |
| Three months  ended March 31, 2006            |       | 50.6%                                                                                                          |       | 48.4%                                                                                                                |       |
| Change from same period  of prior fiscal year |       | 29.2%                                                                                                          |       | (27.4)%                                                                                                              |       |

 

*Hardwareand Media.*  Hardware and media revenue decreased duringthe three month period ended March 31, 2007 as compared to the three month periodended March 31, 2006 due to a decrease in sales of our legacy fax products,which sales are the main driver for our hardware revenue.  This decrease was offset in part by the$170,000 of media revenue that we added during the first quarter of fiscal year2007 as a result of our acquisition of BlueChip.
|                                               | ** ** | **Hardware and Media  Revenue** | ** ** | **Hardware and Media  Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                         | 462,006    |                                                                                                 | 12.1%      |   |
| Three months  ended March 31, 2006            |       | $                                         | 557,400    |                                                                                                 | 16.7%      |   |
| Change from same period of  prior fiscal year |       | $                                         | (95,394)   |                                                                                                 | (4.6)%     |   |
|                                               |       | or (17.1)%                                |       |                                                                                                 |       |

 

*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, installation, andimplementation services, increased in the three months ended March 31, 2007 ascompared to the same period in the prior fiscal year.  This increase wasdue primarily to $420,000 of  service andimplementation revenue that we added in connection with our December 2006acquisition of BlueChip.  To a lesserextent, the increase in service revenue for the quarter ended March 31, 2007 ascompared to the same period in the prior fiscal year stemmed from a 51%increase in support revenue from our AccuRoute product during those periods.
|                                               | ** ** | **Service and Other Revenue** | ** ** | **Service and Other Revenue as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                            | 2,323,795  |                                                                                                    | 60.6%      |   |
| Three months  ended March 31, 2006            |       | $                                            | 1,747,285  |                                                                                                    | 52.4%      |   |
| Change from same period of  prior fiscal year |       | $                                            | 576,510    |                                                                                                    | 8.2%       |   |
|                                               |       | or 33.0%                                     |       |                                                                                                    |       |

 

We are focused onimproving the renewal rate of software maintenance contracts with our existingcustomer base in the United States, Europe, and other non-U.S. locations, andwe continue to focus our attention on generating additional service and otherrevenue in future quarters.

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**Cost of 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 licenserevenue for the three months ended March 31, 2007 increased as compared to thecorresponding period in the previous fiscal year.  This increase is dueprimarily to the amortization of purchased technology associated with ouracquisition of BlueChip, which is being amortized over its estimated futurelife of five years.  To a lesser extent,cost of software license revenue increased due to a change in the mix ofsoftware license products sold, resulting in higher royalty fees.  We may license additional third-partysoftware components in the future and, if that were to happen, we would expectthat our cost of software license revenue as a percentage of software licenserevenue would increase slightly.

As a result of theincrease in the cost of software license revenue that we incurred during thefirst quarter of 2007, we incurred a decrease in our software license grossmargin percentage as set forth in the following table:
|                                               | ** ** | **Cost of Software License Revenue** | ** ** | **Software License Gross Margin** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                                        | 101,275    |                                             | 90.3%      |   |
| Three months ended  March 31, 2006            |       | $                                                        | 31,441     |                                             | 97.0%      |   |
| Change from same period of  prior fiscal year |       | $                                                        | 69,834     |                                             | (6.7)%     |   |
|                                               |       | or 222.1%                                                |       |                                             |       |

                                                

*Hardwareand Media. * Cost of hardware and media revenue consistsprimarily of the costs we incur in purchasing third-party hardware and mediaproducts.  During the first quarter of 2007, we incurred decreased costsof hardware revenue due to the decrease in our hardware unit sales.  Thisdecrease was offset in part by our cost of media revenue of approximately$102,000, which cost relates entirely to the media sales that we are now makingas a result of our acquisition of BlueChip. Our hardware and media gross margin percentage decreased during thequarter ended March 31, 2007 as compared to the same period in the prior fiscalyear due to an unfavorable change in the mix of particular hardware productsthat we sold, offset in part by an increase in the gross margin related tomedia sales, which had a higher gross margin than our hardware sales.  We do not expect significant changes in unitprices for the remainder of 2007.
|                                               | ** ** | **Cost of Hardware and Media Revenue** | ** ** | **Hardware and Media Gross  Margin** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                                               | 294,130    |                                                | 36.3%      |   |
| Three months  ended March 31, 2006            |       | $                                                               | 345,078    |                                                | 38.1%      |   |
| Change from same period of  prior fiscal year |       | $                                                               | (50,948)   |                                                | (1.8)%     |   |
|                                               |       | or (14.8)%                                                      |       |                                                |       |

 

*Serviceand Other. * Cost of service and other revenue consistsprimarily of the costs we incur in providing telephone support, implementationas well as other miscellaneous customer service-related expenses.  Cost ofservice and other revenue increased in absolute dollars and the service andother revenue gross margin decreased during the first three months of 2007compared to the same period in the prior fiscal year.  The increase inabsolute dollars and decrease in gross margin is primarily due to the additionof former BlueChip employees in December 2006 to our service department, aswell as the hiring of additional employees during the second quarter of fiscalyear 2006.  We expect our service andother gross margin to remain relatively consistent on a quarterly basis for theremainder of fiscal year 2007.
|                                               | ** ** | **Cost of Service and Other  Revenue** | ** ** | **Gross Margin for Service  and Other Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                                          | 1,068,375  |                                                                     | 54.0%      |   |
| Three months  ended March 31, 2006            |       | $                                                          | 713,099    |                                                                     | 59.2%      |   |
| Change from same period of  prior fiscal year |       | $                                                          | 355,276    |                                                                     | (5.2)%     |   |
|                                               |       | or 49.8%                                                   |       |                                                                     |       |

 

**Operating Expenses**

*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 communication costs. Sales and marketing expenses increased in absolute dollars but decreased as apercentage of total revenue in the first quarter of 2007 as compared to thesame period in 2006 due to the addition of former BlueChip employees to oursales and marketing departments, which resulted in increased wages and othercosts associated with supporting those employees.  During the first quarter of fiscal year 2007we also increased our marketing program expenditures, including tradeshows,public relations, and collateral as compared to the same period in the priorfiscal year.  These increases in sales and marketing expenses were offsetin part by a decrease in commission expense due to the restructuring plan thatwe adopted in March 2007, as well as changes we made to our sales commissionplans.  Sales and marketing expenses as apercentage of total revenue decreased during the three month period ended March31, 2007 as compared to the three month period ended March 31, 2006 due to ouraccelerated investment in sales 

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and marketing during thefirst quarter of 2006.  We expect oursales and marketing expenses to decrease in absolute dollars during theremainder of fiscal year 2007 as a result of our recently adopted restructuringplan.
|                                               | ** ** | **Sales and Marketing Expenses** | ** ** | **Sales and Marketing Expenses as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                               | 2,196,729  |                                                                                                       | 57.3%      |   |
| Three months  ended March 31, 2006            |       | $                                               | 2,052,207  |                                                                                                       | 61.5%      |   |
| Change from same period of  prior fiscal year |       | $                                               | 144,522    |                                                                                                       | (4.2)%     |   |
|                                               |       | or 7.0%                                         |       |                                                                                                       |       |

 

*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 the quarter ended March 31, 2007, ourresearch and development expenses increased in absolute dollars and as apercentage of total revenue as compared to the same period in the prior fiscalyear, due to an increase in the number of engineers we employed as a result ofnew hires through our acquisition of BlueChip, which resulted in increasedwages and other costs associated with supporting those employees.  This increase in research and developmentexpenses was offset in part by a decrease in consulting expenses resulting fromthe completion of a consulting project during the first quarter of 2006 and, toa lesser extent, a decrease in recruiting fees. We expect our research and development expenses to decrease in absolutedollars during the remainder of fiscal year 2007 as a result of our recentlyadopted restructuring plan, through which we have decreased the number ofemployees engaged in research and development and decreased consulting costsfor research and development services.
|                                               | ** ** | **Research and Development  Expenses** | ** ** | **Research and Development  Expenses as a Percentage of  Total Revenue** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                                | 880,081    |                                                                                                        | 23.0%      |   |
| Three months  ended March 31, 2006            |       | $                                                | 707,252    |                                                                                                        | 21.2%      |   |
| Change from same period of  prior fiscal year |       | $                                                | 172,829    |                                                                                                        | 1.8%       |   |
|                                               |       | or 24.4%                                         |       |                                                                                                        |       |

 

 *General and Administrative. * Generaland administrative expenses consist primarily of employee salaries, benefitsfor administrative, executive and finance personnel, and associated corporate,general, and administrative expenses.  In the most recently completedfiscal quarter, our general and administrative expenses increased as comparedto the same period in the prior fiscal year. The increase in general and administrative expenses is due to anincrease in legal and accounting fees related primarily to work associated withpublic company reporting requirements and a review of our existing commercialand licensing agreements and, to a lesser extent, an increase in consultingexpenses associated with our fiscal year-end regulatory filings with theSecurities and Exchange Commission (“SEC”).  We expect our general and administrativeexpenses to decrease in absolute dollars during the remainder of fiscal year2007 as a result of our recently adopted restructuring plan that reduced thenumber of employees in the general and administrative department as well asdecreased consulting costs.
|                                               | ** ** | **General and Administrative  Expenses** | ** ** | **General and Administrative Expenses  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                                                  | 996,945    |                                                                                                              | 26.0%      |   |
| Three months  ended March 31, 2006            |       | $                                                  | 899,942    |                                                                                                              | 27.0%      |   |
| Change from same period of  prior fiscal year |       | $                                                  | 97,003     |                                                                                                              | (1.0)%     |   |
|                                               |       | or 10.8%                                           |       |                                                                                                              |       |

 

*RestructuringCosts.*  In March 2007, we announced arestructuring of certain of our operations and reduced our workforce byapproximately twelve positions.  Since then,  employee attrition and the elimination ofadditional positions, when combined with the March restructuring and the otheroperating expense reductions we have made, has resulted in a total decrease ofapproximately thirty positions and, we believe, an annual savings ofapproximately $3.6 million.  Our threegoals in undertaking these cost reduction measures are: one, to achievefinancial results that will enable us to be at or near cash flow break even bythe end of fiscal year 2007; two, to enable our sales force to focus on sellingproducts to customers in the legal and healthcare vertical markets directly andalso in partnership with indirect sales channels, while allowing our partnersto focus on selling our products to customers in the financial services andother vertical markets; and three, to support our integration of the BlueChipbusiness.

As a result ofthese cost reduction activities, we recorded a pre-tax charge of $212,802,which charge included $177,630 of severance-related costs and $35,172 of costsrelating to the closing of BlueChip’s former headquarters.  The total cash impact of the restructuringwas $212,802; $63,889 was paid during the quarter ended March 31, 2007 andthe remaining balance of $148,913 is expected to be paid during the secondquarter of fiscal year 2007 and has been included in accrued liabilities in ourconsolidated balance sheet as of March 31, 2007.

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|                                               | ** ** | **Restructuring Costs** | ** ** | **Restructuring Costs  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                            | 212,802    |                                                                                    | 5.6%       |   |
| Three months  ended March 31, 2006            |       | $                            | 0          |                                                                                    | 0.0%       |   |
| Change from same period of  prior fiscal year |       | $                            | 212,802    |                                                                                    | 5.6%       |   |
|                                               |       | or 100.0%                    |       |                                                                                    |       |

 

*InterestIncome and Interest Expense. * Interest income consistsprimarily of interest income earned on cash and cash equivalent balances.  The decrease in interest income is a resultof a lower average investment balance during the first three months of fiscalyear 2007 as compared to the first three months of fiscal year 2006.  Interest expense represents the interestassociated with the capital lease that we entered into in May 2006 to financethe purchase of furniture and equipment for our new headquarters, as well asinterest expense associated with the promissory note issued to the seller ofBlueChip.

We expect interest incomeand interest expense to remain relatively stable for each quarter of theremainder of fiscal year 2007.  
|                                               | ** ** | **Interest Income** | ** ** | **Interest Expense** | ** ** | **Interest Income  as a Percentage   of Total Revenue** | ** ** | **Interest Expense  as a Percentage   of Total Revenue** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|---------------------------|------------|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| Three months ended March 31,  2007            |       | $                        | 20,488     |                      | $          | (51,037                                                                               | )          | 0.5%                                                                                   |       | 1.3% |   |
| Three months  ended March 31, 2006            |       | $                        | 44,573     |                      | $          | (60                                                                                   | )          | 1.3%                                                                                   |       | 0.0% |   |
| Change from same period of  prior fiscal year |       | $                        | (24,086)   |                      | $          | 50,977                                                                                |       | (0.8)%                                                                                 |       | 1.3% |   |
|                                               |       | or (54.0)%               |       | or 84,961.7%              |       |                                                                                  |       |                                                                                   |       |

 

*IncomeTax Benefit. * We did not record an income tax benefitassociated with any pre-tax loss for the three months ended March 31, 2007 or2006 due to uncertainty regarding future taxable income.

**Inflation**

During the fiscal yearsended December 31, 2004, 2005 and 2006 and the three months ended March 31,2007, neither inflation nor changing prices have had a material impact on ournet sales, revenue or income from continuing operations.

**Liquidityand Capital Resources**

Since 1996, we havefinanced our operations primarily through cash flow from operations privatesales of securities, and our As of March 31, 2007, we had cash and cashequivalents of $4.1 million and a net working deficit of $2.0 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** | ** ** |
| Three months ended March 31,  2007            |       | $                          | (642,449   | ) | $ | (127,496 | ) | $ | (575,219 | ) |
| Three months  ended March 31, 2006            |       | $                          | (965,824   | ) | $ | (374,461 | ) | $ | (5,103 | ) |
| Change from same period of  prior fiscal year |       | $                          | 323,375    |   | $ | 246,965 |   | $ | (570,116) |   |
|                                               |       | or 33.5%                   |       | or 66.0% |   | or (11,172.2)% |   |

 

Our operating activitiesused cash of $642,000 and $966,000 for the three months ended March 31, 2007and 2006, respectively.  We believe that the resources we are allocatingto improve the success of our AccuRoute product in the legal vertical marketand its expansion into the financial services and healthcare vertical marketswill continue to put pressure on our earnings during the remainder of 2007, butthat our existing cash is sufficient for at least the next twelve months.

Net cash used during thethree months ended March 31, 2007 consisted primarily of a net loss fromoperations and a decrease in accounts payable, offset in part by an increase indeferred revenue and accrued liabilities, as well as by the non-cash effects ofdepreciation and amortization and stock-based compensation, predominately forvesting of restricted stock shares.

The decrease in accountspayable is primarily due to the payment of financial advisory, legal, andaccounting expenses associated with our acquisition of BlueChip.  The increase in deferred revenue is primarilydue to the deferral of sales orders for our healthcare customers for whichservices had not yet been performed and accepted, as well as deferredimplementation services for BlueChip which were recorded as deferred revenuefor purposes of purchase accounting.  Theincrease in accrued liabilities is due to the unpaid restructuring chargesrecorded in the first quarter of 2007 and an increase in accrued wages due tothe timing of payroll disbursements.  Theincrease in depreciation and amortization expense is due to the amortizationrelated to the net identifiable intangible assets recorded in connection withour December 2006 acquisition of BlueChip. Net cash used during the three months ended March 31,

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2006 consisted primarilyof net loss from operations and a decrease in accrued liabilities, offset inpart by an increase in accounts payable, an increase in deferred revenue, and adecrease in inventory, as well as the non-cash effects of stock-basedcompensation and depreciation.

Investing activities usedcash of $127,000 and $374,000 during the three months ended March 31, 2007 and2006, respectively.  The primary use of cash for investing activitiesduring the first quarter of 2007 was for additional legal and accounting feesrelated to our December 2006 acquisition of BlueChip.

The sole use of cashduring the first quarter of 2006 was for the purchases of furniture, equipmentand construction costs associated with the moving of our headquarters in 2006.

Financing activities usedcash of $575,000 and $5,000 during the three months ended March 31, 2007 andMarch 31, 2006, respectively.  Theprimary use of cash during the three months ended March 31, 2007 was the $562,090cash payment made to the Seller of BlueChip as part of the purchaseconsideration for BlueChip and for the repayment of capital leaseobligations.  Cash used during the threemonths ended March 31, 2006 consisted primarily of the purchase of treasurystock related to sales of restricted stock under our 1997 Stock Plan, offset inpart by the net proceeds from the issuance of common stock pursuant to ouremployee stock purchase program.

Based on our performancefor the three months ended March 31, 2007 and current expectations for theremainder of 2007, we believe that our current cash and cash equivalentsbalance, as well as the cash expected to be generated from operations for theremainder of the year, will satisfy our working capital needs, capitalexpenditures, and other liquidity requirements associated with our operationsthrough at least the next twelve months.  We expect that principal uses ofcash will be for operations, repayment of capital lease obligations, and notespayable.  There can be no assurance thatany necessary additional financing will be available to us on commerciallyreasonable terms, or at all.  Theissuance of additional equity or equity-related securities would be dilutive toour stockholders.  If we cannot raisefunds on acceptable terms, or at all, we may not be able to develop or enhanceour products or respond appropriately to competitive pressures, which wouldseriously limit our ability to increase our revenue and grow our business.

The followingtable represents the approximate amounts of payments due under specifiedcontractual obligations as of March 31, 2007:
| **Contractual Obligations**  | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|-----------------------------------|------------|-----------|------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-------------------------------------|------------|
|                              |       |      |       |                              |       |                              |       |                               |       |                                |       |
| Operating lease  obligations(1,2) |       | $         | 3,926,001  |                              | $          | 646,659                           |       | $                                  | 304,986    |                                | $          | 309,164 |   | $ | 2,665,192 |   |
| Capital lease  obligations(3)     |       | 491,290   |       | 491,290                           |       | —                            |       | —                             |       | —                              |       |
| Note payable(4)                   |       | 1,930,294 |       | 752,404                           |       | 1,177,890                         |       | —                             |       | —                              |       |
| Total contractual  obligations    |       | $         | 6,347,585  |                              | $          | 1,890,353                         |       | $                                  | 1,482,176  |                                | $          | 309,164 |   | $ | 2,665,192 |   |

 

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(1) Operating leaserequirements consist mainly of lease payments for our offices in Andover,Massachusetts and London, England, United Kingdom and BlueChip’s formerheadquarters in Danvers, Massachusetts. The lease for the Danvers, Massachusetts facility terminates in July2007 and we do not have any plans to renew the lease.  As of March 31, 2007, we did not have anylong-term debt obligations, material commitments for capital expenditures, orother long-term liabilities for which payments are required.

(2) Excludes subleaserental income of $394,000 through February 2011.

(3) The Company enteredinto a capital lease agreement in the amount of $491,000 on May 1, 2006 tofinance the purchase of furniture and equipment for the Company’s headquarterslocated in Andover, Massachusetts.  Thelease, which has a five year term, expires on May 31, 2011 and is payable in 60equal monthly installments.  The leasecontains a provision whereby the Company may be required to repay immediatelythe outstanding principal balance under the lease should the Company’s cashbalance fall below $5.0 million.  InJanuary 2007, the Company’s cash balance fell below $5.0 million and thereforethe entire principal balance of $421,088 may be required to be paid in full in2007.

(4) The note, which wasissued to BlueChip’s sole shareholder as part of the consideration forBlueChip, is payable in 36 monthly principal installments of $47,000 plusinterest with the first payment made on April 5, 2007.

**Off-BalanceSheet Arrangements**

We do not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,that would have been established for the purpose of facilitating off-balancesheet 

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arrangements (as thatterm is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractuallynarrow or limited purposes.  As such, we are not exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in thosetypes of relationships.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

*DerivativeFinancial Instruments, Other Financial Instruments, and Derivative CommodityInstruments. *As ofMarch 31, 2007, the Company did not participate in any derivativefinancial instruments or other financial and commodity instruments for whichfair value disclosure would be required under SFAS No. 133, “*Accounting for Derivative Instruments and Hedging Activities.*”All of the Company’s investments consist of money market funds and commercialpaper that are carried on the Company’s books at amortized cost, whichapproximates fair market value. Accordingly, the Company has no quantitative information concerning themarket risk of participating in such investments.

*PrimaryMarket Risk Exposures. *TheCompany’s primary market risk exposures are in the areas of interest rate riskand foreign currency exchange rate risk. The Company’s current investment portfolio of cash equivalents issubject to interest rate fluctuations, but the Company believes this risk isimmaterial due to the short-term nature of these investments.  The Company’s exposure to currency exchangerate fluctuations has been and is expected to continue to be modest due to thefact that the operations of its United Kingdom subsidiary are almostexclusively conducted in the United Kingdom subsidiary’s local currency.  The Company translates the operating resultsof its United Kingdom subsidiary into U.S. dollars and consolidates them forreporting purposes.  The impact ofcurrency exchange rate movements on intercompany transactions was immaterialfor the quarter ended March 31, 2007. The Company manages its foreign currency exchange risk by monitoring itsnet monetary position using natural hedges of its assets and liabilitiesdenominated in local currencies.  Therecan be no assurance that this approach will eliminate all foreign currencyexchange rate exposure.  Currently, theCompany does not engage in foreign currency hedging activities.

**Item4.  Controls and Procedures**

(a)                   Evaluationof disclosure controls and procedures.

As of March 31, 2007 (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 that evaluation, the Company’sChief Executive Officer and Chief Financial Officer concluded that, as of theEvaluation Date, the Company’s disclosure controls and procedures wereeffective in ensuring that information relating to the Company (including itsconsolidated subsidiaries) required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized, and reported within the time periods specified in the Securitiesand Exchange Commission’s rules and forms, including ensuring that thisinformation is accumulated and communicated to the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure.

(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 March 31, 2007 or in other factors that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**PARTII:  OTHER INFORMATION**

**Item1.  Legal Proceedings**

The information contained in Note 12 to the Consolidated FinancialStatements provided in Item 1 of Part I of this Quarterly Report on Form 10-Qis incorporated herein by reference.

**Item1A.  Risk Factors**

**From timeto time we update, revise and supplement the risk factors described under thetitle “Risk Factors” in our Annual Report on Form 10-K for the fiscal yearended December 31, 2006.  There are nomaterial changes to the risk factors described in the “Risk Factors” section inour Annual Report on Form 10-K for the fiscal year ended December 31, 2006other than the inclusion herein of two updated Risk Factors below entitled*“Wehave experienced operating losses and our future operating results areuncertain and difficult to predict,”***and* “Our common stock is listed on the NASDAQCapital Market and any failure to maintain that listing could significantlyimpair our stock price and our ability to raise future capital,”***and a****new Risk Factor entitled*“We are in the process of identifying and analyzing strategic, financial andoperating alternatives, and any such alternatives may not lead to theachievement of desired results.”*

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**Weoperate in a rapidly changing environment that involves a number of risks, someof which are beyond our control.  Thisdiscussion highlights some of the risks that may affect future operatingresults.  These are the risks anduncertainties we believe are most important for you to consider.  Additional risks and uncertainties notpresently known to us, which we currently deem immaterial or which are similarto those faced by other companies in our industry or business in general, mayalso impair our business operations.  Ifany of the following risks or uncertainties actually occurs, our business,financial condition, and operating results would likely suffer.**

****We haveexperienced operating losses and our future operating results are uncertain anddifficult to predict.  ******We had an operating lossfor the quarter ended March 31, 2007 and for the years ended December 31, 2006and 2005 and we last recorded an operating profit in the year ended December31, 2004. There can be no assurance that we will be able to increase our levelof revenue or become profitable again in the future, as our operating historymakes the accurate prediction of future operating results difficult orimpossible. We do, however, anticipate increases in operating expenses and,together with any pricing pressures, failure to achieve broader marketacceptance of our products and decline in the growth rate of the overall UnitedStates economy or our industry in particular, we may experience continuingoperating losses.**

Our AccuRouteproduct represented 80%, 59%, and 50% of software license revenue for thequarter ended March 31, 2007 and the years ended December 31, 2006 and2005, respectively.  Our ability toimprove our operating results will depend upon, among other things, our abilityto increase sales of our AccuRoute, Genifax and BlueChip products to newcustomers, as well as our ability to increase product penetration into existingcustomers.  We expanded our strategicfocus to include document routing and distribution software.  To date, we have limited financial andoperating data and a limited operating history relevant to this strategy.  Accordingly, it is difficult to evaluate theprospects for the level of acceptance of this strategy.  In addition, we plan to continue investingsignificantly in the expansion of our AccuRoute product into new verticalmarkets, including the healthcare and financial services vertical markets, inadvance of significant related revenue from those markets.  We cannot predict the timing or level ofrevenue resulting from these investments. Future operating results will depend on many other factors, including,without limitation, the degree and rate of growth of the markets in which wecompete; the level of product and price competition; our ability to establishstrategic relationships and develop and market new and enhanced products; ourability to control costs; our ability to expand our direct and indirectdistribution channel sales both domestically and internationally; our abilityto integrate our products and cross-sell our solutions across vertical markets;and our ability to attract and retain key personnel.  As a result, it is possible that in thefuture, our operating results will be below the expectations of public marketanalysts and investors.  In that event,the price of our common stock would likely be materially adversely affected.

***Our common stock is listed on the Nasdaq Capital Market andany failure to maintain that listing could significantly impair our stock priceand our ability to raise future capital.***   InNovember 2006, we received a letter from the Listing QualificationsDepartment of the Nasdaq Stock Market (“Nasdaq”) stating that we did not comply with MarketplaceRule 4310(c)(2)(B), which requires issuers on the Nasdaq Capital Market tohave (i) a minimum of $2,500,000 in stockholders’ equity (the “Stockholders’ Equity Requirement”);(ii) $35,000,000 market value of listed securities; or (iii) $500,000of net income from continuing operations for the most recently completed fiscalyear or two of the three most recently completed fiscal years.  Although we regained compliance with theStockholders’ Equity Requirement by December 31, 2006, we have againfallen below the $2,500,000 threshold of the Stockholders’ Equity Requirementas of March 31, 2007 and thus are not in compliance with Marketplace Rule4310(c)(2)(B).  Because we have failed tocomply with the Stockholders’ Equity Requirement for two of the three mostrecently completed fiscal quarters, we may be subject to delisting from theNasdaq Capital Market and, therefore, we cannot predict our ability to maintainour listing in the future on the Nasdaq Capital Market.  The delisting of our common stock from theNasdaq Capital Market, if that were to occur, could materially impairstockholders’ ability to buy and sell shares of our common stock and could havean adverse effect on the market price of, and the efficiency of the tradingmarket for, our common stock.  Furthermore,the delisting of our common stock could significantly impair our ability toraise capital should we desire to do so in the future.

***We are in theprocess of identifying and analyzing strategic, financial and operatingalternatives, and any such alternatives may not lead to the achievement ofdesired results. ***In light of our current and historicaloperating results and the continuing challenges we face, and in order tomaximize shareholder value, we are in an ongoing process of examining ouroperations as well as our strategic and financial alternatives.  The strategic and financial options we mayconsider could include a variety of different business arrangements including,but not limited to: combinations with or a sale to another entity; equity or debtfinancings; strategic partnerships and joint ventures; the sale or spin off ofcertain assets; the acquisition of complementary businesses, technologies orproduct lines; investments in new businesses; reorganization, recapitalization,or distribution alternatives; or other alternatives.  Changes, if any, implemented as a result ofthe strategic and financial alternatives review could affect the basic natureof our Company.  The examination of thesestrategic and financial alternatives requires significant time and attentioncommitments from our management team and could result in additionalexpense.  Any strategic and financialoptions we identify may not be available to us or ultimately consummated.  Any strategic or financial decision willinvolve risks and uncertainties and present challenges in implementation andintegration.  As a result, any suchbusiness arrangement may not lead to increased shareholder value.  In addition, any strategic or financialdecision could lead to non-recurring or other charges or be dilutive to ourcurrent shareholders.

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**Item5.  Other Information**

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

**Item6.  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

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                   | OMTOOL, LTD. |
|-------------------|--------------|
|              |         |   |
|              |         |   |
| May 15, 2007 | By:          | /s/ Daniel A. Coccoluto |   |
|              |         | Daniel A. Coccoluto |
|              |         | Chief Financial Officer, Secretary and Treasurer |
|              |         | (Duly authorized officer and principal financial  officer) |

 

**ExhibitIndex**
| 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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