**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                                                         |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                   |
| **ý**                                                                                                                                                                                             | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                   |
| **For the quarterly period ended  June 30, 2003**                                                                                                                                                 |
|                                                                                                                                                                                                   |
| **OR**                                                                                                                                                                                                 |
|                                                                                                                                                                                                   |
| **o**                                                                                                                                                                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                   |
| **For the transition period from                 to               ** |
|                                                                                                                                                                                                   |
| **Commission File Number 0-22871**                                                                                                                                                                     |

 

**OMTOOL,LTD.**

(ExactName of Registrant as Specified in Its Charter)

 

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

 

Indicate by check markwhether the Registrant has: (1) filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during 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 ý    No o

 

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

 

Yes o    No ý

 

There were 1,750,006shares of the Company’s Common Stock, par value $0.01, outstanding onAugust 7, 2003.

 

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended June 30, 2003

CONTENTS

 
| **Item  Number**                                                                                                         |
|--------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                     |
| PART I: FINANCIAL INFORMATION                                                                                            |
|                                                                                                                     |
| Item 1.   Consolidated Financial Statements                                                                         |
| Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and  December 31, 2002                             |
| Consolidated Statements of Operations for  the three months and six months ended June 30, 2003 and 2002 (Unaudited) |
| Consolidated Statements of Cash Flows for  the six months  ended June 30,  2003 and 2002 (Unaudited)           |
| Notes to Consolidated Financial Statements                                                                               |
|                                                                                                                     |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations               |
|                                                                                                                     |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                                |
|                                                                                                                     |
| Item 4.  Controls and  Procedures                                                                                   |
|                                                                                                                     |
| PART II: OTHER INFORMATION                                                                                               |
|                                                                                                                     |
| Item 4.   Submission of Matters to a Vote of Security Holders                                                       |
|                                                                                                                     |
| Item 6.   Exhibits and Reports on Form 8-K                                                                          |
|                                                                                                                     |
| Signatures                                                                                                               |

 

2

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**PART I:  FINANCIALINFORMATION**

Item 1.  ConsolidatedFinancial Statements

 

**OMTOOL, LTD. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                                                                                            |   | **June 30,  2003** |       | **December 31,  2002** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                                                            |   | **(Unaudited)**         |       |                        |       |
| **Assets**                                                                                                                                                                                                                                      |   |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                                                 |   |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                       |   | $                       | 8,383,209  |                        | $          | 8,192,523 |   |
| Short-term investments                                                                                                                                                                                                                          |   | —                  |       | 1,597,155                   |       |
| Accounts receivable, less reserves of  $472,000 at June 30, 2003 and $615,000 at December 31, 2002                                                                                                                                    |   | 1,369,693               |       | 1,664,849                   |       |
| Inventory – finished goods                                                                                                                                                                                                                 |   | 164,493                 |       | 187,918                     |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                       |   | 228,021                 |       | 420,083                     |       |
| Total current assets                                                                                                                                                                                                                            |   | 10,145,416              |       | 12,062,528                  |       |
|                                                                                                                                                                                                                                            |   |                    |       |                        |       |
| Property and equipment, net                                                                                                                                                                                                                     |   | 554,154                 |       | 615,703                     |       |
| Other assets                                                                                                                                                                                                                                    |   | 13,962                  |       | 13,962                      |       |
|                                                                                                                                                                                                                                            |   |                    |       |                        |       |
| Total assets                                                                                                                                                                                                                                    |   | $                       | 10,713,532 |                        | $          | 12,692,193 |   |
|                                                                                                                                                                                                                                            |   |                    |       |                        |       |
| **Liabilities and  Stockholders’ Equity**                                                                                                                                                                                                  |   |                    | ** ** |                        | ** ** |
| Current liabilities:                                                                                                                                                                                                                            |   |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                |   | $                       | 1,061,600  |                        | $          | 1,019,584 |   |
| Accrued liabilities                                                                                                                                                                                                                             |   | 1,591,383               |       | 1,665,046                   |       |
| Accrued state sales tax                                                                                                                                                                                                                         |   | 976,272                 |       | 1,275,735                   |       |
| Deferred revenue                                                                                                                                                                                                                                |   | 3,173,117               |       | 3,397,568                   |       |
| Total current liabilities                                                                                                                                                                                                                       |   | 6,802,372               |       | 7,357,933                   |       |
|                                                                                                                                                                                                                                            |   |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                                      |   |                    |       |                        |       |
| Preferred Stock, $.01 par value —                                                                                                                                                                                                          |   |                    |       |                        |       |
| Authorized — 2,000,000 shares; Issued and  outstanding — none                                                                                                                                                                         |   | —                  |       | —                      |       |
| Common Stock, $.01 par value —                                                                                                                                                                                                             |   |                    |       |                        |       |
| Authorized — 35,000,000 shares; Issued —  1,858,482 shares at June 30, 2003 and December 31, 2002,  Outstanding —  1,746,113 and 1,744,542  shares at June 30, 2003 and December 31, 2002, respectively |   | 18,585                  |       | 18,585                      |       |
| Additional paid-in capital                                                                                                                                                                                                                      |   | 31,980,616              |       | 31,990,720                  |       |
| Accumulated deficit                                                                                                                                                                                                                             |   | (27,095,729             | )          | (25,671,834                 | )          |
| Treasury stock, at cost  (112,369 shares at June 30, 2003 and  113,940 shares at December 31, 2002)                                                                                                                              |   | (911,826                | )          | (924,570                    | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                            |   | (80,486                 | )          | (78,641                     | )          |
| Total stockholders’ equity                                                                                                                                                                                                                 |   | 3,911,160               |       | 5,334,260                   |       |
|                                                                                                                                                                                                                                            |   |                    |       |                        |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                 |   | $                       | 10,713,532 |                        | $          | 12,692,193 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**OMTOOL,LTD. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(Unaudited)

 
|                                                  |   | **Three  months ended  June 30,** |      | **Six months  ended  June 30,** |   |
|-------------------------------------------------------|--------|----------------------------------------|-----------|--------------------------------------|--------|
|                                                  |   | **2003**                               |      | **2002**                             |   | **2003** |   | **2002** |   |
| Revenues:                                             |   |                                   |      |                                 |   |   |   |   |   |
| Software license                                      |   | $                                      | 1,110,787 |                                 | $      | 862,591 |   | $ | 1,988,278 |   | $ | 2,141,412 |   |
| Hardware                                              |   | 611,131                                |      | 648,258                              |   | 1,117,339 |   | 1,431,299 |   |
| Service and other                                     |   | 1,609,867                              |      | 1,780,658                            |   | 3,208,323 |   | 3,681,420 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Total revenues                                        |   | 3,331,785                              |      | 3,291,507                            |   | 6,313,940 |   | 7,254,131 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Cost of revenues:                                     |   |                                   |      |                                 |   |   |   |   |   |
| Software license                                      |   | 96,780                                 |      | 78,632                               |   | 150,815 |   | 152,845 |   |
| Hardware                                              |   | 451,330                                |      | 443,701                              |   | 799,520 |   | 960,817 |   |
| Service and other                                     |   | 805,646                                |      | 829,127                              |   | 1,597,400 |   | 1,599,177 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Total cost of revenues                                |   | 1,353,756                              |      | 1,351,460                            |   | 2,547,735 |   | 2,712,839 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Gross profit                                          |   | 1,978,029                              |      | 1,940,047                            |   | 3,766,205 |   | 4,541,292 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Operating expenses:                                   |   |                                   |      |                                 |   |   |   |   |   |
| Sales and marketing                                   |   | 1,336,674                              |      | 1,875,410                            |   | 2,668,522 |   | 3,522,240 |   |
| Research and development                              |   | 587,516                                |      | 863,484                              |   | 1,172,121 |   | 1,695,925 |   |
| General and administrative                            |   | 826,418                                |      | 1,398,586                            |   | 1,558,218 |   | 2,659,143 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Total operating expenses                              |   | 2,750,608                              |      | 4,137,480                            |   | 5,398,861 |   | 7,877,308 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Loss from operations                                  |   | (772,579                               | )         | (2,197,433                           | )      | (1,632,656 | ) | (3,336,016 | ) |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Interest and other income, net                        |   | 14,095                                 |      | 46,490                               |   | 53,363 |   | 97,671 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Loss before tax provision (benefit)                   |   | (758,484                               | )         | (2,150,943                           | )      | (1,579,293 | ) | (3,238,345 | ) |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Tax provision (benefit)                               |   | —                                 |      | 1,225,350                            |   | (155,398 | ) | 1,225,350 |   |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Net loss                                              |   | $                                      | (758,484  | )                                    | $      | (3,376,293 | ) | $ | (1,423,895 | ) | $ | (4,463,695 | ) |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Net loss per share                                    |   |                                   |      |                                 |   |   |   |   |   |
| Basic and Diluted                                     |   | $                                      | (0.43     | )                                    | $      | (1.86 | ) | $ | (0.82 | ) | $ | (2.46 | ) |
|                                                  |   |                                   |      |                                 |   |   |   |   |   |
| Weighted  average number of common shares outstanding |   |                                   |      |                                 |   |   |   |   |   |
| Basic and diluted                                     |   | 1,746,113                              |      | 1,814,893                            |   | 1,746,043 |   | 1,814,657 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements*.*

 

4

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**OMTOOL,LTD. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Unaudited)

 
|                                                                              |   | **Six months  ended  June 30,** |       |
|-----------------------------------------------------------------------------------|--------|--------------------------------------|------------|
|                                                                              |   | **2003**                             |       | **2002** |   |
| Cash Flows from Operating Activities:                                             |   |                                 |       |   |   |
| Net loss                                                                          |   | $                                    | (1,423,895 | ) | $ | (4,463,695 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities– |   |                                 |       |   |   |
| Depreciation and amortization                                                     |   | 227,051                              |       | 267,470 |   |
| Deferred taxes                                                                    |   | —                               |       | 1,225,350 |   |
| Accounts receivable reserve                                                       |   | (146,746                             | )          | 80,000 |   |
| Changes in assets and liabilities–                                           |   |                                 |       |   |   |
| Accounts receivable                                                               |   | 450,142                              |       | 434,457 |   |
| Prepaid expenses and other current assets                                         |   | 193,607                              |       | 170,575 |   |
| Inventory                                                                         |   | 23,863                               |       | (123,911 | ) |
| Accounts payable                                                                  |   | 39,250                               |       | (161,332 | ) |
| Accrued liabilities                                                               |   | (80,498                              | )          | 257,102 |   |
| Accrued state sales tax                                                           |   | (299,463                             | )          | 549,376 |   |
| Deferred revenue                                                                  |   | (236,111                             | )          | (133,811 | ) |
|                                                                              |   |                                 |       |   |   |
| Net cash used in operating activities                                             |   | (1,252,800                           | )          | (1,898,419 | ) |
|                                                                              |   |                                 |       |   |   |
| Cash Flows from Investing Activities:                                             |   |                                 |       |   |   |
| Purchases of property and equipment                                               |   | (164,603                             | )          | (186,509 | ) |
| Purchases of short-term investments                                               |   | (1,999,449                           | )          | — |   |
| Proceeds from sale of short-term  investments                                     |   | 3,596,604                            |       | 1,296,750 |   |
|                                                                              |   |                                 |       |   |   |
| Net cash provided by investing activities                                         |   | 1,432,552                            |       | 1,110,241 |   |
|                                                                              |   |                                 |       |   |   |
| Cash Flows from Financing Activities:                                             |   |                                 |       |   |   |
| Net proceeds from issuance of common stock                                        |   | 2,640                                |       | 10,893 |   |
| Purchases of treasury stock                                                       |   | —                               |       | (5,339 | ) |
|                                                                              |   |                                 |       |   |   |
| Net cash provided by financing activities                                         |   | 2,640                                |       | 5,554 |   |
|                                                                              |   |                                 |       |   |   |
| Foreign exchange effect on cash                                                   |   | 8,294                                |       | 18,137 |   |
|                                                                              |   |                                 |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                             |   | 190,686                              |       | (764,487 | ) |
|                                                                              |   |                                 |       |   |   |
| Cash and cash equivalents, beginning of  period                                   |   | 8,192,523                            |       | 11,194,118 |   |
|                                                                              |   |                                 |       |   |   |
| Cash and cash equivalents, end of period                                          |   | $                                    | 8,383,209  |   | $ | 10,429,631 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements*.*

 

5

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**OMTOOL,LTD. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**(1)****               Basis ofPresentation**

 

The accompanying unaudited consolidated financialstatements have been prepared by Omtool, Ltd. (the “Company” or “Omtool”)pursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements and should be read in conjunction with the consolidated financialstatements and notes thereto for the year ended December 31, 2002 as filedwith the SEC on March 11, 2003. The accompanying consolidated financialstatements reflect all adjustments (consisting of normal recurring adjustments)which are, in the opinion of management, necessary for a fair presentation ofresults for the interim periods presented. The results of operations for the six month period ended June 30,2003 are not necessarily indicative of the results to be expected for the fullfiscal year.

 

The Company’s total revenues for the first six monthsof 2003 declined 13% from total revenues for the first six months of 2002primarily due to the general decline in information technology spending and adecrease in demand for enterprise software solutions.  This decrease reflected the overall sluggishness of the UnitedStates economy in the first six months of 2003 causing customers andprospective customers to defer technology purchases.  However, the Company’s combined software and hardware revenuesfor the three months ended June 30, 2003 were higher than the combinedsoftware and hardware revenues for the three months ended June 30, 2002.The increased revenue was due primarily to the recognition of previouslydeferred revenue and an increase in sales bookings. The Company’s net lossimproved from $4.5 million for the six months ended June 30, 2002 to $1.4million for the six months ended June 30, 2003 due primarily to reducedoperating expenses associated with a reduction in the Company’s workforce and a$1.2 million tax provision recognized in the second quarter of 2002.  The Company has experienced decliningrevenues and operating losses over an extended period of time.  Based upon the current economic environment,general softness in information technology spending, products that may notachieve market acceptance, and limited forecasting visibility, the Companycannot predict that the financial and operating performance, financial positionor cash flow will improve over the next twelve months.  The Company’s cash and cash equivalents atJune 30, 2003 were $8.4 million. The Company anticipates that itsbalance of cash and cash equivalents will be approximately $7 million at theend of the third quarter of 2003. The Company believes that its existing cashand cash equivalents will be sufficient to meet the Company’s working capitaland capital expenditures for at least the next twelve months.

 

**(2)****               Net Loss per CommonShare**

 

The Company reports earnings per share in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 128,*Earningsper Share*.  Diluted weightedaverage shares outstanding for the three months ended June 30, 2003 andJune 30, 2002 exclude the potential common shares related to 375,580 and344,145, respectively, outstanding stock options because to include them wouldhave been antidilutive for the periods presented.

 

**(3)****               Income Taxes**

 

SFAS No. 109, *Accounting for Income Taxes,* requires avaluation allowance to be recorded against deferred tax assets when it is morelikely than not that some or all of the deferred tax assets will not berealized.  As a result of continuedeconomic uncertainty, the Company has provided a full valuation allowanceagainst all of its net deferred tax assets and will do so until it returns toan appropriate level of taxable income. The ultimate realization of these deferred tax assets depends upon theCompany’s ability to generate sufficient future taxable income. If the Companyis successful in generating sufficient future taxable income, the Company willreduce the valuation allowance through a reduction in income tax expense in thefuture.

 

During the six months ended June 30, 2003, theCompany recorded $155,398 of tax benefit due to a tax refund that its UnitedKingdom subsidiary received during the first quarter of 2003.  This subsidiary had incurred a loss for theyear ended

 

6

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December 31,1999 which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resultedin a tax refund.  Because the subsidiarywas undergoing an Inland Revenue audit for tax year 1999, there existed doubtabout the realizability of this refund and the Company did not record thebenefit on its books until the audit was cleared and the cash was received,both of which occurred in the first quarter of 2003.

 

During the quarter ended June 30, 2002, theCompany recorded an additional valuation allowance of  $1.2 million against all of its net deferred tax assets. As a resultof the downturn in the economy in the first half of 2002, the Company hadincurred significant and previously unanticipated losses and the outlookindicated that significant uncertainty would continue for the remainder of thatfiscal year and into the following fiscal year. These cumulative losses,together with the Company’s prior losses, resulted in management’s decisionthat it was more likely than not that all of its deferred tax assets would notbe realized in the then foreseeable future. Accordingly, the remaining net deferred tax asset was written off in thesecond quarter of 2002.

 

**(4)****               ComprehensiveLoss**

 

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

 
|                                     |   | **Three  months ended  June 30,** |     | **Six months  ended  June 30,** |   |
|------------------------------------------|--------|----------------------------------------|----------|--------------------------------------|--------|
|                                     |   | **2003**                               |     | **2002**                             |   | **2003** |   | **2003** |   |
| Net loss                                 |   | $                                      | (758,484 | )                                    | $      | (3,376,293 | ) | $ | (1,423,895 | ) | $ | (4,463,695 | ) |
| Foreign currency translation adjustments |   | 32,015                                 |     | (7,575                               | )      | (1,845 | ) | (1,645 | ) |
| Comprehensive loss                       |   | $                                      | (726,469 | )                                    | $      | (3,383,868 | ) | $ | (1,425,740 | ) | $ | (4,465,340 | ) |

 

**(5)****               Stock BasedCompensation**

 

The Companyaccounts for stock-based compensation for employees under the recognition andmeasurement principles of APB Opinion No. 25, *Accounting for Stock Issued toEmployees,* and related interpretations.  The following table illustrates the effect on net loss and netloss per share if the Company had applied the fair value recognition provisionsof FASB Statement No. 123, *Accounting for Stock-Based Compensation,*to stock-based employee compensation.

 
|                                                                                                        |   | **Three months Ended June 30,** |     | **Six months Ended June 30,** |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|----------|------------------------------------|--------|
|                                                                                                        |   | **2003**                             |     | **2002**                           |   | **2003** |   | **2002** |   |
|                                                                                                        |   |                                 |     |                               |   |   |   |   |   |
| Net loss, as  reported                                                                                      |   | $                                    | (758,484 | )                                  | $      | (3,376,293 | ) | $ | (1,423,895 | ) | $ | (4,463,695 | ) |
| Deduct:  Total stock-based employee compensation expense determined under fair value  method for all awards |   | (174,188                             | )        | (259,237                           | )      | (440,182 | ) | (509,857 | ) |
| Pro forma  net loss                                                                                         |   | $                                    | (932,672 | )                                  | $      | (3,635,530 | ) | $ | (1,864,077 | ) | $ | (4,973,552 | ) |
|                                                                                                        |   |                                 |     |                               |   |   |   |   |   |
| Net loss per  share:                                                                                        |   |                                 |     |                               |   |   |   |   |   |
| Basic and  diluted, as reported                                                                             |   | $                                    | (0.43    | )                                  | $      | (1.86 | ) | $ | (0.82 | ) | $ | (2.46 | ) |
| Basic and  diluted, pro forma                                                                               |   | $                                    | (0.53    | )                                  | $      | (2.00 | ) | $ | (1.07 | ) | $ | (2.74 | ) |

 

**(6)****               Segmentand Geographic Information**

 

To date, the Company has viewedits operations and manages its business as principally one segment, softwaresales and associated services. As a result, the financial information disclosedherein represents all of the material financial information related to theCompany’s principal operating segment in accordance with SFAS No. 131, *DisclosuresAbout Segments of an Enterprise and Related Information*.

 

Total revenues frominternational sources were $717,000 and $1.2 million for the three months andsix months ended June 30, 2003 and $509,000 and $1.3 million for the threemonths and six months ended June 30, 2002, respectively. The Company’srevenues from international sources were primarily generated from customerslocated in Europe. The following table represents amounts relating togeographic locations:

 

7

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|                   |   | **Three  months ended  June 30,** |      | **Six months  ended  June 30,** |   |
|------------------------|--------|----------------------------------------|-----------|--------------------------------------|--------|
| **Total revenues (1)** |   | **2003**                               |      | **2002**                             |   | **2003** |   | **2002** |   |
| United States          |   | $                                      | 2,615,274 |                                 | $      | 2,782,918 |   | $ | 5,156,653 |   | $ | 5,988,679 |   |
| Europe                 |   | 533,711                                |      | 345,748                              |   | 884,208 |   | 838,187 |   |
| Rest of World          |   | 182,800                                |      | 162,841                              |   | 273,079 |   | 427,265 |   |
|                   |   | $                                      | 3,331,785 |                                 | $      | 3,291,507 |   | $ | 6,313,940 |   | $ | 7,254,131 |   |

 
| **Long-lived assets (2)** |   | **June 30,  2003** |    | **December   31,  2002** |   |
|---------------------------|--------|-------------------------|---------|-------------------------------|--------|
| United States             |   | $                       | 547,439 |                          | $      | 600,116 |   |
| United Kingdom            |   | 20,677                  |    | 29,549                        |   |
|                      |   | $                       | 568,116 |                          | $      | 629,665 |   |

 

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(1)  Revenues are attributed to geographic regions based on locationof customer.

(2)  Long-lived assets include all long-term assets except thosespecifically excluded under SFAS No. 131 such as deferred income taxes andfinancial instruments.

 

**(7)****               Guarantees**

 

InNovember 2002, the FASB issued FASB Interpretation 45,*Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers* (“FIN 45”). FIN 45 elaborates on the existing disclosurerequirements for most guarantees, including loan guarantees such as standby lettersof credit. It also clarifies that at the time a company issues a guarantee, thecompany must recognize an initial liability for the fair value, or marketvalue, and of the obligations it assumes under the guarantee and must disclosethat information in its interim and annual financial statements. The provisionsrelated to recognizing a liability at inception of the guarantee for the fairvalue of the guarantor’s obligations does not apply to product warranties or toguarantees accounted for as derivatives. The disclosure requirements areeffective for financial statements issued after December 15, 2002 and therecognition/measurement requirements are effective on a prospective basis forguarantees issued or modified after December 31, 2002. The following is asummary of the Company’s agreements that it has determined are within the scopeof FIN 45.

 

As permitted under Delaware law, the Company has agreements whereby itindemnifies its officers and directors for certain events or occurrences whilethe officer or director is, or was serving, at the Company’s request in suchcapacity. The term of the indemnification period is for the officer’s ordirector’s lifetime. The maximum potential amount of future payments theCompany could be required to make under these indemnification agreements isunlimited; however, the Company has a Director and Officer insurance policythat limits its exposure and enables it to recover a portion of any futureamounts paid. As a result of its insurance policy coverage, the Companybelieves that the estimated fair value of these indemnification agreements isminimal.

 

The Company enters into standard indemnification agreements in itsordinary course of business. Pursuant to these agreements, the Companyindemnifies, holds harmless, and agrees to reimburse the indemnified party forlosses suffered or incurred by the indemnified party, generally its resellersor certain customers, in connection with any U.S. patent, or any copyright orother intellectual property infringement claim by any third party with respectto its products. The term of these indemnification agreements is generallyperpetual any time after execution of the agreement. The maximum potentialamount of future payments the Company could be required to make under theseindemnification agreements is unlimited. The Company has never incurred coststo defend lawsuits or settle claims related to these indemnificationagreements. As a result, the Company believes that the estimated fair value ofthese agreements is minimal.

 

The Company warrants that its software products will perform in allmaterial respects in accordance with its standard published specifications ineffect at the time of delivery of the licensed products to certain of itscustomers for the life of the product. If necessary, the Company would providefor the estimated cost of product warranty based on specific warranty claimsand claim history, however, the Company has never incurred significant expenseunder its product warranty. As a result, the Company believes that theestimated fair value on these agreements is minimal.

 

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**(8)****               Recently IssuedAccounting Standards**

 

InNovember 2002, the FASB Emerging Issues Task Force released Issue No.00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables* (“EITF 00-21”).EITF 00-21 addresses certain aspects of the accounting by a vendor forarrangements under which it will perform multiple revenue-generatingactivities. EITF 00-21 establishes three principles: (a) revenue arrangementswith multiple deliverables should be divided into separate units of accounting;(b) arrangement consideration should be allocated among the separate units ofaccounting based on their relative fair values; and (c) revenue recognitioncriteria should be considered separately for separate units of accounting. EITF00-21 is effective for all arrangements entered into in fiscal periodsbeginning after June 15, 2003, with early adoption permitted. The Companyis currently reviewing and evaluating the scope of EITF 00-21, but does notexpect the adoption of EITF 00-21 will have a material impact on the Company’sfinancial statements.

 

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**Item 2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with the accompanying consolidated financial statementsfor the periods specified and the associated notes.  Further reference should be made to the Company’s Annual Reporton Form 10-K as filed with the Securities Exchange Commission on March 11,2003.

 

**Overview**

 

Omtool, Ltd.is a leading provider of e-mail and fax-based messaging software that enablessecure, confirmed document exchange between businesses. The Company wasincorporated in March 1991 and shipped its initial facsimile softwareproducts in 1991. Omtool’s GenidocsTM product family enables users throughout anenterprise to deliver confidential and secure e-mail over the Internet.  Omtool’s AccuRouteTM software enables usersto deliver a hardcopy document from certain digital scanning andmultifunctional devices to multiple recipients, via multiple channels,simultaneously using a method that is as simple as using a photocopier. Themultiple channels consist of fax, e-mail, or a document management system.Omtool’s Fax Sr.TM, LegalFaxTM and GenifaxTM product families provide userswith an extensive, flexible feature set for transmitting and receiving faxesand improve an organization’s management of its fax communications process byproviding a suite of utility and control functions. A significant portion ofthe Company’s revenues is derived from licensing rights to use its Genifax andFax Sr. software products directly to end-users and indirectly throughresellers.

 

The Company’s total revenues for the first six months of 2003 declined13% from total revenues for the first six months of 2002 primarily due to thegeneral decline in information technology spending and a decrease in demand forenterprise software solutions.  Thisdecrease reflected the overall sluggishness of the United States economy in thefirst six months of 2003 causing customers and prospective customers to defertechnology purchases.  However, theCompany’s combined software and hardware revenues for the three months endedJune 30, 2003 were higher than the combined software and hardware revenuesfor the three months ended June 30, 2002. The increased revenue was dueprimarily to the recognition of previously deferred revenue and an increase insales bookings. The Company’s net loss improved from $4.5 million for the sixmonths ended June 30, 2002 to $1.4 million for the six months endedJune 30, 2003 due primarily to reduced operating expenses associated witha reduction in the Company’s workforce and a $1.2 million tax provisionrecognized in the second quarter of 2002. The Company has experienced declining revenues and operating losses overan extended period of time.  Based uponthe current economic environment, general softness in information technologyspending, products that may not achieve market acceptance, and limitedforecasting visibility, the Company cannot predict that the financial andoperating performance, financial position or cash flow will improve over thenext twelve months.  The Company’s cashand cash equivalents at June 30, 2003 were $8.4 million. The Companyanticipates that its balance of cash and cash equivalents will be approximately$7 million at the end of the third quarter of 2003. The Company believes thatits existing cash and cash equivalents will be sufficient to meet the Company’sworking capital and capital expenditures for at least the nexttwelve months.

 

The Company cannotpredict when the market for enterprise software solutions will improve. Whenthe market does improve, the Company cannot predict whether, and to whatextent, the demand for its products will increase.  The Company believes that the current lack of demand forenterprise software solutions will continue for the foreseeable future, andthat its operations and financial results will continue to be negatively affectedduring that period. Any continued decline in the Company’s revenues will have asignificant impact on the Company’s financial results, particularly because asignificant portion of the Company’s operating costs (such as personnel, rentand depreciation) are fixed in advance of a particular quarter. As a result,the Company’s costs for sales and marketing, research and development andgeneral and administrative could continue to increase as a percentage ofrevenues, thereby affecting the Company’s operating results.

 

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The Company’sfuture revenues and operating results may fluctuate from quarter to quarterbased on the number and size of sales transactions the Company enters into withcustomers, the adequacy of provisions for losses, general economic conditionsand other factors. In addition, revenue from a large order may constitute asignificant portion of the Company’s total revenues in a particular quarter.

 

The Company has historically derived asubstantial portion of its total revenues from sales within North America.Sales outside of North America (primarily in Europe) represented 15% and 13% ofthe Company’s total revenues for the six months ended June 30, 2003 and2002, respectively.

 

The Company’s United Kingdom subsidiarytransacts business primarily in its local currency. The Company manages itsforeign exchange exposure by monitoring its net monetary position using naturalhedges of its assets and liabilities denominated in local currencies. There canbe no assurance that this policy will eliminate all currency exposure. If theCompany’s business denominated in foreign currencies increases, the Company maybe required to use derivatives to hedge foreign currency exposure.

 

The Company continues to actively recruitvalue-added resellers (“VARs”), systems integrators, resellers and distributorsto expand its indirect distribution channel. The Company is pursuing salesopportunities via its solution/reseller channel as well as focusing salesefforts on specific market segments in order to facilitate productacceptance.  Sales through the Company’sindirect distribution channels represented 23% and 20% of the Company’s totalrevenues for the six months ended June 30, 2003 and 2002, respectively.

 

**CriticalAccounting Policies and Estimates**

 

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

 

*Revenue Recognitionand Accounts Receivable Reserves.*  The Company derives its revenue fromprimarily two sources (i) product revenue, which includes software license andhardware revenue and (ii) services and support revenue, which includes softwaremaintenance and support, installation, training and consulting revenue. TheCompany licenses its software products on a perpetual basis.  The Company generates revenue from licensingthe rights to use its software products and sales of hardware directly toend-users and indirectly through resellers. The Company’s resellers orderproducts from the Company based on purchase orders received from end-users anddo not order stock. The Company’s products are sold to resellers and directlyto end-users without any specifically stated rights of return. Occasionally,however, the Company, in its sole discretion, will accept a product return ifthe end-user finds that the product does not fit its needs. The Company alsosells hardware products, which are provided by a third-party, on a pass throughbasis, plus an additional mark-up, to end-users and indirectly throughresellers. To support its software products, the Company sells softwaremaintenance and support, installation, training and consulting services toend-users and indirectly through resellers.

 

The Companyapplies the provisions of Statement of Position (“SOP”) 97-2, *SoftwareRevenue Recognition*, as amended by SOP 98-9, Modification of SOP97-2, *SoftwareRevenue Recognition, With Respect to Certain Transactions*, to alltransactions involving the sale of multiple elements including software,hardware and service revenue.  InDecember 1999, the SEC issued Staff Accounting Bulletin (“SAB”) No. 101, *RevenueRecognition in Financial Statements*. This bulletin establishesguidelines for revenue recognition. The Company’s revenue recognition policycomplies with this pronouncement as well. The Company applies the provisions of SFAS No. 48, *Revenue Recognition When Right ofReturn Exists*, with respect to providing for potential futureproduct returns.   As described below,significant management judgments and estimates must be made and used inconnection with the revenue recognized in any accounting period.  Material differences may result in theamount and timing of the Company’s revenue if management made differentjudgments or utilized different estimates.

 

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The Company recognizes revenue from the sale of software products andhardware to both end-users and resellers when persuasive evidence of anarrangement exists, the products have been delivered, the fee is fixed ordeterminable, collection of the resulting receivable is reasonably assured andthere are no customer acceptance provisions. The Company maintains a reservefor potential product returns. Software maintenance and support revenue isrecognized ratably over the term of the related maintenance period, typicallyone-year.  Other services revenue isrecognized as the services are performed. If an arrangement includes anacceptance provision, the Company will defer all revenue until the customeraccepts the products.  Acceptancegenerally occurs upon the earlier of receipt of a written customer acceptanceor expiration of the acceptance period.

 

The Company’s transactions frequently involve the sales of software,hardware and related services under multiple element arrangements.   Revenue under multiple element arrangementsis allocated to each element under the residual method, in accordance with SOP98-9, Modification of SOP 97-2,*Software Revenue Recognition, With Respect toCertain Transactions*. Under this method, revenue is allocated firstto all undelivered elements, such as services, based on the fair value of thoseelements, which is the price charged when these elements are sold separatelyand unaccompanied by other elements. The Company’s services are not essential to the functionality of thesoftware as these services do not alter the capabilities of the software and donot carry a significant degree of risk to perform. 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 delivered elements include both software andhardware, the amount allocated to hardware revenue is based on the pricecharged to the Company by the third party vendor plus an additional mark up,with the remainder allocated to software revenue. To the extent that a discountis offered in the arrangement, the entire discount is allocated to thedelivered element or elements. If the delivered elements include hardware andsoftware, the discount is allocated to the hardware and software based on theirrespective list prices.

 

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

 

At the time of thetransaction, the Company assesses whether the fee associated with thetransaction is fixed or determinable and whether or not collection isreasonably assured.  If a significantportion of a fee is due beyond the Company’s normal payment terms, which arethirty to sixty days from invoice date, the Company accounts for the fee as notbeing fixed or determinable.  In thesecases, the Company recognizes revenue as the fees become due. The Companyassesses collection based on a number of factors, including past transactionhistory with the customer and the credit-worthiness of the customer.  The Company reviews D&B credit reportsfor all of its resellers and adjusts its credit limits with those resellersaccordingly.  If the reseller does nothave a favorable report or the Company does not have enough credit informationto determine if the reseller is credit-worthy then the Company predominantlysells to such resellers on C.O.D. terms. The Company does not request collateral from its customers.  If the Company determines that collection ofa fee is not reasonably assured, the fee is deferred and revenue is recognizedat the time collection becomes reasonably assured, which is generally uponreceipt of payment.

 

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

 

The Company’s combined accounts receivable and returns reserve was$472,000 and $716,000 as of June 30, 2003 and 2002, respectively.  Both components of calculating the estimatedreserve, specific identification and historic ratio, are materialjudgments.  These judgments are based onhistoric trends, taking into consideration current business and economic

 

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conditions, which could changematerially, thus changing the required reserve level materially.  The potential change could be positive, inthe event the reserve estimate proves unnecessary, or negative, if the reserveproves inadequate.

 

The Company’s deferred revenue is comprised mainly ofrevenue that is deferred for software maintenance and support contracts.  The other components of deferred revenue arethe amounts from sales transactions****that were deferred because they did notmeet all of the provisions of the Company’s revenue recognition policy.

 

*Software DevelopmentCosts*. Software development costs are considered for capitalization whentechnological feasibility is established in accordance with SFAS No. 86, *Accountingfor the Costs of Computer Software To Be Sold, Leased or**OtherwiseMarketed*. The Company sells software in a market that is subject torapid technological change, new product introductions and changing customerneeds. Accordingly, the Company has determined that it cannot determinetechnological feasibility until the development state of the product is nearlycomplete. The time period during which cost could be capitalized from the pointof reaching technological feasibility until the time of general product releaseis very short and, consequently, the amounts that might be capitalized are notmaterial to the Company’s consolidated financial position or results ofoperations. Therefore, the Company charges all software development costs tooperations in the period incurred.

 

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

 

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

 

The Companywill continue to provide a valuation allowance against all of its net deferredtax assets until it returns to an appropriate level of taxable income. Theultimate realization of these deferred tax assets depends upon the Company’sability to generate sufficient future taxable income. If the Company issuccessful in generating sufficient future taxable income, the Company willreduce the valuation allowance through a reduction in income tax expense in thefuture.

 

Accrued statesales taxes are estimated for each reporting period based on tax rates ineffect for the reporting periods in each of the states where the Company haspotential nexus. In the event that actual results differ from these estimates,the Company’s state sales taxes expense could be materially impacted.

 

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**Results of Operations**

 

The following table sets forth certain financial datafor the periods indicated as a percentage of total revenues:

 
|                           |   | **Three  months ended  June 30,** |   | **Six months  ended  June 30,** |   |
|--------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                           |   | **2003**                               |   | **2002**                             |   | **2003** |   | **2002** |   |
| Revenues:                      |   |                                   |   |                                 |   |   |   |   |   |
| Software license               |   | 33.3                                   | %      | 26.2                                 | %      | 31.5 | % | 29.5 | % |
| Hardware                       |   | 18.3                                   |   | 19.7                                 |   | 17.7 |   | 19.7 |   |
| Service and other              |   | 48.4                                   |   | 54.1                                 |   | 50.8 |   | 50.8 |   |
| Total revenues                 |   | 100.0                                  |   | 100.0                                |   | 100.0 |   | 100.0 |   |
| Cost of revenues:              |   |                                   |   |                                 |   |   |   |   |   |
| Software license               |   | 2.9                                    |   | 2.4                                  |   | 2.4 |   | 2.1 |   |
| Hardware                       |   | 13.5                                   |   | 13.5                                 |   | 12.7 |   | 13.2 |   |
| Service and other              |   | 24.2                                   |   | 25.2                                 |   | 25.3 |   | 22.1 |   |
| Total cost of revenues         |   | 40.6                                   |   | 41.1                                 |   | 40.4 |   | 37.4 |   |
| Gross profit                   |   | 59.4                                   |   | 58.9                                 |   | 59.6 |   | 62.6 |   |
| Operating expenses:            |   |                                   |   |                                 |   |   |   |   |   |
| Sales and marketing            |   | 40.2                                   |   | 57.0                                 |   | 42.2 |   | 48.5 |   |
| Research and development       |   | 17.6                                   |   | 26.2                                 |   | 18.6 |   | 23.4 |   |
| General and administrative     |   | 24.8                                   |   | 42.5                                 |   | 24.7 |   | 36.7 |   |
| Total operating expenses       |   | 82.6                                   |   | 125.7                                |   | 85.5 |   | 108.6 |   |
| Loss from operations           |   | (23.2                                  | )      | (66.8                                | )      | (25.9 | ) | (46.0 | ) |
| Interest and other income, net |   | 0.4                                    |   | 1.4                                  |   | 0.8 |   | 1.3 |   |
| Tax benefit (provision)        |   | —                                 |   | (37.2                                | )      | 2.5 |   | (16.9 | ) |
|                           |   |                                   |   |                                 |   |   |   |   |   |
| Net loss                       |   | (22.8                                  | )%     | (102.6                               | )%     | (22.6 | )% | (61.5 | )% |
|                           |   |                                   |   |                                 |   |   |   |   |   |
| Gross profit:                  |   |                                   |   |                                 |   |   |   |   |   |
| Software license               |   | 91.3                                   | %      | 90.9                                 | %      | 92.4 | % | 92.9 | % |
| Hardware                       |   | 26.1                                   |   | 31.6                                 |   | 28.4 |   | 32.9 |   |
| Service and other              |   | 50.0                                   |   | 53.4                                 |   | 50.2 |   | 56.6 |   |

 

**Three Months EndedJune 30, 2003 and 2002**

 

*Revenues*

 

*Total Revenues.*  The Company’s total revenues were$3.3 million for each of the three months ended June 30, 2003 and2002.

 

*Software License.*  Software license revenues for the threemonths ended June 30, 2003 are comprised of the following:  95% from the Company’s fax related productlines and 5% from its non-fax related product lines.  Revenues for the three months ended June 30, 2002 arecomprised of the following:  91% fromthe Company’s fax related product lines and 9% from its non-fax related productlines.  Software license revenues were$1.1 million for the three months ended June 30, 2003 and $863,000 for thethree months ended June 30, 2002, representing an increase of 29%.  Software license revenues accounted for 33%and 26% of total revenues for each respective period.  The increase in software license revenue in dollars and as apercentage of total revenues is primarily the result of recognizing previouslydeferred revenue and an increase in sales bookings.

 

*Hardware.*  Hardware revenues were $611,000 for thethree months ended June 30, 2003 and $648,000 for the three months endedJune 30, 2002, representing a decrease of 6%. Hardware revenues accountedfor 18% and 20% of total revenues for each respective period.  The decrease in hardware revenues was dueprimarily to a change in the particular mix of products sold in the three monthperiod ended June 30, 2003 resulting in a decrease in accompanyinghardware sales.  The decrease inhardware revenue as a percentage of total revenues is a result of higherrelative software revenues in the second quarter of 2003 compared to the secondquarter of 2002.

 

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*Service and Other.*  Service and other revenues were$1.6 million for the three months ended June 30, 2003 and $1.8million for the three months ended June 30, 2002, representing a decreaseof 10%. Service and other revenues accounted for 48% and 54% of total revenuesfor each respective period. The decrease in service and other revenues is dueprimarily to continuing decreases in software maintenance and supportrevenues.  The decrease in service andother revenues as a percent of total revenues is due primarily to the increasein software license revenue, resulting in a decreased percentage in servicerevenue to total revenue.

 

*Cost of Revenues*

 

*Software License.*  Cost of software license revenues consists primarily of the costsof sublicensing third-party software products, product media and productduplication.  Cost of software licenserevenues was $97,000 and $79,000 for the three months ended June 30, 2003and 2002, respectively, representing an increase of 23%.  The increase is due to the increase insoftware sales as software license gross margin percentages were 91% for eachrespective period.

 

*Hardware.* Cost of hardware revenues consists primarily of the costs of third-partyhardware products. Cost of hardware revenues was $451,000 and $444,000 forthe three months ended June 30, 2003 and 2002, respectively, representing74% and 68% of hardware revenues for each respective period. The increase indollar amount for the cost of hardware revenues was due primarily to theincrease of hardware unit sales accompanying the Company’s products as well asa $20,000 reserve for potentially obsolete inventory. The gross marginpercentage for hardware sales was 26% and 32% for each of the three monthperiods ended June 30, 2003 and 2002 due to a change in the mix ofhardware products sold.

 

*Service and Other.*  Cost of service and other revenues consists primarily of thecosts incurred in providing telephone support as well as other miscellaneouscustomer service-related expenses.  Costof service and other revenues was $806,000 and $829,000 for the three monthsended June 30, 2003 and 2002, respectively, representing 50% and 47% ofservice and other revenues for each respective period.  The gross margin percentage for service andother revenues decreased to 50% for the three months ended June 30, 2003,compared to 53% in the same period in 2002. The decrease in gross margin is due to decreased support revenues whilethe infrastructure cost remained consistent. The decrease in the cost of service and other revenues was due primarilyto a decrease in travel related expenses in the installation services area.

 

*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses consist primarily of employeesalaries, benefits, commissions, and associated overhead costs, and the cost ofmarketing programs such as advertisements, direct mailings, public relations,trade shows, seminars and related communication costs.  Sales and marketing expenses were$1.3 million and $1.9 million for the three months endedJune 30, 2003 and 2002, respectively, or 40% and 57% of total revenues foreach respective period.  The decrease indollar amount was due to a decrease in the number of sales personnel and theirassociated costs, a decrease in advertising expenses during the quarter and theabsence of severance related expenses incurred in 2002.  The Company expects sales and marketingexpenses to remain consistent in absolute dollars.

 

*Research and Development.* Research anddevelopment expenses include expenses associated with the development of newproducts, enhancements of existing products and quality assurance activities.These expenses consist primarily of employee salaries, benefits, associatedoverhead costs, consulting expenses and the cost of software development tools.Research and development expenses were $588,000 for the three months endedJune 30, 2003 and $863,000 for the three months ended June 30, 2002,representing 18% and 26% of total revenues for each respective period.  The decrease in the expense and in theexpense as a percent of total revenues was due to a fewer number of employeesin the research and development department as well as the absence of severancerelated expenses incurred in 2002.  TheCompany expects research and development expenses to remain consistent inabsolute dollars.

 

*General andAdministrative.* General and administrative expenses consist primarily of employeesalaries, benefits for administrative, executive and finance personnel andassociated corporate general and administrative expenses. General andadministrative expenses were $826,000 and $1.4 million for the three monthsended June 30, 2003 and 2002, respectively, or 25% and 43% of totalrevenues for each period. The decrease in dollar amount and percent of totalrevenues is due to the reduction in the number of general and administrativepersonnel and overhead costs associated with supporting such personnel, adecrease in management consulting expenses and a decrease in state sales tax accrualsduring the quarter.  The Company expectsgeneral and administrative expenses to remain consistent in absolute dollars.

 

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*Interest and other Income, net.*  Interest and other income, net consists principallyof interest income, net earned on cash balances.  Interest and other income, net was $14,000 for the three monthsended June 30, 2003 and $46,000 for the three months ended June 30,2002.  The decrease in interest andother income, net is due to changes in principal balances of the Company’sinvestments combined with a currency exchange loss that was recognized duringthe quarter.

 

*Tax Provision*.  The Company recorded a provision of $1.2 million against thevaluation of its net deferred tax asset in the three months ended June 30,2002. See also Note 3. Income Taxes of the Notes to the Consolidated FinancialStatements for more information.

 

**Six Months EndedJune 30, 2003 and 2002**

 

*Revenues*

 

*Total Revenues.*  The Company’s total revenues were $6.3 million for the sixmonths ended June 30, 2003 and $7.3 million for the six months endedJune 30, 2002.

 

*Software License.*  Software license revenues for the six months ended June 30,2003 are comprised of the following: 95% from its fax related product lines and 5% from its non-fax relatedproduct lines.  Revenues for the sixmonths ended June 30, 2002 are comprised of the following:  91% from its fax related product lines and9% from its non-fax related product lines. Software license revenues were $2.0 million for the six months endedJune 30, 2003 and $2.1 million for the six months ended June 30,2002, representing a decrease of 7%. The decline in software license revenue can be attributed to a number offactors that had an impact on first quarter results such as a general declinein information technology spending, a decrease in demand for enterprisesoftware solutions and continued sluggishness of the United States economycausing customers and prospective customers to defer technology purchases. However,this decline was partially offset by increased sales bookings in the secondquarter of 2003 compared to the second quarter of 2002. Software licenserevenues accounted for 32% and 30% of total revenues for each respective sixmonth period.  The increase in softwarelicense revenue as a percentage of total revenues is a result of lower relativeservice and other revenues in the first two quarters of 2003 compared to thefirst two quarters of 2002.

 

*Hardware.* Hardware revenues were $1.1 million for the six months endedJune 30, 2003 and $1.4 million for the six months ended June 30,2002, representing a decrease of 22%. Hardware revenues accounted for 18% and20% of total revenues for each respective period.  The decrease in hardware revenues was due primarily to thedecrease in the number of software license transactions in the six month periodended June 30, 2003 resulting in a decrease in accompanying hardwaresales.  The decrease in hardware revenueas a percentage of total revenues is a result of lower hardware revenues in thefirst two quarters of 2003 compared to the first two quarters of 2002, as wellas the increase in software license revenue.

 

*Service and Other.*  Service and other revenues were $3.2 million for the sixmonths ended June 30, 2003 and $3.7 million for the six months endedJune 30, 2002, representing a decrease of 13%. Service and other revenuesaccounted for 51% of total revenues for each respective period. The decrease inservice and other revenues is due primarily to decreases in softwaremaintenance, support revenues and consulting service revenues. Service andother revenues did not change as a percent of total revenues due to the factthat service and other revenue declined in the same percentage as total revenuein the first two quarters of 2003 compared to the first two quarters of 2002.

 

*Cost of Revenues*

 

*Software License.*  Cost of software license revenues was $151,000 and $153,000 forthe six months ended June 30, 2003 and 2002, respectively, representing adecrease of 1%. The decrease in the cost of software license revenue is due todecreased production expenses.  Cost ofsoftware license revenues as a percentage of software license revenue was 8%and 7% for each respective period. Software license gross margin percentages were 92% and 93% for the sixmonth periods ended June 30, 2003 and June 30, 2002.

 

*Hardware.* Cost of hardware revenues was $800,000 and $961,000 for the sixmonths ended June 30, 2003 and 2002, respectively, representing 72% and67% of hardware revenues for each respective period. The decrease in dollaramount for the cost of hardware revenues was due primarily to the decrease ofhardware unit sales accompanying the Company’s products. The gross marginpercentage for hardware sales was 28% and 33% for each of the six month periodsended June 30, 2003 and 2002 which represents a change in the mix ofhardware products sold and a $20,000 reserve for potentially obsolete inventoryin the second quarter of 2003.

 

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*Service and Other.*  Cost of service and other revenues was $1.6 million for each ofthe six month periods ended June 30, 2003 and 2002, respectively,representing 50% and 43% of service and other revenues for each respective period.  The gross margin percentage for service andother revenues decreased to 50% for the six months ended June 30, 2003,compared to 57% in the same period in 2002. The decrease in gross margin percentage was due primarily to thedecrease in service and other revenue while the infrastructure cost remainedrelatively flat in the first six months of 2003 as compared to the first sixmonths of 2002.

 

*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses were $2.7 million and$3.5 million for the six months ended June 30, 2003 and 2002,respectively, or 42% and 49% of total revenues for each respective period.  The decrease in dollar amount was due to adecrease in the number of sales personnel and their associated costs, theabsence of severance related expenses incurred in 2002 and a decrease inadvertising expenses during the first two quarters of 2003.  The Company expects sales and marketingexpenses to remain consistent in absolute dollars.

 

*Research and Development.* Research anddevelopment expenses were $1.2 million for the six months ended June 30,2003 and $1.7 million for the six months ended June 30, 2002, representing19% and 23% of total revenues for each respective period.  The decrease in the expense and in theexpense as a percent of total revenues was due to a decrease in the number ofresearch and development personnel, the absence of severance related expensesincurred in 2002 and a decrease in consulting expenses.  The Company expects research and developmentexpenses to remain consistent in absolute dollars.

 

*General andAdministrative.* General and administrative expenses were $1.6 million and $2.7 millionfor the six months ended June 30, 2003 and 2002, respectively, or 25% and37% of total revenues for each period. The decrease in dollar amount and as apercent of total revenues is due a decrease in the number of general andadministrative personnel and overhead costs associated with supporting suchpersonnel, a decrease in management consulting expenses and a decrease in statesales tax accruals.  The Company expectsgeneral and administrative expenses to remain consistent in absolute dollars.

 

*Interest and other Income, net.*  Interest and other income, net consistsprincipally of interest income earned on cash balances.  Interest and other income, net was $53,000for the six months ended June 30, 2003 and $98,000 for the six monthsended June 30, 2002.  The decreaseis due to changes in principal balances of the Company’s investments combined witha currency exchange loss that was recognized during the second quarter of 2003.

 

*TaxProvision*.   Duringthe six months ended June 30, 2003, the Company recorded a $155,398 taxbenefit which resulted from a tax refund that its United Kingdom subsidiaryreceived during the first quarter of 2003. This subsidiary had incurred a loss for the fiscal year endedDecember 31, 1999 which resulted in an income tax benefit.  The tax benefit was carried back to prioryears’ taxes paid and resulted in a tax refund.  Because the subsidiary was undergoing an Inland Revenue audit fortax year 1999, the realizability of this refund was not certain and thereforethe Company did not record the benefit on its books until the audit was clearedand the cash was received, both of which occurred in the first quarter of 2003.

 

The Company recorded a provision of $1.2million against the valuation of its net deferred tax asset in the six monthsended June 30, 2002. See also Note 3. Income Taxes of the Notes to theConsolidated Financial Statements for more information.

 

### **Liquidityand Capital Resources**

### ** **

Since 1996, the Company has financed itsoperations primarily through cash flow from operations, the private sales ofpreferred stock and the Company’s initial public offering of Common Stockcompleted in August 1997. At June 30, 2003, the Company had cash andcash equivalents of $8.4 million and working capital of $3.3 million.

 

The Company’s operating activities used cashof $1.3 million and $1.9 million for the six months ended June 30, 2003and 2002, respectively. Net cash used during the six months ended June 30,2003 consisted primarily of a net loss from operations and decreases indeferred revenue; accrued sales tax and accounts receivable reserve offset bydepreciation and amortization; and a decrease to accounts receivable, prepaidsand other current assets.  The decreasein deferred revenue is due primarily to the recognition of previously deferredrevenue during the first six months of 2003. The decrease to accrued sales tax is due to payments made to variousstates in the first two quarters of 2003 for sales taxes due.  The decrease to the accounts receivablereserve is due primarily to the collection of certain accounts for whichmanagement had previously specifically reserved.  The decline in the accounts receivable balance is a function ofdecreased sales activities as well as continued efforts by management tocontinue to improve its working capital by expediting the collection ofaccounts receivable.  Net cash used 

 

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during the six months endedJune 30, 2002 resulted from a net loss from operations and a decrease indeferred revenues and accounts payable offset by the deferred tax change,depreciation and amortization,  a decreasein accounts receivable and an increase in accrued liabilities. In anticipationof continuing economic softness, the Company anticipates that it may useapproximately $2 million of cash and cash equivalents during the remainder of2003.

 

Investing activities provided cash of $1.4million and $1.1 million during the six months ended June 30, 2003 and2002, respectively.  During the sixmonths ended June 30, 2003, the principal uses were purchases of propertyand equipment and short-term investments, offset by proceeds from the sale ofshort-term investments.  The Company’sinvestments are professionally managed and the Company has instructed itsbroker to earn the highest interest rate possible for very low-risk securities.  The Company’s broker primarily purchasescash equivalent securities but may, on occasion, purchase short-terminvestments.  Property and equipmentpurchases were predominately of computer related software and hardwareproducts.

 

Financing activities provided cash of $2,600and $5,500 for the six months ended June 30, 2003 and 2002, respectively,largely from the issuance of common stock pursuant to the Company’s employeestock purchase program.

 

The Company has experienced decliningrevenues and operating losses over an extended period of time.  Based upon the current economic environment,general softness in information technology spending, the release of new andemerging products that may not achieve market acceptance, and shortenedforecasting visibility, the Company cannot estimate that the financial andoperating performance, financial position or cash flow will improve over thenext twelve months.  Subject to thefactors contained herein, the Company believes that it has sufficient liquidityand cash available to meet the operating needs of the Company for at least thenext twelve months.  There can be noassurance that any necessary additional financing will be available to theCompany on commercially reasonable terms, or at all.

 

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The following table represents the approximateamounts of payments due under specified contractual obligations as ofJune 30, 2003:

 

|                         |   | **Less than  one year** |       | **One to  three years** |       | **Three to  five years** |       | **More than  Five years** |       |
|------------------------------|--------|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------|------------|
|                         |   |                    | ** ** |                    | ** ** |                     | ** ** |                      | ** ** |
| Operating  lease obligations |   | $                       | 215,000    |                    | $          | 624,000                  |       | —                    |       | — |   |
| Total  obligations           |   | $                       | 215,000    |                    | $          | 624,000                  |       | —                    |       | — |   |

 

Operating lease requirements consist mainlyof lease payments for the Company’s offices in Salem, NH and London, England.As of June 30, 2003, the Company did not have any long-term debtobligations, material commitments for capital expenditures, capital leaseobligations, or other long-term liabilities for which payments are required.

 

**Recently Issued Accounting Standards**

 

InNovember 2002, the FASB Emerging Issues Task Force released Issue No.00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables* (“EITF 00-21”).EITF 00-21 addresses certain aspects of the accounting by a vendor forarrangements under which it will perform multiple revenue-generatingactivities. EITF 00-21 establishes three principles: (a) revenue arrangementswith multiple deliverables should be divided into separate units of accounting;(b) arrangement consideration should be allocated among the separate units ofaccounting based on their relative fair values; and (c) revenue recognitioncriteria should be considered separately for separate units of accounting. EITF00-21 is effective for all arrangements entered into in fiscal periodsbeginning after June 15, 2003, with early adoption permitted. The Companyis currently reviewing and evaluating the scope of EITF 00-21, but does notexpect the adoption of EITF 00-21 will have a material impact on the Company’sfinancial statements.

 

**CertainFactors Affecting Future Operating Results**

 

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

 

Informationprovided by the Company from time to time including statements in thisForm 10-Q which are not historical facts are so-called “forward-lookingstatements” that involve risks and uncertainties, made pursuant to the safeharbor provisions of the Private Securities Litigation Reform Act of 1995. Inparticular, statements contained in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations which are not historical facts(including, but not limited to, statements concerning:  the plans and objectives of management;expectations for sales and marketing, research and development and general andadministrative expenses; developments relating to the Company’s product andservice offerings, markets and acquisitions; anticipated trends in theCompany’s business; the Company’s strategic alliances; changes in theregulatory environment; the Company’s expected liquidity and capital resourcesand the Company’s critical accounting policies) may constitute forward-lookingstatements. These forward-looking statements are neither promises nor guarantees,but are subject to risk and uncertainties that could cause actual results todiffer materially from the expectations set forth in the forward-lookingstatements. Factors that may cause such differences include, but are notlimited to, the factors discussed below, and the other risk discussed from timeto time in the Company’s other filings with the Securities and ExchangeCommission.

 

*Future OperatingResults Uncertain.* The Company incorporated and shipped its initial facsimile softwareproducts in 1991.  In the years endingDecember 31, 2000, 2001, 2002 and the six months ending June 30,2003, the Company had operating losses and decreasing revenues. There can be noassurance that the Company will be able to increase its level of revenues orreturn to profitability in the future as the Company’s operating history makesthe prediction of future operating results difficult or impossible.  Increases in operating expenses may continueand, together with pricing pressures and a continued decline in the growth rateof the overall U.S. economy, may result in a continued decrease in operatingincome and operating margin percentage. The Company’s ability to improve its operating results will depend upon,among other things, its ability to increase sales of the Company’s securebusiness-to-business electronic document exchange solutions and client/serverfacsimile solutions to new customers as well as increased product penetrationinto existing customers.  The Companycommenced its strategic expansion into secure business-to-business electronicdocument exchange solutions market in the fourth quarter of 2000, and haslimited financial and operating data and a limited operating history relevantto these solutions.

 

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Accordingly, it is difficult to evaluate the prospects for the level ofacceptance of the Company’s secure business-to-business electronic documentexchange solutions. Future operating results will depend on many other factors,including, without limitation, the degree and rate of growth of the markets inwhich the Company competes, the level of acceptance of the Windows NT, Windows2000 and Windows XP operating systems, the level of product and pricecompetition, the ability of the Company to establish strategic relationshipsand develop and market new and enhanced products and to control costs, theability of the Company to expand its direct sales force and indirectdistribution channels both domestically and internationally and the ability ofthe Company to attract and retain key personnel. As a result, it is possiblethat in the future the Company’s operating results will be below theexpectations of public market analysts and investors.  In such event, the price of the Company’s common stock wouldlikely be materially adversely affected.

 

*ProductConcentration.* To date, much of the Company’s revenues have been attributable tolicenses of the Company’s facsimile-based enterprise solutions and relatedproducts and services. The Company expects such products and related servicesto continue to account for much of the Company’s future revenues. However,recently the amount of revenues attributable to the licenses of such productshas declined and there can be no assurances that such decline will not continue.Furthermore, in September 2000, the Company changed its strategic focus tothe development of secure business-to-business electronic document exchangesolutions. The Company introduced its secure business-to-business electronicdocument exchange products, Genidocs and Genifax, to the market in the fourthquarter of 2000 and it introduced its proprietary document and routingsoftware, Accuroute, in the second quarter of 2002.  To date, the Company has not recognized a significant amount ofrevenues from its Genidocs and Accuroute products. The Company expects that itsGenidocs and Accuroute products may account for an increasing portion of futurerevenues however, there can be no assurances that these products will befinancially successful or result in any significant revenues. Factors adverselyaffecting the pricing of or demand for such products, such as competition ortechnological change, could have a material adverse effect on the Company’sbusiness, financial condition and results of operations. The Company’sprospects must be considered in light of the risks and difficulties frequentlyencountered by companies dependent upon operating revenues from a new productline in an emerging and rapidly evolving market.

 

*New Products andTechnological Change.* The markets for the Company’s products are relatively new and arecharacterized by rapid technological change, evolving industry standards,changes in end-user requirements and frequent new product introductions andenhancements. The Company’s future success will depend upon its ability toenhance its current products and to develop and introduce new products thatkeep pace with technological developments and respond to evolving end-userrequirements. There can be no assurance that the Company will be successful indeveloping and marketing new products or product enhancements on a timelybasis, or that new products or product enhancements developed by the Company,such as the Genidocs, Genifax and Accuroute products will achieve marketacceptance. The introduction of products embodying new technologies and theemergence of new industry standards could render the Company’s existingproducts obsolete and unmarketable. From time to time, the Company and itscompetitors may announce new products, capabilities or technologies that havethe potential to replace or shorten the life cycle of the Company’s existingproduct offerings. There can be no assurance that announcements of new productofferings by the Company or its competitors will not cause customers to defer orforego the licensing of the Company’s existing or planned products and have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

*The Market Risks forSecure Business-to-Business Electronic Document Exchange Solutions.*  The market for Genidocs, the Company’ssecure business-to-business electronic document exchange solution is new andevolving rapidly. The Company’s success will depend upon the adoption and useby current and potential customers of secure business-to-business electronicdocument exchange solutions. The Company’s success will also depend uponacceptance of its technology as the standard for providing these solutions. Theadoption and use of the Company’s secure business-to-business electronic documentexchange solution will involve changes in the manner in which businesses havetraditionally exchanged information. The Company’s ability to influence usageof its secure business-to-business electronic document exchange solution bycustomers is limited. The Company intends to spend considerable resourceseducating potential customers about the value of secure business-to-businesselectronic document exchange solutions. It is difficult to assess, or topredict with any assurance, the present and future size of the potential marketfor the Company’s secure business-to-business electronic document exchangesolution, or its growth rate, if any. Moreover, the Company cannot predictwhether the Company’s secure business-to-business electronic document exchangesolution will achieve any market acceptance. Any future products or futureproduct enhancements that are not favorably received by customers may not beprofitable and, furthermore, could damage the Company’s reputation or brandname.

 

*Dependence on Genifaxand Fax Sr. NT Product Lines and the Windows NT/2000 Environment.*  The Company currently derives a significantportion of its revenues from licenses of the Genifax and Fax Sr. NTproducts and related services and 

 

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resale of related hardware. Continued market acceptance of the Genifaxand Fax Sr. NT products are critical to the Company’s future success. As aresult, any decline in demand for or failure to maintain broad marketacceptance of the Genifax and Fax Sr. NT product lines as a result ofcompetition, technological change or otherwise, would have a material adverseeffect on the Company’s business, financial condition and results ofoperations. The Company’s future financial performance will depend in largepart on new and enhanced versions of the Genifax product and customeracceptance of the Fax Sr. NT product. There can be no assurance that theCompany will continue to be successful in marketing the Genifax andFax Sr. NT products or any new or enhanced versions of the Genifaxproduct. In addition, there can be no assurance that the Windows NT operatingsystem will not be replaced by a new or enhanced operating system. There can beno assurance that the Company will be successful in developing products for newor enhanced operating systems such as Windows 2000 or Windows XP, or that suchsystems will not obviate the need for the Company’s products. If any new orenhanced operating system gains widespread use and the Company fails to developand provide its products for this operating system on a timely basis, theCompany’s business, financial condition and results of operations would bematerially adversely affected.

 

*Dependence onClient/Server Environment.*  The Company’s enterprise, client/server facsimile softwareproducts are intended to help organizations efficiently manage their facsimilecommunications, utilizing a client/server computing environment. Theclient/server market is relatively new and there can be no assurance thatorganizations will move away from the use of stand-alone fax machines orcontinue to adopt client/server environments, or that customers of the Companythat have begun the migration to a client/server environment will broadlyimplement this model of computing. The Company’s future financial performancewill depend in large part on continued growth in the market for client/serverapplications, which in turn will depend in part on the growth in the number oforganizations implementing client/server computing environments. There can beno assurance that these markets will continue to grow or that the Company willbe able to respond effectively to the evolving requirements of these markets.If the market for client/server application products and services does not growin the future, grows more slowly than the Company anticipates, or if theCompany fails to respond effectively to evolving requirements of this market,the Company’s business, financial condition and results of operations would bematerially adversely affected.

 

*Risks Associatedwith Listing on the Nasdaq SmallCap Market*.  In August 2002, the Nasdaq NationalMarket (“Nasdaq”) informed the Company that its common stock had traded for 30consecutive trading days below the minimum bid price and that the Company haduntil November 4, 2002, to demonstrate compliance with Nasdaq’s listingrequirements by maintaining a bid price for its common stock of at least $1.00for a minimum of ten consecutive trading days. The Company did not regain compliance and on October 29, 2002, theCompany applied to transfer from the Nasdaq National Market to the NasdaqSmallCap Market. On November 26, 2002, the Company transferred to theNasdaq SmallCap Market and it was afforded the remainder of this market’s 180calendar day grace period, or until February 3, 2003, to regain compliancewith the minimum bid price per share requirement. On January 14, 2003,Omtool’s Board of Directors voted a one-for-seven stock split of the Company’sCommon Stock effective January 15, 2003 pursuant to a special meeting ofstockholders that was held on the same day approving an amendment to theCompany’s Amended and Restated Certificate of Incorporation of the Company toeffect a reverse stock split.  OnFebruary 5, 2003, the Company was notified by Nasdaq that it had regainedcompliance.  The Company cannot predictthe impact, if any, of a change in listing to the SmallCap Market. In addition,the Company cannot predict the continuance of its listing status in the futureincluding the possibility of delisting from the Nasdaq SmallCap Market.  The delisting of the Company’s common stockfrom Nasdaq may materially impair the stockholder’s ability to buy and sellshares of the Company’s common stock and could have an adverse effect on themarket price of, and the efficiency of the trading market for, the Company’scommon stock.  Furthermore, thedelisting of the Company’s common stock could significantly impair theCompany’s ability to raise capital should it desire to do so in the future.

 

*Intense Competition.*  The secure business-to-business electronicdocument exchange solution and enterprise, client/server facsimile solutionmarkets are intensely competitive and rapidly changing and the Company expectscompetition to continue to increase. The Company believes its ability tocompete successfully depends upon a number of factors both within and beyondits control, including product performance; reliability and features; productadoption; ease of use; product scalability; quality of support services;price/performance; timeliness of enhancements and new product releases by theCompany and its competitors; the emergence of new computer-based facsimile andsecure business-to-business electronic document exchange solutions andstandards; name recognition; the establishment of strategic alliances withindustry leaders and industry and general economic trends.

 

The Companymay not be able to compete successfully against current and future competitorsin the secure business-to-business electronic document exchange solutionsmarket, and the competitive pressures the Company faces could harm its businessand prospects. In the intensely competitive and rapidly changingbusiness-to-business secure document exchange market, the Company competesdirectly with Authentica, Sigaba, Tumbleweed, and Zixit and a number of otherproviders.  There are also 

 

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other categories of technologysolution that overlap and compete in certain ways with aspects of the Company’sproducts.  These include:

 

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

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

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

 

The Company expects the competition in thebusiness-to-business secure document exchange market to increase over time.

 

The Companycompetes directly with a large number of vendors of facsimile products,including providers of facsimile software products for client/server networkssuch as RightFAX (a subsidiary of Captaris), Fenestrae, TopCall Internationaland Biscom. The Company also competes with providers offering a range ofalternative facsimile solutions including outsourcing network facsimilesolutions, such as Easylink Services; operating systems containing facsimileand document e-mail features; low-end fax modem products; providers of desktopfax software; single-platform facsimile software products; and customizedproprietary software solutions. In addition, providers of operating systems orbusiness software applications may bundle competitive facsimile solutions aspart of their broader product offerings.

 

Many of the Company’s competitors and potential competitors have longeroperating histories and greater financial, technical, sales, marketing andother resources, as well as greater name recognition and market acceptance oftheir products and technologies than the Company. In addition, there arerelatively low barriers to entry in the markets in which the Company operatesand intends to operate, and new competition may arise either from expansion byestablished companies or from new emerging companies or from resellers of theCompany’s products. There can be no assurance that current or potentialcompetitors of the Company will not develop products comparable or superior—interms of price and performance features—to those developed by the Company,adapt more quickly than the Company to new or emerging technologies and changesin market opportunities or customer requirements, establish alliances withindustry leaders, or take advantage of acquisition opportunities more readilythan the Company. In addition, no assurance can be given that the Company willnot be required to make substantial additional investments in connection withits research, development, engineering, marketing, sales and customer serviceefforts in order to meet any competitive threat, or that such requiredinvestments will not have a material adverse effect on operating margins.  Changes in government laws and regulationsmay also affect our ability to maintain competitiveness.  Increased competition may result inreduction in market share, pressure for price reductions and related reductionsin gross margins, any of which could materially adversely affect the Company’sability to achieve its financial and business goals. There can be no assurancethat in the future the Company will be able to successfully compete against currentand future competitors.

 

*Fluctuations inQuarterly Results of Operations; Seasonality.*  The Company’s quarterly revenues and resultsof operations have fluctuated significantly in the past and will likelyfluctuate significantly in the future. Causes of such fluctuations haveincluded and may include, among others, the demand for the Company’s productsand services; the size and timing of orders; the number, timing andsignificance of new product announcements by the Company and its competitors;the ability of the Company to develop, introduce, market and ship new andenhanced versions of the Company’s current and planned products on a timelybasis; the level of product and price competition; changes in operatingexpenses; changes in average selling prices and mix of the Company’s products;changes in the Company’s sales incentive strategy; the mix of direct andindirect sales, and general economic factors, including a continued decline inthe growth rate of the overall U.S. economy. In addition, the sale of theCompany’s products often involves delays because customers tend to implementthe products on a large scale and they also must establish certain minimumhardware capabilities. The Company’s products therefore often have a lengthysales cycle while the customer evaluates and receives approvals for thepurchase of the Company’s products. During such sales cycles, the Company mayexpend substantial funds and management efforts yet receive no revenues. It isdifficult to accurately predict the sales cycle of any large order. If one ormore large orders fail to close as forecasted in a fiscal quarter, theCompany’s revenues and operating results for such quarter could be materiallyadversely affected. Any one or more of these or other factors could have amaterial adverse effect on the Company’s business, financial condition andresults of operations. The potential occurrence of any one or more of thesefactors makes the prediction of revenues and results of operations on aquarterly basis difficult and performance forecasts derived from suchpredictions unreliable.

 

In general, revenues are difficult to forecast because the market forsecure business-to-business electronic document exchange, enterpriseclient/server facsimile solutions software and routing and distributionsoftware is evolving rapidly and the 

 

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Company’s sales cycle—from thecustomer’s initial evaluation through purchase of licenses and the relatedsupport services—varies substantially from customer to customer. License feerevenues in any quarter depend on orders received and shipped in that quarterwith an increasing percentage of orders in any quarter being received in thelast weeks of the quarter.  License feerevenues from quarter to quarter are difficult to forecast, as no significantorder backlog exists at the end of any quarter because the Company’s productstypically are shipped upon receipt of customers’ orders.

 

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

 

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

 

*Expansion ofIndirect Channels; Potential for Channel Conflict; Strategic Alliances.*  The Company markets its products andservices directly through telesales and indirectly through marketing channelssuch as VARs, systems integrators, distributors and strategic businesspartners. Although the Company has historically focused its efforts onmarketing through its sales force, the Company is increasing resourcesdedicated to developing and expanding indirect marketing channels. There can beno assurance that the Company will be able to attract and retain a sufficientnumber of qualified VARs, systems integrators, distributors and strategicbusiness partners to successfully market the Company’s products. In addition,there can be no assurance that the Company’s resellers and strategic businesspartners will not develop, acquire or market computer-based facsimile productsthat are competitive with the Company’s products. The failure to retain itsVARs, systems integrators, distributors and strategic partners could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

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

 

Selling through indirect channels may limit the Company’s contacts withits customers.  As a result, theCompany’s ability to accurately forecast sales, evaluate customer satisfactionand recognize emerging customer requirements may be hindered. The Company’sstrategy of marketing its products directly to end-users and indirectly throughVARs, systems integrators and distributors may result in distribution channelconflicts. The Company’s direct sales efforts may compete with those of itsindirect channels and, to the extent different resellers target the samecustomers, resellers may also come into conflict with each other. As theCompany strives to expand its indirect distribution channels, there can be noassurance that emerging channel conflicts will not materially adversely affectits relationships with existing VARs, systems integrators or distributors oradversely affect its ability to attract new VARs, systems integrators anddistributors.

 

*Risks Associatedwith Acquisitions.* The Company may augment its internal growth with acquisitions ofbusinesses, products and technologies that could complement or expand theCompany’s business. Certain of these businesses may be marginally profitable orunprofitable. In order to achieve anticipated benefits from these acquisitions,the Company must successfully integrate the acquired businesses with itsexisting operations and no assurance can be given that the Company will besuccessful in this regard. The Company has limited experience in integratingacquired companies into its operations, in expanding the scope of operations ofrequired businesses, in managing geographically dispersed operations and inoperating internationally. In the past the Company has incurred one-time costsand expenses in connection with acquisitions and it is likely that similarone-time costs and expenses would be incurred in connection with futureacquisitions.  In addition, attractiveacquisitions are difficult to identify and complete for a number of reasons,including competition among prospective buyers and the possible need to obtainregulatory approval. There can be no assurance that the Company will be able tocomplete 

 

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future acquisitions. In order to finance such acquisitions, it may benecessary for the Company to raise additional funds either through public orprivate financings, including bank borrowings. Any financing, if available at all, may be on terms which are notfavorable to the Company.  The Companymay also issue shares of its common stock to acquire such businesses, which maydilute the Company’s existing stockholders.

 

*Ability to ManageGrowth.*  TheCompany may expand its operations and anticipates that expansion may berequired in order to address potential market opportunities. The Company may increasethe size of its sales and marketing and research and development expendituresas necessary. There can be no assurance that such expansion would be completedsuccessfully or that it would generate sufficient revenues to cover theCompany’s expenses. The Company will need to continue to attract and retainhighly qualified technical, sales and managerial personnel. There can be noassurance that the Company will be able to retain or continue to hire suchpersonnel in the future. The inability of the Company to effectively expandoperations and manage growth, if any, could have a material adverse effect onthe Company’s business, financial condition and results of operations.

 

*Risks Associated with the Use of Arthur Andersen asIndependent Auditors. *Arthur Andersen LLP (“Andersen”), the Company’sformer independent public accountants that audited the Company’s financialstatements until June 28, 2002, was found guilty by a jury onJune 15, 2002 of federal obstruction of justice in connection with the government’sinvestigation of Enron Corporation. Andersen ceased practicing before the SEC effective August 31,2002.  Although the Company has noreason to believe that those financial statements are incorrect, it is possiblethat events arising out of the indictment may adversely affect Andersen’sability to satisfy any claims arising from its provision of auditing and otherservices to the Company, including claims that may arise out of Andersen’saudit of the Company’s financial statements. The SEC has indicated that it will continue accepting financialstatements audited or reviewed by Andersen provided that the Company complywith the applicable rules and orders issued by the SEC in March 2002 forsuch purpose.

* *

*Risks Associatedwith International Expansion.*  An element of the Company’s strategy is tocontinue to maintain its international sales. The Company expects to facecompetition from secure business-to-business electronic document exchangesolutions and local facsimile product providers in their native countries. Tosuccessfully maintain international sales, the Company needs to recruit andretain additional international resellers and distributors. There can be noassurance that the Company will be able to maintain international sales of itsproducts or that the Company’s international distribution channels will be ableto adequately market, service and support the Company’s products. Internationaloperations generally are subject to certain risks, including dependence onindependent resellers, fluctuations in foreign currency exchange rates,compliance with foreign regulatory and market requirements, variability offoreign economic conditions and changing restrictions imposed by United Statesexport laws. Additional risks inherent in the Company’s international businessactivities generally include unexpected changes in regulatory requirements,tariffs and other trade barriers, costs of localizing products for foreigncountries, lack of acceptance of localized products in foreign countries,longer accounts receivable payment cycles, difficulties in managinginternational operations, difficulties in enforcing intellectual propertyrights and the burdens of complying with a wide variety of foreign laws.  The Company has a sales office outside ofthe United States, such operations are subject to certain additional risks,including difficulties in staffing and managing such operations and potentiallyadverse tax consequences including restrictions on the repatriation ofearnings. There can be no assurance that such factors will not have a materialadverse effect on the Company’s future international sales and, consequently,the Company’s business, financial condition and results of operations. To date,a majority of the Company’s sales have been made in United States dollars andthe Company has not engaged in any hedging transactions through the purchase ofderivative securities or otherwise.

 

*Dependence on KeyPersonnel.*  TheCompany’s future performance depends, in significant part, upon the continuedservice of its key technical, sales and senior management personnel, most ofwho are not bound by an employment agreement or by a noncompetition agreement.The loss of the services of one or more of the Company’s executive officers orother key employees could have a material adverse effect on the Company’sbusiness, financial condition and results of operations. The Company’s futuresuccess also depends on its continuing ability to attract and retain highlyqualified technical, sales and managerial personnel. Competition for suchpersonnel is intense, and the Company has experienced difficulty in recruitingqualified technical personnel. There can be no assurance that the Company willbe able to retain or continue to hire key technical, sales and managerial personnelin the future.

 

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Item 3.Quantitative and Qualitative Disclosures About Market Risk

 

**DerivativeFinancial Instruments, Other Financial Instruments, and Derivative CommodityInstruments**

 

As of June 30, 2003, the Company did notparticipate in any derivative financial instruments or other financial andcommodity instruments for which fair value disclosure would be required underSFAS No. 107,*Disclosures about Fair Value of Financial Instruments*. Allof the Company’s investments consist of money market funds and commercial paperthat are carried on the Company’s books at amortized cost, which approximatesfair market value. Accordingly, the Company has no quantitative informationconcerning the market risk of participating in such investments.

 

**PrimaryMarket Risk Exposures**

 

The Company’s primary market risk exposuresare in the areas of interest rate risk and foreign currency exchange rate risk.The Company’s investment portfolio of cash equivalents is subject to interestrate fluctuations, but the Company believes this risk is immaterial due to theshort-term nature of these investments. The Company’s exposure to currencyexchange rate fluctuations has been and is expected to continue to be modest dueto the fact that the operations of its United Kingdom subsidiary are almostexclusively conducted in its local currency. The United Kingdom subsidiaryoperating results are translated into U.S. dollars and consolidated forreporting purposes. The impact of currency exchange rate movements onintercompany transactions was immaterial for the quarter ended June 30,2003. Currently the Company does not engage in foreign currency hedgingactivities.

 

Item 4.Controls and Procedures

 

As of the end of the fiscal quarter (the“Evaluation Date”), the Company, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) and15d-15(b) promulgated under the Securities Exchange Act of 1934, as amended(the “Exchange Act”).  Based upon thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, the Company’s disclosure controlsand procedures are effective in ensuring that information relating to theCompany (including its consolidated subsidiaries) required to be disclosed bythe Company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, including ensuringthat such information is accumulated and communicated to the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

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

 

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**PART II: OTHER INFORMATION**

 

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

 

The annual meeting ofsecurity-holders of the Company was held on April 21, 2003.  The following nominees were re-elected asClass III Directors of the Company each to serve for a three-year term or untilhis successor is elected and qualified.

 
| **Nominee**       |   | **Total  Votes for Nominee** |   | **Total  Votes Withheld  for Nominee** |   |
|-------------------|--------|------------------------------|--------|----------------------------------------|--------|
| Robert L. Voelk   |   | 1,581,476                    |   | 10,363                                 |   |
|              |   |                         |   |                                   |   |
| Martin A. Schultz |   | 1,581,476                    |   | 10,363                                 |   |

 

The term of office forthe following directors continued after the meeting:  Richard D. Cramer (Class I), Andrew E. Lietz (Class I), Arnold E.Ditri (Class II) and William C. Styslinger, III (Class II).

 

At the same annual meeting, theStockholders ratified the appointment of PricewaterhouseCoopers LLP as theCompany’s independent auditors for the fiscal year ending December 31,2003 by the following vote:

 
| **For**   |   | **Against** |   | **Abstention** |   | **Broker Non-Votes** |   |
|-----------|--------|-------------|--------|----------------|--------|----------------------|--------|
| 1,590,878 |   | 469         |   | 492            |   | 0                    |   |

 

Item 6.                       Exhibits and Reports on Form 8-K

 

(a)                      Exhibits

 

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

 

 

(b)         Reports on Form 8-K

 

The Company did not file any reports on Form 8-K during the secondquarter of 2003; however, the Company furnished a Report onForm 8-K, dated April 21, 2003, pursuant to Item 9 thereof furnishing the results of its operationsfor the quarter ended March 31, 2003.

 

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OMTOOL, LTD.

 

Signatures

 

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

 
|                | OMTOOL, LTD. |
|---------------------|--------------|
|                |         |
|                |         |
| August 8, 2003 | By:          | /s/ Timothy P. Losik |   |
|                |         | Timothy P. Losik |
|                |         | Vice President, Chief Financial Officer, Chief Operating Officer,  Secretary and Treasurer |

 

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

 

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